Understanding Capital Allowances in Upstream Petroleum Operations under the Nigeria Tax Act, 2025

Understanding Capital Allowances in Upstream Petroleum Operations under the Nigeria Tax Act, 2025

Published by Bahas Books – bahasbooks.com

The Nigeria Tax Act, 2025 provides a detailed framework on how businesses in the country can claim capital allowances—that is, tax deductions for money spent on long-term assets like buildings, machinery, and equipment. However, the section of the law that deals with upstream petroleum operations goes even further, recognizing that oil and gas exploration, drilling, and production have unique features that require special tax rules.

This portion of the law builds upon the general principles of capital allowance but customizes them to the realities of the petroleum industry—an industry characterized by heavy capital investment, long gestation periods, and complex ownership arrangements. It outlines when allowances can be claimed, defines key terms like “residue,” sets strict rules for asset disposal, and even specifies how to value and apportion assets when multiple companies are involved.

Let’s break this down in detail to understand how these provisions work and why they matter.

1. When a Company Can Claim Capital Allowance

The law first establishes that any company engaged in upstream petroleum operations is entitled to a capital allowance once it incurs qualifying capital expenditure—that is, money spent on assets like drilling rigs, pipelines, or plant equipment that are used in petroleum operations. Importantly, the allowance becomes due in the same year the expenditure is incurred. The company does not have to wait until the asset begins to generate revenue, as long as it is connected to petroleum exploration or production activities.

This rule acknowledges the long-term nature of oil and gas investments. Exploration and drilling often occur years before oil is extracted and sold, so companies are allowed to start claiming their tax deductions early to ease the financial pressure of these upfront costs.

2. The 1% Notional Value Rule

The Act then introduces a bookkeeping requirement that even after a company has claimed all possible allowances on an asset, 1% of the qualifying expenditure must still be recorded in the company’s capital allowance schedule. This figure is called a notional amount—it doesn’t affect the company’s taxes but ensures that the asset remains visible in the accounting records until it is finally disposed of.

This provision promotes transparency and accountability. By keeping an active record of every asset that has benefited from capital allowance, both the company and the tax authorities can trace the history of capital claims and prevent duplication or misuse.

3. Disposal Restrictions and Certificate of Disposal

The Act then places a restriction on how assets that have received capital allowance can be disposed of. Once an asset—say a drilling rig or petroleum facility—has been used to claim capital allowance, it cannot be sold, transferred, or otherwise disposed of without the approval of the regulatory commission. This approval is documented through a certificate of disposal.

This rule prevents companies from prematurely selling off or transferring assets that were previously used to gain tax benefits. It ensures that every disposal is properly recorded and that any tax implications, such as gains or losses, are duly captured and reported.

4. The Asset Must Be “In Use”

The Act clarifies that capital allowance is only available for assets that are actively in use by the company at the end of the accounting period. This means that a company cannot claim deductions for idle, abandoned, or unused assets.

This rule enforces the principle that capital allowance is tied to productive use, not mere ownership. A company must actually use the asset in its petroleum operations—such as drilling, pumping, or transporting crude oil—for it to qualify for the tax relief.

5. Understanding the “Residue” of Expenditure

The concept of residue is one of the most technical yet important elements of this section. The residue refers to the balance of an asset’s qualifying expenditure that has not yet been relieved through capital allowances. In essence, it is the remaining cost of the asset after accounting for all previous allowances.

For instance, if a company purchased equipment worth ₦100 million and has claimed ₦60 million in capital allowances over time, the residue stands at ₦40 million. This residue becomes crucial when determining future allowances or calculating gains or losses if the asset is sold, scrapped, or destroyed.

6. Disposal of Qualifying Capital Expenditure

Disposal is another major area the Act addresses in depth. It defines disposal broadly to cover every situation in which an asset ceases to be used for petroleum operations.

A building, structure, or permanent work is considered disposed of when the company sells the relevant interest, when a concession or lease ends, or when a leasehold interest reverts to its owner. It also counts as a disposal if the asset is demolished, destroyed, or permanently abandoned.

For plant, machinery, or fixtures, disposal occurs when they are sold, discarded, or stop being used in petroleum operations. In the case of drilling assets, disposal happens when the asset is sold, replaced, or the company ceases to operate in petroleum exploration or production altogether.

The Act also includes scenarios where assets are lost or destroyed and the company receives insurance or compensation money. In such cases, the law treats those payments as though the company had sold the asset for that amount. This ensures the company’s gain or loss can still be calculated for tax purposes.

7. Valuing an Asset or Petroleum Interest

When a company disposes of an asset or an interest in a Petroleum Prospecting Licence (PPL) or Petroleum Mining Lease (PML), the Act provides clear guidance on valuation.

If the asset is sold, its value is the net sale proceeds—that is, the amount received minus reasonable selling expenses. However, if the asset isn’t sold but is otherwise disposed of (for instance, surrendered or forfeited), the tax authority determines the market value at the time of disposal. This ensures all disposals are treated fairly, even if no money changes hands.

When insurance or compensation is received instead of a sale, the same principle applies. The compensation is treated as sale proceeds. However, if that money is used to replace the asset, the law makes an adjustment:

  • If the compensation plus any scrap or residual value exceeds the cost of the new asset, the excess is taxable.

  • If it is less, the company can claim additional allowance to make up the difference.

This prevents abuse of the system and ensures that tax benefits continue only when money is reinvested into new productive assets.

8. Part Disposal and Joint Interests

The petroleum industry often involves joint ventures where several companies share ownership of a single asset—such as pipelines or offshore rigs. The Act anticipates this reality and provides for part disposal.

In cases where only part of an asset is sold or transferred, or where several companies jointly own an asset, the law requires the tax authority to apportion costs, values, and allowances fairly among the parties. This apportionment must be done in a manner considered just and reasonable by the authority.

This rule prevents disputes and ensures each party’s tax position reflects its actual stake in the asset.

9. The Principle of Apportionment

Finally, the law establishes apportionment as a guiding principle for all references to disposal, sale, or purchase of assets. Whether an asset is sold entirely or partially, and whether ownership is divided among several companies or individuals, the capital allowance system must reflect the true economic position.

The Act ensures that tax deductions and liabilities are shared equitably, based on the facts and circumstances of each case. This is especially important in the oil and gas industry, where assets are often co-owned by multiple entities under joint operating agreements.

Conclusion

The provisions of the Nigeria Tax Act, 2025 dealing with capital allowances in upstream petroleum operations demonstrate a deep understanding of the complexities of the oil and gas sector. The law ensures that tax relief aligns with genuine investment and use, that assets are carefully tracked, and that fairness governs both joint operations and disposals.

By setting out detailed rules for valuation, disposal, and apportionment, the Act promotes transparency, accountability, and fiscal discipline in one of Nigeria’s most strategic industries. It gives oil and gas companies the relief they need to invest while ensuring that the government maintains oversight and prevents tax abuse.

For anyone studying taxation, oil and gas accounting, or the Nigerian fiscal framework, this section of the Act offers a comprehensive look into how tax policy supports investment while maintaining fairness and control in national revenue systems.

For more detailed guides on Nigerian taxation and business laws, visit bahasbooks.com

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