Navigating Nigeria’s Dual Tax Landscape: Capital Allowances for Petroleum and Essential VAT Compliance

Navigating Nigeria’s Dual Tax Landscape: Capital Allowances for Petroleum and Essential VAT Compliance

For businesses operating in Nigeria, especially within the complex oil and gas sector, a robust understanding of key tax legislation is paramount. This comprehensive guide from Bahas Books dissects two critical areas of the Nigerian fiscal regime: the rules governing Capital Allowances for Petroleum Operations as stipulated in the Nigeria Tax Act, 2025, and the core principles of Value Added Tax (VAT) compliance.

Part I: Capital Allowances for Petroleum Operations (Nigeria Tax Act, 2025)

The provisions for Capital Allowances under Part III of Chapter Three of the Nigeria Tax Act, 2025, create the structured framework for capital cost recovery for companies subject to the Petroleum Profits Tax and those operating under Deep Offshore and Inland Basin Production Sharing Contracts.

Foundational Concepts and Definitions

The Act begins by defining the key elements of the industry. A "concession" is broadly defined to encompass all legal rights related to petroleum, including an oil exploration license, an oil prospecting license, an oil mining lease, any right or interest in the oil in the ground, and even the option to acquire such rights. A "lease" includes any agreement for a lease where the term has commenced, any tenancy, and any agreement for letting or hiring an asset, but it explicitly excludes a mortgage and similar agreements. For continuity, a new lease granted to the same party upon the termination of an old one is treated as a continuation of the first lease, and possession after termination without a new grant is also deemed to be a continuation of the lease for tax purposes.

The central concept for cost recovery is "qualifying expenditure," which is capital expenditure incurred in an accounting period, falling into four distinct categories:

  1. Qualifying Plant Expenditure: Spending on tangible assets like plant, machinery, and fixtures.

  2. Qualifying Pipeline and Storage Expenditure: Investment in essential infrastructure such as pipelines and storage tanks.

  3. Qualifying Building Expenditure: Costs for the construction of permanent buildings, structures, or works not covered by the first two categories.

  4. Qualifying Drilling Expenditure: This is a broad category for all other capital expenditures related to petroleum operations, including the costs for acquiring petroleum deposits or rights, expenses incurred in searching for, discovering, and testing deposits, and costs for constructing works or buildings likely to have little or no residual value when the operations for which they were built cease. A critical restriction is that any amount already deductible under section 92 of the Act cannot be treated as qualifying expenditure.

The Dual System of Allowances and Rates

The Act establishes two types of allowances for qualifying capital expenditure used wholly and exclusively for petroleum operations:

  1. Petroleum Investment Allowance: This is a special allowance granted in addition to the standard capital allowance, applicable in the accounting period when the asset is first used. The rate is strategically varied to encourage offshore investment: 5% for Onshore operations, 10% for operations up to 100 metres of water depth, and 15% for operations in water depth between 100 and 200 metres.

  2. Standard Capital Allowance: This allowance is due from the period the expenditure was incurred. The rate for all four categories of qualifying expenditure is set at 20% for each of the 1st, 2nd, 3rd, 4th, and 5th years, providing a standard five-year recovery period.

A significant provision exists for Exploration expenditure: the cost of the first and second appraisal wells in the same field, related to the pre-production period, is allowed as a 100% deduction in the year incurred. Any remaining amount of this expenditure is then amortised at the 20% per annum capital allowance rate starting from the commencement of the accounting period. While a notional 1% of the qualifying expenditure must be recorded for statistical purposes, this figure does not impact the claimable allowance. Crucially, it must be noted that capital allowance for the computation of hydrocarbon tax is not available for cost recovery in production sharing contracts.

Rules for Asset Status, Disposal, and Pre-Operation Costs

The Residue of an asset is defined as the total qualifying expenditure less the total capital allowance made to date. This figure is key to the Disposal without change of ownership rule: if an asset is disposed of but the owner retains ownership, the owner is deemed to have bought the asset back immediately for a price equal to the residue at the disposal date, ensuring the allowance computation continues. Any disposal of an asset for which capital allowance has been granted requires a Certificate of Disposal issued by the Commission.

An asset is deemed "in use" even during a period of temporary disuse. If an asset is acquired for petroleum operations but not immediately used for that purpose, it is deemed to be in use from the date the expenditure was incurred. However, an allowance claimed for such an asset shall be withdrawn and added back to tax if the asset is not put to use within five years from the date the expenditure was incurred.

Disposal events are clearly defined: for permanent works, disposal occurs upon sale, expiration of interest, termination of a leasehold without the reversionary interest holder acquiring possession, or if the asset is demolished or ceases to be used. Plant, machinery, and fixtures are disposed of if sold, discarded, or cease to be used. Drilling assets are disposed of if sold, cease to be used, or when the company ceases operations and receives compensation.

The Value of an asset at disposal is its net proceeds of sale or the open market value estimated by the Service, minus selling expenses. Insurance or compensation monies are treated as net proceeds, unless they are used for the replacement of the lost asset. In the case of replacement, the allowance for the new asset is granted based on the replacement cost, factoring in the residual/scrap value of the old asset.

For pre-commencement expenditure, any qualifying expenditure incurred before a company's first accounting period is deemed to be incurred on the first day of its first accounting period. If an asset is disposed of before the first accounting period begins, any resulting loss incurred is deemed to be qualifying petroleum expenditure incurred on that first day, while any profit realised is treated as income of the company in its first accounting period.

Finally, expenditure on an ocean-going oil tanker plying between Nigeria and any other territory is excluded from qualifying expenditure. For joint interests or where qualifying and non-qualifying assets are involved, the Service shall make a just and reasonable apportionment of value.

Part II: Core Value Added Tax (VAT) Concepts

The second set of compliance information provides the essential rules governing Value Added Tax in Nigeria.

VAT Liability, Collection, and Calculation

All taxable persons engaged in taxable supplies are responsible for charging and collecting VAT, with small businesses being the exception. VAT collection methods include charging during the supply of taxable goods, being withheld at source by an appointed agent, or through a self-account system operated by the taxpayer.

VAT is categorized into two types: Input VAT, which is applicable on purchases of goods, services, or fixed assets by the business, and Output VAT, which is the VAT charged on the taxable supplies made by the business. The amount of VAT Payable to the tax authority is calculated as VAT Output minus VAT Input. When the Input VAT exceeds the Output VAT, the resulting surplus is a VAT Credit, which the company is liable to claim back.

VAT Invoice and Compliance Requirements

Compliance hinges on proper documentation, specifically the VAT Invoice. A taxable person who makes a taxable supply shall maintain a sequential invoice numbering system. A VAT Invoice must be issued on supply, whether or not payment is made at the time of supply. The invoice must contain specific information as stipulated by NTA (153), including the Supplier's tax ID, an invoice number, the name and address of the supplier, the supplier's incorporation or business registration number, the date of supply, the name of the purchaser or client, the gross amount of transaction, and the VAT charged and the rate.

This unified perspective on both Capital Allowances and VAT compliance is essential for any entity navigating the Nigerian tax environment. For expert resources and detailed financial analysis, trust bahasbooks.com.

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