THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA Established

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA ………. . (Established by Act of Parliament No 15 of 1965)…… TAX PRACTICE SECTOR TOPIC: Petroleum Industry Legislation: Tax Issues and Challenges By ALATOYE, Folorunso Azeez, FCA Partner /Chief Operations Officer Saffron Professional Services

Objective of Presentation At the end of this session, participants should be able to: • Identify the tax regulations in the petroleum industry • Discuss the need for the reform • Recognise the changing Structure, expectations of the key stakeholders ; and • Appraise the business impact of the reform. 2

Contents • • Overview of the Nigerian Oil & Gas industry Tax Reform in the Petroleum Industry National Oil & Gas Policy The Petroleum Industry Bill (Act) The Implication of reforms on foreign investment and government revenue Opportunities and Challenges of implementing the fiscal provisions Case study Conclusion 3

Overview of the Nigerian Oil & Gas industry Oil and Gas Industry sectors: ◦ Upstream Exploration Production ◦ Midstream Refining ◦ Downstream Retail This session will focus on upstream oil and gas industry. 4

Overview of the Nigerian Oil & Gas industry ◦ 283 trillion standard cubic feet of proven gas reserves in custody {only 25 billion+ barrels of oil to become 40 b barrels by 2010}! Africa in all has 500 trillion standard cubic ft. against Europe & North America Reserve of 450 trillion standard cubic ft. ◦ 65 trillion standard cubic feet of recoverable undiscovered reserves ◦ 3 rd largest exporter of Liquefied Natural Gas (LNG) in the world ◦ 12 th largest major gas reserve country in world ◦ By 2015, Nigeria/WA to supply 1. 8 trillion scf. to U. S {1/3 rd of its import needs} ◦ The $7 billion Nigeria-Algeria (NIGAL) project planned. 4, 000 km pipeline from Nigeria to Algeria's export terminals on the Mediterranean. 5

Overview of the Nigerian Oil & Gas industry ◦ Plans to double electricity access, additional 15, 000 km transmission and 16 new power plants. ◦ Running fast to equate gas revenue to oil revenue ◦ Aggressively moving to stop gas flaring ◦ Promote local content in gas to 100% in 2010 [70% onshore, 30% offshore] ◦ 13% of current gas is being produced and used ◦ 12% is re-injected for oil enhancement [total utilization =25%] ◦ 75% flared 6

Upstream Crude Oil Fiscal Regime The Nigerian Oil Extraction activities keep on moving from one arrangement to the other while the existing arrangement continues as parallel running since 1958 to date. The current Position is as below. Nigeria Oil Fiscal Regime Concessionary / Licensing Arrangement Joint Venture Contractual Arrangement Service Contract Sole Risk Operation Marginal fields Hybrid Production Sharing Contract Condensate 7

Upstream Crude Oil Fiscal Regime Oil Sector [ Upstream Regimes] ◦ Joint Venture Cash-call challenges are moving the government away from this arrangement ◦ Sole Risk Operations Local content directives of 60%/40% [funding, revenue & tax sharing issues] ◦ Risk Service Contract No increase in the numbers of RSCs ◦ Production Sharing Contracts The New order ◦ Marginal Field operations ◦ Hybrids 8

Current Crude Oil & Gas Taxation Regimes Presently, Nigeria operates the 3 PETROLEUM ARRANGEMENTS or regimes that could be found anywhere in the world: ü Concessions (Licenses & Lease : JVs , Sole Risks) : (Countries practicing: Nigeria, USA, Canada, Norway, UK, Russia, Brazil, Algeria, Saudi Arabia (for gas only), South Africa, Pakistan, Thailand Australia) ü Production Sharing Contracts : (Countries practicing: Nigeria, Indonesia, Malaysia, India, Egypt, Gabon, Ivory Coast, Syria, Yemen and Trinidad and Tobago) ü Risk Service Contracts (Countries practicing: Nigeria, Mexico, Iran, Iraq and Kuwait). Iraq and Kuwait practices Technical Services Agreement where IOCs only Consult for them while the operate 100%. - All the regimes could result in the same Government Take(%) and Government Revenue (Undiscounted) and Discounted Revenue 9

Current Crude Oil & Gas Taxation Regimes Fiscal means all government take in cash or kind including: ü ü ü ü Bonuses (signature bonus, production bonus etc) royalties, corporate income taxes, profit oil shares, windfall profits taxes (Delayed+**loss**+loss**) property taxes, export duties, carried interest provisions, and Contractors take in ü ü Performance Fees / Bonus to Contractors RSC’s fees paid by government to the contractors Profit oil share Interest on intercompany/group funding 10

Current Crude Oil & Gas Taxation Regimes Factors driving government take: High Government Take (Max… 99%) ü development of low cost LIGHT OIL in already discovered fields Low Government Take (Min… 25%) ü ü high risk exploration projects for small target fields Offshore investments Target ü To maximise Govt revenue, Govt to maximise level of production ü To increase level of Reserves. Increase in reserves does not mean increase in Production (Venezuela has 177 billion barrels of reserve but producing 2 billion barrels per annum in 2009 from 72 billion barrels of reserve in 2004 with a production level of 3 billion) 11

Current Crude Oil & Gas Taxation Regimes Target (contd) ü Government to encourage investor to ensure maximum production at lowest cost ü Higher Government Take during high oil & gas prices to avoid windfall profits ü Increase in oil price from 2003 make governments to start adjusting their prices ü In 2009 the prices started falling. - Nigeria started reform in 2003 – National Study Group / Working Group to Oil & Gas Implementation Reform Committee leading to PIB 12

Current Crude Oil & Gas Taxation Regimes The “government take” is the share that the government receives of the divisible income as government revenues. Government take could be the same in the three arrangements: v For instance, where Govt. take is 95% Government Revenue will be US$B v Gross Revenue 1 b X $100 = 100 Less: Capital Expenditure 3. 5 Less: Operating Expenditure 4. 5 Total Cost Divisible Income Government Take 95% Contractor’s Take 5% discounted Vakue of Govt revenue US$B 8 92 87. 4 4. 6 52. 2 13

Current Crude Oil & Gas Taxation Regimes v v Under Concession US$B Gross Revenue 1 b X $100 = Less: 46% Royalty 46 Less: Costs 8 Total Cost Taxable Income 46 Government Tax 90% 41. 4 Government Take Contractor’s Take 5% discounted Vakue of Govt revenue US$B 100 87. 4 4. 6 52. 2 14

Current Crude Oil & Gas Taxation Regimes v v Under PSC US$B Gross Revenue 1 b X $100 = Less: 46% Royalty oil 46 Less: Costs 8 Total Cost Taxable Income 46 Government Tax 90% 41. 4 Government Take Contractor’s Take 5% discounted Vakue of Govt revenue Under RSC US$B Gross Revenue 1 b X $100 = Less: Costs Contractor’s further paid $4. 6 pb Government Take 5% discounted Vakue of Govt revenue US$B 100 87. 4 4. 6 52. 2 US$B 100 8 4. 6 87. 4 52. 2 15

Current Crude Oil & Gas Taxation Regimes Presently, the UPSTREAM CRUDE OIL TAXATION is being governed by: 1. The Petroleum Profits Tax Act , Cap P 13, Laws of the Federation of Nigeria, 2004 2. Deep Offshore Inland Basin Production Sharing Contract Act Cap D 3, LFN, 2004 3. Memorandum of understanding & Agreements 4. Decided Cases 5. Side Letters 16

Current Crude Oil & Gas Taxation Regimes The UPSTREAM GAS TAXATION is being governed by a hybrid of: 1. Petroleum Profits Tax Act 2. Companies Income Tax Act, Cap C 21, LFN 2004 - Gas Utilization - Downstream Sector 3. NLNG Act 1990 & 1993. The proposed PIB attempts to consolidate the taxation of the Upstream Crude Oil and upstream Gas into one Act. 17

Tax Reform in the Petroleum Industry The Nigerian Tax Reform exercise started as far back as 2003 with the works of the Study Group led by Professor Dotun Phillips. There was also the Working Group led by Mr Seyi Bickestet that was set up to review the works of the Study Group with a view to fine-tuning the recommendations of the Study Group for implementation purposes. The two groups identified the fact that many of the tax laws needed to be urgently reviewed of which Petroleum Profits Tax Act was one. 18

Tax Reform in the Petroleum Industry The 9 Tax Bills sent to National Assembly were: 1. 2. 3. 4. 5. 6. 7. 8. 9. A Bill for an Act to establish the FIRS as an autonomous Service A Bill for an Act to amend the Companies Income Tax Act A Bill for an Act to amend the Petroleum Profit Tax Act A Bill for an Act to amend the Personal Income Tax Act. A Bill for an Act to amend the Value Added Tax Act A Bill for an Act to amend the Education Tax Act. A Bill for an Act to amend the Customs, Excise tariffs, etc. (Consolidation) Act. A Bill for an Act to amend the National Sugar Development Council Act. A Bill for an Act to amend the National Automotive Council Act. As far back as 2005, we had it that the House of Representatives at its sitting of 10 th August 2005 has concluded deliberations on the general principle underlying the nine tax reform bills and referred same to its joint committees on Finance and Justice for further legislative action. In April 2007, some of the Bills were passed into law which are 1, 2, 5, and 9. No 6 has been dropped while all others including the PPTA are outstanding. 19

Tax Reform in the Petroleum Industry One would have thought that if a bill will be passed in order of importance, next to the Federal Inland Revenue Services should be the PPTA. In 2007, there were two versions of the PPTA proposed amendment. The FIRS version and the NNPC version. In 2008, the Oil & Gas Implementation Committee came up with the recommendation of the PIB materially believed to be driven by the Nigerian National Petroleum Corporation (NNPC) and in December 2008, there was the 1 st reading of the PIB Bill. In 2009, significant work was done by both the Senate and the House of Representative including the 2 nd reading that was done between March and May 2009 and the Public Hearing in July 2009. In 2010, there were committee reviews. It is believed that the currently as at today September 28 2010, the Committees are finalising their reports in preparation for the 3 rd reading by both Houses. 20

Features of The Proposed National Gas Policy 2005 Highlights of the Gas Policy include: Intro. of the Natural Gas (Fiscal Reform) Act = Gas Tax Act Introduction of the Downstream Gas Act Unbundling of NGC into: GRC (regulatory), NGTC (transmission), NGMC (marketing) Encourage exports- WA Gas Pipeline project, NLNG Future oil field approval only if specific plans for associated gas are included Penalties for Gas flaring Electricity Power Sector Reform Act (EPSRA) Tax Issues – next slide

Features of The Proposed National Gas Policy 2005 Highlights of the Tax Issues include: ◦ Gas Profits Tax (GPT) replaces PPT and CIT i. e would apply to both upstream and downstream sectors. ◦ Separate income & expenditure iro oil from gas and apply to tax separately – level playing ground for non-oil players ◦ VAT, import duties and Niger Delta Devt levy would continue to apply to Gas projects ◦ Dividend payable from gas projects would be exempt from WHT ◦ Royalty rate of 0%

Petroleum Industry Bill (Act), 2010 Petroleum Industry Bill 2010 – 10 Parts , 495 Sections, 10 Schedules. Part I: Part III Part IV Part VII*PART VIII Part IX: Part X- Fundamental Objectives Institutions Upstream Petroleum Incorporated Joint Ventures Downstream Licensing Downstream Products Indigenous Oil Companies and Nigerian Content Health, Safety and Environmental Responsibilities over the Environment FISCAL PROVISIONS (Section 414 – 477) Repeals, Transitional and Savings Provisions Interpretation and Citation *The bone of contention has been Part VIII. Meanwhile the problem of not agreeing and passing the bill is a loss of Government Take and huge uncertainty on the side of the IOCs. 23

Petroleum Industry Bill (Act), 2010 Also in 2010, the Inter Government Agency Team, IAT comprising of key ministries have come up with a draft of how PIB should look like. As it is now, it still has to pass through the concurrence of the Houses, Presidential approval and Assent. In May 2010, the Honourable Minister for Petroleum Resources was optimistic that the Bill would be passed very shortly. There is a very huge uncertainty as to whether the bill will be passed before the end of 2010 in view of the coming election in April 2011. There is also a huge uncertainty as to what is going to be the content of the Act when passed into law. In summary, with respect to the timing of the passage of the PIB, just as it has been from the inception to date, the UNCERTAINTY continues !!! 24

Implications of Delayed Passing of the Bill Between 2003 and 2009 there was increase in crude oil price and Governments with crude oil resources all over the world carried out reform to benefit from the windfall. It is by way of adjustment to the Government Take in the form of “FISCAL ADJUDSTMENT”. Currently under the JV, Nigeria takes averagely 86 – 94% which is estimated to be increasing to 96% under the proposed PIB Currently Nigeria takes averagely 61% moving to 82%. Leaving IOCs with about 18% from 39%. 25

PIB Tax Provisions – Opportunities & Challenges of Implementation - Increased royalty with change in base from water depth to production value. Rate up to 25%. - Dual tax filing for Upstream Oil operations i. e. NHT and CIT - Introduction of Dividend Withholding Tax (10%) - Introduction of ‘minimum tax’ at a percentage of gross revenue; capital allowance restriction eliminated 26

PIB Tax Provisions – Opportunities & Challenges of Implementation ▪ Stricter rules governing tax deductibility of costs ▪ Basis for taxes and royalties on production instead of actual sales ▪ Separate tax regime for the midstream sector and introduction of the ‘measurement point’ to demarcate the upstream from the midstream 27

PIB Tax Provisions – Opportunities & Challenges of Implementation 1. Commencement date ü Setting the right commencement date ü Eliminating complications ü January 1 of any year as appropriate date 2. Negotiated Terms (Section 4) Opportunity to come to a common understanding and agreement that whatever TERMS are agreed between Applicants and the Minister of Petroleum Resources will be binding on the Federal Inland Revenue Service (FIRS). 28

PIB Tax Provisions – Opportunities & Challenges of Implementation 3. A Friendly Taxation policy ( Section 6) The Federal Government shall, to the extent possible …. . promote …. a taxation policy that encourages fuel efficiency by producers and consumers (Economically viable? Certainty? ) 4. Minister of Petroleum Resources Overall Function (Section 9, 10 & 11) “The Minister in charge of petroleum resources shall be responsible for the co-ordination of the activities of the petroleum industry and shall have overall supervisory functions over petroleum operations and all the Institution of the Industry”. 29

PIB Tax Provisions – Opportunities & Challenges “The Minister shall represent the Federal Government in all transactions between Government and any other persons in respect of any matter contemplated by this Act” “The Minister may by regulations prescribe all matters which under this Act are required and necessary to give effect to this Act” Is the FIRS having the same understanding? 5. ≤ 2 % Earmarked Levy (Section 28) …. Shall be paid by every company engaged in petroleum operations……. 30

PIB Tax Provisions – Opportunities & Challenges “The exact percentage of fiscalised crude or fiscalised natural gas, as the case may be, shall be as contained in the guideline that shall be issued by the Minister on the advise by the Directorate, three months before the end of the financial year preceding the year in which the guideline will be applicable and shall be an amount not greater than 2%. . . ”. What happens if no guideline is issued at the end of the year that the guideline relates? Can Uncertain Tax Provision be (UTP) reduced? 31

PIB Tax Provisions – Opportunities & Challenges 6. Tax Deductibility of the ≤ 2 % Earmarked Levy (Section 34) “ Where contribution to the fund of the Directorate are made by a person subject to tax under the provision of any law in force in Nigeria, all such contribution shall be tax deductible” Where provisions are made and guideline was not issued, are such provisions tax deductible? 32

PIB Tax Provisions – Opportunities & Challenges 6. Tax Audit / Revenue Assurance (Section 59) Office of Auditor General of the Federation was to audit the Inspectorate. Should the Office of Auditor General of the Federation audit the books of private companies for compliance ? 7. Costs Approval (Section 114) The National Petroleum Assets Management Agency (NPAMA) shall be in charge of monitoring and approving costs in the upstream petroleum industry of Nigeria with the objective of maximizing the total revenue accruing to the government…” 33

PIB Tax Provisions – Opportunities & Challenges Costs Approval (Section 114) (Contd. ) If a cost is not cost recoverable, does it have any bearing with tax deductibility? (section 115 (g) requires the agency to liaise with the FIRS for cost deductibility) If a cost is recovered, will charging the amount as tax deductible amount to a double claim? 34

PIB Tax Provisions – Opportunities & Challenges 8. Evidencing Tax Payment (Tax Receipt) (Section 115) “ The function of the agency shall be… (f) to receive and dispose of petroleum accruing to the Federal Government which is produced under production sharing contract, consisting of TAX and Royalty OIL but not profit oil”. Will the FIRS issue Official Receipt for uncollected taxes? 35

PIB Tax Provisions – Opportunities & Challenges 9. Transfer of Assets from NOC/IOCs to IJVC / incorporated PSC Company (Section 137/ 246 / 256) Can the transfer be deemed to be a statutory or compulsory transfer with no transaction taxes – ◦ ◦ CGT, VAT, Stamp duties WHT ? Is there a need for a special application? 36

PIB Tax Provisions – Opportunities & Challenges 10. Definition Issues (Section 414) “Contract Area means the contract area as defined in the PSC” Can two or more blocks be a contract area for tax deductibility purposes ? 11. Can the Tax Treatment of condensate not Spiked? (if any) (Section 419 (1 a) be agreed) ? 37

PIB Tax Provisions – Opportunities & Challenges 12. Application of Accounting Period (Section 420) With respect to the definition of an accounting period, what would be tax treatment of pre-production operating expenses? 13. Allowable Deductions (Section 420) To be: ◦ Benchmarked (price set by the authority – S 494) ◦ Verified ◦ Approved ◦ 100% Cost incurred in Nigeria allowable / 80% of costs incurred outside Nigeria 38

PIB Tax Provisions – Opportunities & Challenges 14. Allowable Deductions (Section 420) No mention was made of Interest allowable (Section 421 (2) disallows intercompany interest chargeable). 15. Pension - Allowable Deductions (Section 420 j ) Any contribution to a pension, provident or other society, scheme or fund which may ……. be approved by the Board. What makes of Pencom Approval? 39

PIB Tax Provisions – Opportunities & Challenges 16. Regime Clarification and Applicable Tax Rates (Section 429 / 430) 50% 30% NHT (Onshore shallow water) Offshore Plus CIT Earlier proposal: 50% PSC Upstream Crude Oil 60% Indigenous company (<50 k b) 45% JV Upstream Gas 35% PSC Upstream Gas - If an indigenous co crosses to over 50, 000 barrels per day, what rate is applicable? 40

PIB Tax Provisions – Opportunities & Challenges - If a new co farm in into assets existing from more that 5 years, what rate is applicable? 17. Investment Tax Credit or Petroleum Investment Allowance (Section 431) The title and the body should align to eliminate ambiguities. 41

Some recent allegations of Petroleum Profits Tax Evasion / Case study 1 (Thisday News 21 May 2008) ◦ Yar’Adua Orders Shell, Exxon. Mobil to Refund N 236 bn – President Umaru Musa Yar’Adua has ordered the Nigerian National Petroleum Corporation (NNPC) to immediately recover outstanding payments of $1. 91 billion (N 236 billion) due to the Federal Government from Shell and Exxon. Mobil on the Production Sharing Contracts (PSCs) for the Bonga and Erha oil fields. “President Yar’Adua directed as follows: That the total sum of $1. 496 billion accruable to NNPC based on the proper application of the PSC’s capital allowance should be recovered. This sum is made up of $850 million from Bonga and $646. 3 million from Erha; “That the sum of $414. 6 million accruable to NNPC and to government from Bonga gas sales and as tax revenue from the gas sales should be recovered; and “That all future government gas sales agreements should account for Natural Gas Liquids (NGLs) to ensure that government derives maximum economic benefits from them and that this position be adopted in the renegotiation of all existing PSC agreements which are due for renegotiation, ” he said. Question: Ambiguity leading to Tax Disagreement or outright case of Tax Evasion? 42

Some recent allegations of Petroleum Profits Tax Evasion / Case study 2 (Thisday News 15 November 2006) ◦ The $500 Billion Question: Using the final tax returns submitted to the Federal Inland Revenue Service (FIRS) by Shell, Mobil, Chevron Nigeria, Nigeria Agip Oil Company (NAOC), Texaco and Elf, the Okoguled unit started by conducting a study on the margin of profit allowed to oil companies under the Memorandum of Understanding (Mo. U) based on the existing fiscal regime, a study which revealed very clearly that Nigeria was being shortchanged by the oil majors. With the report, Okonjo-Iweala thought that on her own, working with FIRS, she could arm-twist the oil companies to pay back the $340 million shortfall by the calculations done. ……………. . "Part of the incentive package granted to oil companies under the Memorandum of Understanding (MOU) in the Joint Venture agreements was a guaranteed margin of at least $2. 50 per barrel irrespective of the oil price. In addition, the companies are allowed an extra margin based on a formula that escalates the base margin when the price lies between $19 and $30 per barrel, which works out at $4. 147 when the oil price reaches $30. If the price stays above this level for 45 consecutive days, the MOU states that the Oil Minister would advise the oil companies on any change in applicable margin. …………… After reading this memo, the president was said to have exclaimed: "Are you sure of your facts? " Okonjo-Iweala answered in the affirmative. There and then, Obasanjo requested that a letter be drafted for him to the oil majors. The next day, he signed the letter as the de facto oil minister and within weeks, $340 million was returned to the Nigerian treasury by the oil companies. Just like that! 43

Case studies – issues identified Case study 1 - Yar’Adua Orders Shell, Exxon. Mobil to Refund N 236 bn – based on the proper application of the PSC’s capital allowance and the gas sales “That all future government gas sales agreements should account for Natural Gas Liquids (NGLs). . ”. Questions – 1) Was it a tax evasion? Tax avoidance? Or Tax Uncertainty and Controversy? 2) Was there a clear understanding? 3) Was there a genuine efforts to seek clarifications by the NNPC & the contractors 4) Who should be blamed for the gaps in the laws and its poor admin? Govt or Operators? 5) Should the only one issue identified be the one to address? 44

Case studies – issues identified Case study 2 – The $500 Billion Question - a study on the margin of profit under the Memorandum of Understanding (Mo. U) based on the existing fiscal regime, a study which revealed very clearly that Nigeria was being shortchanged by the oil majors. $340 million was returned to the Nigerian treasury by the oil companies. Just like that! Questions – 1) Was it a tax evasion? Tax avoidance? Or Tax Uncertainty and Controversy? 2) Was there a clear understanding? 3) Was there a genuine efforts to seek clarifications by the NNPC & the contractors 4) Who should be blamed for the gaps in the laws and its poor admin? Govt or Operators? 5) Should the only one issue identified be the one to address? 45

Conclusion It will be a great opportunity to use the Petroleum Industry Bill, 2010 to address all the issues identified. If not addressed, those issues would obviously from part of the future challenges of implementing the Bill when passed into law. Thank you. 46

It Can only be better ! Thank you. 47

References Petroleum Profits Tax Act , Cap 13 LFN 2004 Deep Offshore Inland Basin Production Sharing Contract Act Cap D 3, LFN, 2004 Companies Income Tax Act, Cap C 21 LFN 2004 The Petroleum Industry Bill 2010 Petroleum Accounting & Taxation in Nigeria, R U Uche, Ph. D, FCA in collaboration with K A Adebiyi, FCA (2002) Overview of Country Oil & Gas Tax Practices – Ernst & Young (2008) Thisday News 21 May 2008) Thisday News 15 November 2006) Nigerian Tax Reform Manual, 2003 Nigeria Oil & Gas Monthly Magazine. 48