First let me state a couple of points
1. I hate taxes. I am from the school of thought which defines taxation as the art of plucking the goose with the least amount of hissing. So you will never catch me arguing for higher taxes (except when there’s an externality that needs to be dealt with or bad behaviour corrected). Nevertheless, I think that what is worse than taxation is a system that allows different people to play by different rules. If taxes are levied at a 99% rate, I can live with them insofar as some people are not finding a way to game the system and end up paying only 10%.
2. I don’t really understand the oil and gas business. My knowledge of how things work there is perhaps no more than basic. So part of my reason for writing this post is to learn some more. I invite you to use the comments section under this post.
Industrial Development Act
Nigeria has something called the Industrial Development Act which was passed to encourage investment in the country. If you build a new plant or industry, you get exempted from paying taxes on it for a number of years. This is a good thing of course because if a company had a choice between investing in say Kenya and Nigeria and Kenya does not offer such incentives, then this law can easily swing things in Nigeria’s favour.
But rather than speculate, let’s quote from the law itself as amended in 2004:
1. Publication of list of pioneer industries and products and issuing of pioneer cer-
(1) Where the President is satisfied that-
(a) any industry is not being carried on in Nigeria on a scale suitable to the eco-
nomic requirements of Nigeria or at all, or there are favourable prospects of
further development in Nigeria of any industry; or
(b) it is expedient in the public interest to encourage the development or estab-
lishment of any industry in Nigeria by declaring the industry to be a pioneer
industry and any product of the industry to be a pioneer product,
That’s from Section 1 of the act. Pretty straightforward to interpret that this is something that should apply to new industries in the country i.e. something we are not currently doing but we want to or something we are doing but not enough. So we can safely conclude that a pure water manufacturing company should not be able to get pioneer status based on the letter and spirit of that law.
So far so uncontroversial. If we move down to Section 10 of the law, we see how long the pioneer status is supposed to last for:
10. Tax relief period
(1) The tax relief period of a pioneer company shall commence on the date of the
production day of the company, and subject to sections 3 (6) and of 7 (2) of this Act, the
tax relief period shall continue for three years.
(2) The tax relief period of a pioneer company may at the end of the three years be
extended by the President-
(a) for a period of one year and thereafter for another period of one year com-
mencing from the end of the first period of extension; or
(b) for one period of two years.
So the maximum period for pioneer status is 5 years. Again, nothing controversial here. Let’s skip some more legal jargon and go to Section 16 to see what exactly this pioneer status does for a company:
16. Profits exempted from income tax
(1) Subject to the provisions of subsection (2) of this section and section 17 (6) of
this Act, where in the application of Parts IX and X of the principal Act, a statement is-
sued under section 14 (4) of this Act has become final and conclusive, any profits shown
by that statement shall not form part of the assessable profits or total profits of the pion-
eer company for any year of assessment and shall be exempt from tax under the principal
(2) The Board may, in relation to any statement issued under section 14 (4) of this
Act, declare that the whole or a specified part of the profits is not in dispute, and any such
undisputed profits shall be exempt from tax under the principal Act pending the statement
becoming final and conclusive.
I highlighted the section above for emphasis. Once you have been granted pioneer status, after fulfilling the necessary conditions, you don’t pay any taxes on the profits you make in the 5 year period of the pioneer status (assuming the initial 3 years is extended). The best example of a company using this pioneer tax status is perhapsDangote Cement:
Looking at the numbers above (page 3 of the Dangote accounts) you see that rather than pay any taxes, the company actually got a tax credit as a result of the new cement plants like Obajana that it built. This is how the system works. In the case of Dangote, we know for a fact that cement production in Nigeria has increased as a result of his investments and he has built new plants that weren’t there previously.
For a quick primer on the IDA, click here (PDF).
Which brings me to the purpose of this post. Seplat was in the news recently when it raised $500m on the London and Lagos Stock Exchanges. It’s one of, if not the most, successful beneficiaries of Nigeria’s Local Content Act which has been transferring assets in the oil industry to Nigerians to allow them participate and grow their skills.
Seplat acquired 45% of 3 oil-producing assets from Shell and Agip namely OMLs 4, 31 and 41 in July 2010 when they were producing around 18,000bpd. My rudimentary knowledge of the O&G industry tells me that the difference between an OPL (where the P is for Prospecting) and an OML (where the M is for Mining) is that an OML is one that is already producing oil i.e. all the exploration and investment has been done and the oil is already coming out of the ground. In other words, buying an OML is like buying a shoe that comes with socks inside it, if you like. An OPL on the other hand has not produced any oil but it is a given that there is oil in the asset i.e. plenty of investment is required to get the oil flowing.
I’m told, reliably, that not only did Seplat buy the OMLs, it even ‘bought’ Shell staff as part of the deal. That is to say, it was handed the keys to the working asset along with people who had experience operating it. This is not to say that Seplat has not done anything since purchasing the assets – it has increased production in the fields mainly by boosting community relations which in turn has greatly reduced the piracy challenges that Shell was finding difficult to manage in those sites.
Having said all that, let’s go to page 28 of the investment prospectus the company released to investors when it was preparing for its IPO:
This is very interesting to say the least. Upon acquiring these assets, Seplat somehow obtained pioneer status on them. Think back to the spirit of the act above on how a company gets pioneer status and then apply to that a company buying working assets and simply continuing a business that was already in operation. How exactly does this work? As you can see from the extract above, the company is exempted from every possible tax it would normally be liable for.
Indeed we can see the effect in the company’s 2013 accounts (page 18):
From 2012 to 2013, profits increased by 45%. In 2012, the Nigerian government collected taxes on these assets to the tune of $95m. By 2013, these same assets that generated tax for the government had somehow become ‘pioneer’ and ended up paying a big fat zero in taxes. Zilch.
What is going on here? I have no idea, but maybe you do. It is indeed difficult to understand how an extant company that was previously paying taxes to the government somehow ‘transformed’ into a pioneer company that pays no taxes.
Tax To GDP Ratio
Why does all this matter? Well, one consequence of rebasing our GDP to $510bn is that it has exposed how little the government is collecting in taxes as a share of GDP. Indeed, the Finance Minister said it in April that this percentage – tax to GDP – declined from 22% to 12% following the rebasing:
But now with this recalculation, our revenue to GDP ratio is 12 per cent and our non-oil revenue ratio to GDP is four per cent, which means that we live worse than before.
“As you know, our revenue ratio to GDP before was 20 per cent, just about in the middle of the emerging market economy, not as good as the 22 per cent that we want to be.
“For tax revenue to GDP, we now have to redouble our efforts to get back to the 20 per cent ratio at least to where we were before,” she said.
What this means is that there is a lot more tax out there to be collected which is a no brainer given the amount of work that needs to be done in Nigeria in all spheres of our development. If you’ve been following the news recently, you will have noticed that every other day the Federal Inland Revenue Service (FIRS) is embarking on one ‘crackdown’ or the other in the name of boosting the government’s tax collection. A random example from last week was when the FIRS carried out ‘enforcement activities‘ against NICON Hotel and NICON Insurance over the companies’ failure to pay N90m it owed in taxes. In the days and months ahead, we are going to be seeing more of such ‘crackdowns’ especially because the Nigerian government has only managed one surplus in the last 13 months – everything it earns, it spends and then borrows more. The deficit – the extra the government had to borrow on top of what it earned – for the first 4 months of the year alone stood at N430bn. The tax forgone from Seplat is at least N15bn (assuming it paid the same tax for 2013 as it did in 2013).
Who pays the taxes around here? Is it the little guy who gets harassed by FIRS and has his business shut down for not paying a couple of millions? I haven’t bothered to check any of the other local content guys but I am almost certain that I will find the same arrangement there. The pioneer status is now evidently meaningless and is something that can be obtained by interpreting the laws very loosely. As I said earlier, I have no problem with anyone not paying taxes as long as the option is available to everybody and not just some connected people. Can we all be pioneers and not pay any taxes? If that’s the case, sign me up!
This is just one aspect of the byzantine laws that are so easily abused in Nigeria. There are waivers and there are concessions that have been abused in the past. All these things increase the government’s desperation for revenues and that in turn contributes to the harsh business environment of Nigeria where all sorts of government agencies turn themselves to parasites on small businesses with all sorts of taxes and levies.
But maybe this is all fine and Seplat is indeed a pioneer company? So what have I missed?
*P.S Thank you to the person who helped me with information in writing this post. You know yourself.
Someone sent me some interesting comments but wants to remain anonymous. They raise some very interesting points I missed out.
I wanted to fill you in on some areas that you may find interesting:
1. The IDA which you referred to, is actually a subsidiary legislation to the Companies Income Tax (CIT) Act. It makes several references to “The Principal Act” which it then defines as the CIT Act. So technically, the tax exemptions in the IDA only relates to companies liable to CIT, rather than Petroleum Profits Tax (PPT). Also, the powers granted to the President or Executive Council to exempt companies from tax (which is what the IDA was enacted to accomplish) is in line with Section 23(2) of the CIT Act. No such powers are given under the PPT Act.
2. So why does a company taxed under the PPT Act enjoy Pioneer Status from the IDA (a CITA subsidiary legislation)? Well strictly speaking, it shouldn’t, based on the above point. And this was the FIRS’ position on the matter until sometime last year, as far as I know. What changed? It received a directive from the Presidency that it should honour the Pioneer Certificate issued to oil and gas companies by the NIPC.
3. I must say that there are arguments that could be made for the NIPC to grant a pioneer certificate to an O&G company (I must admit they are not water tight). For instance:
- The original pioneer list provided in the IDA can be expanded by the Executive Council. The powers of the Council in the IDA has been granted to NIPC (See Sections 22 and 23 of the NIPC Act).
- The NIPC a long time ago (nobody knows exactly when) expanded the pioneer list to include “Mineral Oil Prospecting and Production” and “Petroleum” as pioneer industry and pioneer product respectively. You can find a full list on the NIPC website.
- The presidential directive may have legislative backing. Section 51(1) of the FIRS Establishment Act subjects the FIRS to the general direction of the Minister of Finance. The provisions of this Act takes precedence over those of the PPTA (which has no provisions of tax exemption powers, like I mentioned in 1 above).
- A Pioneer Status Incentive (PSI) Regulation was issued in January 2014 by the NIPC. It provides that an applicant must have incurred a capital expenditure of N10million (small change abi?).
4. You missed out on something interesting, which adds to the question on how an extant company suddenly becomes a pioneer one. The PSI Regulation also provides that an application must be submitted within one year of the applicant’s commencement of commercial production. The IDA (Section 6(1)) also has something similar. You would think that this should fall within a commencement years of the business. However, the NIPC, in practice, gives a discretionary waiver of the timeline for this application. Therefore, whenever you apply, you may get it. And the tax relief period will commence on the date of the Production Day certified by the Federal Ministry of Industry, Trade and Investment.
5. From what I know, Seplat was one of the O&G companies to obtain pioneer status only recently. A few others have obtained same in the past. I know one that has even come out of its 5 year pioneer period. Seplat most likely needed it to make their prospectus smell a lot nicer. So they joined the band wagon. I guess their case is more popular because they went public.
6. Finally, there are strong rumours that the Government is reviewing its policy on granting pioneer status to indigenous O&G companies, as it is causing a serious decline in revenue from PPT. You mentioned that Seplat’s pioneer period commenced on 1 January 2013. Isn’t it odd that it commenced last year when they only obtained the certificate this year? As you may be aware, PPT is paid in installments in advance, so it already paid a significant amount of its 2013 tax. Now they are requesting a refund. They might just be the harbinger of a policy reversal.