FHC Overturns TAT Judgment on the Basis for Computing Balancing Charge on Petroleum Assets

Thursday, January 14, 2021 / 03:44 PM / By Wole Obayomi / Header Image Credit: Ecographics

The Federal High Court (FHC or "the Court") Lagos Division, on Monday 28 September 2020, overturned the judgment of the Tax Appeal Tribunal (TAT or "the Tribunal) in the appeal between the Federal Inland Revenue Service (FIRS or "the Appellant") and Total E&P Nigeria Limited (Total or "the Respondent") by ruling that petroleum investment allowance (PIA) should be included in the computation of balancing charge on disposal of assets used for petroleum operations.

Specifically, the FHC held that PIA granted by Paragraph 5 of the Second Schedule to the Petroleum Profit Tax Act Cap P13, Laws of the Federation of Nigeria (LFN), 2004 (as amended) (PPTA) should be added to annual allowance claimed on the assets for the purpose of computing balancing charge for disposed assets.

The Court, on the other hand, upheld the TAT's decision that tertiary education tax (TET) is not chargeable on balancing charge. It also upheld the Tribunal's decision that interest paid on intercompany loan qualifies as tax deductible expenses for petroleum profit tax (PPT) purposes, provided that the interest rate is at arm's length under terms prevailing in the open market.

Facts of the case

Total held 10% interest in Oil Mining Leases (OMLs) 4, 26, 38, 41and 42. In 2010 and 2011, Total sold its interests in OMLs 4, 38 & 41 and 2 & 42, respectively. However, in computing the balancing charges applicable to the disposal, Total split the sales proceeds between tangible and intangible assets and computed balancing charge on only the tangible assets. The tangible assets included wells, infield pipelines, flow lines, manifolds and flow stations while intangible assets comprised hydrocarbon accumulation data, right to win, work and exploit petroleum in the OML area.

The FIRS challenged the split and argued that all the assets were qualifying expenditure in line with Paragraph 1 of PPTA. The FIRS also included the related PIA on the assets in determining the allowance claimed thereon and computed additional TET on the resulting balancing charge.

Further, the FIRS disallowed the interest on loan obtained by Total from Total Finance, a related party, on the basis that Section 13(2)(c) of PPTA precluded related party loans as allowable expense for petroleum profit tax (PPT) purpose.

Total had declared dividends out of its oil and gas profits without separating the profits. The FIRS maintained that dividend declared out of the Respondent's gas profits was liable to withholding tax (WHT) since gas profits were taxable under the Companies' Income Tax Act, C21, LFN, 2004 (as amended) (CITA) and dividend paid thereon was not exempt from WHT.

Total, aggrieved with the FIRS' position, filed an appeal at the TAT. In May 2016, the Tribunal, after reviewing the issues and arguments submitted to it by both parties, held that:

i.            Interest paid on intercompany loan qualifies as deductible expenses under Section 10(1) (g) of the PPTA provided that the interest rate conforms with the arm's length principle. The interest paid by Total to Total Finance conforms with the arm's length principle and therefore qualifies as tax deductible expenses for PPT purpose.

ii.          Total was liable to pay WHT on the dividend attributable to profits from its gas income as the company failed to separate the dividend attributable to its gas income from oil income. Therefore, Total must rely on FIRS' diligence and fairness mechanism to arrive at the percentage of the dividend attributable to its gas income and compute the WHT payable thereon.

iii.         Total was not liable to include the assets purchased and disposed of in the same accounting period in the calculation of balancing charge as no capital allowance had been validly claimed in respect of the assets.

iv.        PIA and annual allowance are separate and distinct allowances. Therefore, PIA should not be added to annual allowance for the purpose of computing balancing charge under Paragraph 9 of the PPTA.

v.           Assessable profit on which TET is charged is not inclusive of balancing charge. Thus, Total was not liable to pay any additional TET.

However, the FIRS was dissatisfied with the TAT's decision, and appealed the judgement at the FHC. FHC overturns TAT judgment on the basis for computing balancing charge on petroleum assets KPMG in Nigeria January 2021.

Issues for Determination

Based on the prayers and arguments submitted by both parties, the Court formulated one main issue for determination "whether the Appellant is entitled to the reliefs sought in the appeal?". Consequently, the FHC adopted the Appellant's grounds of appeal as follows: 

• Whether the FIRS was given a fair hearing when the Tribunal raised and resolved the question "whether assets having been sold in the same year of acquisition are subject to balancing charge" in favour of the Respondent.
• Whether the TAT was right in disapproving the Appellant's addition of PIA and annual allowance of the Respondent to compute balancing charge, considering Paragraph 5(2) of the Second Schedule to the PPTA.
• Whether the TAT was right in its decision that balancing charge is not a profit of a company and therefore not liable to TET.
• Whether the TAT was right in applying Section 10(1)(g) of the PPTA in determining the deductibility of interest paid on related party loans, rather than Section 13(2).

FHC's decision

After considering the arguments of both parties, the Court held that:

i.      The TAT breached the Appellant's right to fair hearing, as provided in Section 36 of the Constitution of the Federal Republic of Nigeria, 1999 Cap. C23 LFN 2004, wherein having raised the issue of "whether assets having been sold in the same year of acquisition are subject to balancing charge" of its own accord, failed to call upon both parties to address it, before making its decision.

ii.      Based on Paragraph 5(2) of the Second Schedule to the PPTA, which provides that "petroleum investment allowance shall be added to the annual allowance computed under paragraph 6 of this Schedule and shall be subject to the same rules under this Act", the PIA should be added to annual allowance for any purpose, including when computing balancing charge for PPT purpose.

In arriving at the above decision, the FHC noted that:

• The word "shall" in the provision is a mandatory command to do exactly as the law says and entertains no discretion. Therefore, PIA is to be added to the annual allowance in computing the balancing charge.
• When there is no ambiguity, the law must be construed literally, and the words given their plain meanings.

iii.            A balancing charge is not a profit of a company and should not be included in the computation of a company's assessable profits, based on the provisions of Paragraph 9 of the Second Schedule to the PPTA, and Sections 1(1), (2) and (3) of the Tertiary Education Trust Fund (Establishment etc.) Act, (TETFEA), for TET purpose.

iv.        Interest charges on related party loans are tax deductible in line with Section 10(g) of the PPTA, provided that the rate is at arm's length under terms prevailing in the open market.

Commentaries

1. The FHC's judgment that PIA should be included in the computation of balancing charge deviates from normal practice. The implication of the ruling is that computed balancing allowance or charge will reduce and increase by the amount of the PIA, respectively. The judgment casts doubt on the long-held interpretation that PIA, which is similar to a reconstruction investment allowance in CITA, is a one-off uplift granted to companies for incurring qualifying capital expenditure (QCE) in the first year of acquisition and does not form part of the cost of the QCE to be amortised through annual allowances. Paragraphs 8 and 9 of the Second Schedule of PPTA provide for two variables to be used in determining the balancing allowance or charge on disposal of a QCE: "the residue of the QCE" and "the sales value of the QCE" at the date of disposal. Specifically, Paragraph 10 of the Second Schedule defines the residue of a QCE at any date as "the total qualifying expenditure incurred on or before that date, by the owner thereof at that date, in respect of that asset, less the total of any annual allowances due to the owner, in respect of that asset, before that date", Consequently, although the PIA is included in determining the capital allowance claimable by a company on a QCE in the first year it is put to use by the company, it is not considered in computing the residue of the QCE carried forward to subsequent tax years.

However, the judgment failed to consider whether or not the specific provision of Paragraph 10 of the Second Schedule defining the residue of QCE has overridden the general provision of Paragraph 5(2) of the same Schedule, which references the addition of PIA to annual allowances, subjecting both to the same rules under the Act.

The other issue is that the FHC did not consider the principle of "expressio unius est exclusio alterius" (the expression of one thing is the exclusion of the other), given that Paragraph 10 only mentions annual allowance. The general opinion has been that if the Act had intended for PIA to be included in the computation of residue of the QCE, it would have stated so.

It is hoped that a higher court will have the opportunity to review the judgment, if appealed, to enable us have clarity on the issue. Until then, it is certain that the judgment will continue to create disputes between taxpayers and the FIRS.

2. Further, the FHC held that balancing charge should not be included in determining the assessable profit of a company for TET purpose. In its judgment, the FHC held the view that "since Education Tax is on assessable profit which is the adjusted profit to which balancing charge is not inclusive, [Total] is not liable to pay Education Tax [on] the balancing charge".

The Judge, in arriving at this decision, reiterated the decision of the TAT that Total had paid TET on its assessable profit as provided by Section 1, Subsections 1, 2 and 3 of the TETFEA.

Specifically, Section 1(3) of the TETFEA provides that, "the assessable profit of a company shall be ascertained in the manner specified in the Companies Income Tax Act or the Petroleum Profit Tax Act as the case may be". In addition, Section 16 of the PPTA specifies that the assessable profits of any company for any accounting period shall be the amount of adjusted profit of that period after the deduction of any loss incurred by the company, whereas Section 9 (3) of the PPTA provides that, "the adjusted profits of an accounting period shall be the profits of that period after deductions allowed in section 10 of the Act and any adjustments to be made in accordance with the provisions of section 14 of the Act". Therefore, the FHC agreed with the TAT's view that balancing charge is not included in the profits of a company and therefore not liable to TET.

It appears that the FHC gave no further consideration to the implications of Paragraph 9 of the Second Schedule of the PPTA - which had also been deliberated upon by the TAT prior to arriving at its ruling. The provision of Paragraph 9 requires balancing charge to be treated as income of a company in an accounting period for the purposes of Section 9(1)(a) of the PPTA, that is, as part of proceeds of sale of all chargeable oil sold in that period. Section 9(1) seems to suggest that balancing charge be treated as part of the profits of the Company included in the computation of its adjusted profits as well as the assessable profits on which TET is to be assessed. The FHC, in failing to address this provision, passed over the opportunity to provide clarification and resolve any potential conflict in respect of the appropriate interpretation of what constitutes the profits of a company under Section 9(1) of the PPTA. It is, therefore, likely that this argument will persist between taxpayers and the FIRS until a higher court has an opportunity to review the issue.

3. The FHC, in upholding the decision of the TAT that intercompany interest on loans obtained at the prevailing market rates are tax deductible, has settled, for now, this controversy. Consequently, tax authorities should review intercompany or related loans in line with the arm's length principle before challenging its deductibility or otherwise for tax purposes.

4. Finally, it is important to note that the FHC, in deciding whether the Appellant was granted a fair hearing on the issue raised by TAT regarding "whether assets having been sold in the same year of acquisition are subject to balancing charge" did not invalidate the TAT's decision or rule on the issue. The Court simply noted that the failure of the TAT to allow representations from the Respondent on the issue violates its right to fair hearing and, on that basis, sets aside the Tribunal's decision. Therefore, the issue of computation of balancing allowance or charge on assets acquired and sold in the same year remains unresolved. Hopefully, this issue will be resolved by a higher court, if the judgement is appealed.

Credits

* This statement was first published in the Issue 1.6/ January 2021 Newsletter of KPMG of Thursday, January 14, 2021. For further enquiries, please contact the author, Wole Obayomi via ng-fmtaxenquiries@ng.kpmg.com

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