1. INTRODUCTION 1.

1 Introduction to Solid Mineral in Nigeria Under the Nigerian Minerals and Mining Act, 2007, section 1 (1) states that the entire property in and control of all mineral resources in, under or upon any land in Nigeria, its contiguous continental shelf and all mines, streams and water courses throughout Nigeria, any area covered by it territorial waters or constituency and the exclusive economic zone is and shall be vested in Government of the Federation for and on behalf of the people of Nigeria. The mineral sector in Nigeria is currently dominated by artisanal and small-scale mining operators. They are mainly informal, working with rudimentary methods and limited technical training, social provision and environmental consideration. It is only in quarrying that large-scale operations exist with the construction companies (stone aggregates and laterite) and cement manufactures (limestone) dominating. In a bid by the Government to attract foreign investors to the Nigerian solid minerals sector there has been a transformation process going on in the industry which has resulted in the following: Increase in mineral exploration activities arising from more funding and repositioning of NGSA to effectively carry out

geological and geochemical mapping has stranslated into the production of geological data. The creation of the MCO charged with the administration of mineral titles on a first-come-first-serve and use-or-lose-it basis resulting in increase in mineral title acquisition by both local and international mining operators. Increasing the capacity of ministry staff to carry out designated functions as well as increasing the capacity of the ASM to carry out mining in a sustainable manner through the activities of the SMMRP. Enactment of relevant laws and regulations needed to regulate mineral exploration and exploitation activities in a transparent manner, The Nigerian Minerals and Mining Act of 2007, National Minerals and Metals Policy 2008, Nigerian Minerals and Mining Regulations 2011. However MMSD has identified thirty-four (34) minerals of

economic importance in Nigeria across the six regional mining zones. And also the MMSD has also highlighted a number of strategic materials that have the potentialities to contribute significantly to Nigerias economic development. These include barite, gold, bitumen, iron-ore, lead/zinc coal and limestone. 1.1.1 Taxation of the Solid Minerals

It is a statutory obligation of every limited liability companies to file their annual tax returns with FIRS, on or before 30 June of

every year. And also any organisation that has more than five (5) employees is expected to deducted at source from employees monthly salaries (PAYE) and remit to relevant tax authorities (FIRS and BIR). The rates of taxation chargeable are stipulated in the Personal Income Tax Act 2011 (as amended). 1.2 Introduction to Petroleum Taxation in Nigeria The urge to extract as much revenue as possible from a non -renewable patrimonial inheritance that is fast depleting, has seen many countries toy with one fiscal regime for petroleum after another. In doing so however, they often forget the role tax allowances and other incentives can play in increasing their revenue base by attracting more investments to the industry. For others, the allowances and incentives due to poor design, have failed to address the difficulties and high tax burden often associated with the fiscal instruments and therefore cannot promote investments. This has become more problematic for countries whose economies are dependent on oil, as they cannot finance social and economic growth in the absence of a large oil revenue base. Nigeria is not an exception to this. Oil accounts for about 90-95% of its export revenues, over 90% of foreign exchange earnings and about 80% of government revenue. The oil industry is thus the main hub of the Nigerian economy, and needs to be sustained if the country is to achieve real economic growth.

The Oil glut of the 80s that greatly impacted on global oil prices and the very low OPEC quota, foisted on the country various fiscal regime for petroleum especially the petroleum profit tax of 85 % and 20% Royalty regime, all in a bid to get more revenue to oil the Nations economy. Since then Nigeria has had lofty aims for its oil industry, including the desire to increase reserve from 34 billion barrels to 40 billion barrels by 20105 and subsequently its OPEC quota, optimization of oil revenue, increase in the Industrys local content, and continuous attraction of foreign investment as a way of promoting and sustaining investment in the oil industry. But the bane of the industry has been the failure of the allowances and incentives to attract more investment and therefore more wealth capable of sustaining the future growth of the economy even when the oil wells have dried up. There is the need to have i n place, a fiscal regime that will, through tax allowances and other incentives become investor friendly by balancing government needs with those of investors through its stability, efficiency and flexibility. The failure of tax allowances and incentives to achieve governments desire in this respect therefore merits an examination. It is also vital to answer the follow up question, which is, how can the tax allowances and the entire fiscal regime for petroleum be made to promote and sustain investment in the Nigerian oil industry? Providing answers to the above question becomes imperative not only for the government and its citizens who need the oil revenue for economic development, but also for

investors and other stakeholders, who will rely on it for investment decisions in the midst of very competitive global tax climate. This paper in answering these questions, takes a look at the special nature of the petroleum industry and governments objective in taxing the industry. It assesses the need for the introduction of allowances and incentives to ameliorate the often huge tax burden placed on investors. In doing so, it makes a detailed and analytical study of the Nigerian fiscal regime for petroleum, examining the incentives and allowances therein, and their capacity to promote and sustain investment. In identifying the constraints and limitations to the workability of these fiscal incentives, it draws a comparison between Nigeria and some oil producing countries (OPCs) and gives an insight into how these bottlenecks can be removed to encourage a sustained development of the Nigerian oil industry. In canvassing these issues, principles of basic geology,

elementary economics, and law and petroleum taxation are applied in a methodology that is both analytical and prescriptive. For a better understanding of the issues at stake however, an overview of the distinctive nature of the petroleum industry petroleum industry, necessitating a separate FR and special tax treatment is first given.

2. THE SPECIAL NATURE OF THE PETROLEUM INDUSTRY Compared to other economic activities, the petroleum industry has wider attraction because of its special nature, which stems from the fact that till date, it remains the largest and most important industry in the world. It has continuously provided the worlds energy and industrial needs, from transportation to agriculture. It has also been a money-spinner first for the OPCs, providing them with the opportunity of economic and social development, and second, for the multinational oil companies (MNOCs) engaged in its extraction; and by extension the industrialized market to which the earnings of the MNOCs are repatriated. A cheap alternative to oil has been difficult to come by and the worlds total oil consumption continues to increase and is projected to grow by about 36% by 2010. following factors. 2.1 INDUSTRY RISKS The industry also stands miles apart from others as illustrated in table1, due to the

No industry epitomizes these risks better than the oil industry. The whole of the industry, from exploration to production is filled with risks. From the high possibility that a hole in the ground will not yield reserves, the risks that the reserves if discovered will not be in commercial quantity to justify the investment, the technology risk in oil field development, to the failure of operations and vagaries of international oil prices. Thus upstream

investment remains very risky and unpredictable-most times development of new fields involve the sinking of capital before actual production reveals the reservoir characteristics, unlike most other economic activities. Table 1: Illustration of the basic differences based on assumptions only. Most of the factors also hold true for the Mining industry though with some differences

2.2

HIGH COST OF INVESTMENT15

From exploration to eventual production, the cost of developing and operating an oil field is very high and probably higher than any other industry. The technology needed for all activities in the industry is very expensive. The scale and size of investment is usually very high and at times higher than that in the mining

industry. The total market capitalisation of listed oil companies worldwide is more than $1000 billion, while commercial bank lending to the industry is an annual average of US$1 billion ranking it the biggest in terms of size and scale of investment. 2.3 LONG LEAD-TIME

It takes a longer time for investment in oil fields to start yielding returns than any other industrial activity, because of the huge cost of investment and the long time it takes between exploration, development and the production of the first barrel of oil. Other factors include the role of the international market in determining the price of the commodity, coupled with the high profile politics and interests that go with it. There is always the risk of price fall as oil price is not static and is more or less not determined by the MNOCs, but to a large extent by the dictates of demand and supply. The economic rent generated from oil has always been higher than that generated from any other industry including mining. At times, there are lots of political risks associated with the location of oil fields (which due to their fixed nature must be drilled where they are found) especially in the developing countries which incidentally are home to most of the worlds oil reserves, accounting for about 90%23 of the proven oil and gas reserves in the world. Oil depletes and is also non-renewable, a barrel once produced, cannot be produced again.

All these including the need on one hand, to ensure that the State as resource owner, receives an appropriate and equitable share of the economic rent accruing from oil extraction, and the need on the other hand, to compensate the investor adequately, for the excessive risks and costs associated with the investment, make very strong case for a special tax regime for the petroleum industry.

3. THE OBJECTIVES OF PETROLEUM TAXATION The basic reasons for taxation in any economy centre on the need to raise revenue for economic and social development and to guide taxpayers behaviour. However the objectives of government in taxing the PI can be analysed as follows: 3.1 THE PATRIMONIAL FACTOR

In many OPCs, oil is treated as a patrimonial inheritance belonging to the whole nation including future generations. Taxing it becomes a way of achieving governments objective of exercising right and control over this public asset. Government may impose (very high) tax as way of regulating the number of participants in the Industry and discouraging its rapid depletion in other to conserve some of it for future generation. This in effect will also achieve governments aim of controlling the petroleum sector development. 3.2 THE REVENUE FACTOR

The high profit profile of a successful investment in the oil industry makes it a veritable source for satisfying governments objective of raising money to meet its socio-political and economic obligations to the citizenry. In many OPCs, taxes from the oil industry exceed taxes from other sectors, especially for those whose economies are not diversified.

3.3

WEALTH RE-DISTRIBUTION

Petroleum taxation has become an instrument for wealth redistribution between the wealthy and industrialised economies represented by the MNOCs, who own the technology, expertise and capital needed to develop the industry and the poor and emerging economies from where the petroleum resources are extracted. The MNOCs repatriate their earnings and often very huge profit to their wealthy countries; extracting rent from them in the form of petroleum taxation is a way of achieving the objective of wealth re-distribution, among these nations. 3.4 ENVIRONMENTAL FACTOR

This would ordinarily come under the objective to guide the behaviour of economic agents. The high potential for environmental pollution and degradation stemming from industry activities makes it a target for environmental taxation, as a way of regulating its activity and promoting governments quest for a cleaner and healthy environment. Cleaner production may be achieved by imposing tax on it for pollution and other environmental offences. 3.5 OTHERS

Taxes that come in the form of training fees and contribution to education funds underlies government objective of developing indigenous technology, manpower and expertise in the industry,

through

contribution

and

taxes

from

mostly

the

MNOCs.

Government in imposing these taxes may promote or unwittingly cripple the industry especially where the taxes are either front loaded or not based on profit. When these government objectives are carried out, it aligns the petroleum industry to the overall social and economic policy of the government, which to a large extent determines the nature of a countrys fiscal regime for petroleum.

4. THE ROLE AND IMPORTANCE OF TAX ALLOWANCES Tax allowance is a form of incentive used to ameliorate the difficulties and high tax burden inherent in a fiscal regime in order to induce, promote and sustain investment in that fiscal regime. Though incentives it has been argued, are poor instruments for ameliorating negative factors inherent in a countrys investment climate, they still go a long way in determining investors decisions on what and where to invest especially where other risks (e.g. political or labour risks) associated with the investment is the same for a given set of countries, say A and B as in table 2. Tax allowances may not ameliorate the political risks of an investment; but will go a long way in addressing the imbalances (especially between the government and the investor) arising from a very high tax burden. It is on this basis that the role and importance of Tax allowance is discussed here and with particular reference to the petroleum industry. Table 2:

A Fiscal regime and the inherent tax allowances give a picture of how much of the investment risks the government is willing to share with the investor, and therefore affect the investors decision based on his analysis of the after tax return of the

investment in the prevailing circumstances. T ax allowances also make a fiscal regime more conducive and attractive for investment by taking cognisance of investment costs and losses, thus encouraging the investor to take more risks especially in less explored regions and for marginal fields. This is because where there is no incentive, there will be no attraction in exploring small fields. Tax allowances and other incentives are therefore, of particular importance to the petroleum industry especially due to the inherent risks associated with it. 4.1 TYPES OF ALLOWANCES AND INCENTIVES

The range of tax allowances and other incentives vary from country table 3. to country depending on the governments fiscal objectives. However the prevalent ones include the following in

Table 3

Some regimes treat royalty as deductible expense for tax purpose while others dont but treating it as a deductible expense has the effect of mitigating its full impact on firms. However, the overall effect of the above allowances and incentives on any FR will depend on how much they can lessen a high tax burden an d ensure early recovery of investment costs, and dividends for shareholders.

5. NIGERIAs FISCAL REGIME FOR PETROLEUM There are two main types of fiscal regime existing in Nigeria today. These are the joint ventures (JVs) and the production sharing contracts (PSC). Joint operating agreements govern the unincorporated joint ventures between the Nigerian national petroleum corporation (NNPC) and the MNOCs. Tax assessment for the two fiscal regimes is governed by the Petroleum profit tax Act (PPTA), cap 354 L aws of the federation of Nigeria (LFN) 1990, which puts the tax rate generally at 85%. Production from the joint ventures accounts for nearly 97%38 of the Countrys crude oil production. models. This analysis will therefore centre on these two

5.1

THE PRODUCTION SHARING CONTRACT

Fig. 1

Nigerias Production Sharing Contract

Under the PSC, a non -refundable signature bonus is payable on the oil prospecting licence (OPL). The oil companies, fund the operations from exploration to production and the profits are shared as agreed under a memorandum of understanding (MOU) after deducting the companys expenses. The contract area is usually located in deep off shore or inland basin and covers an area of not more than 2,950km. The duration is 30 years including an exploration period of 10 years while relinquishment is 50%. The rental fee for OPL is $10/km; any oil mining lease (OML) arising therefrom is $20/km for 1st 10yrs and $15/km thereafter. Royalty based on the realisable price of the oil, is payable after allowances are made for quantity used for drilling, production or pumping operations, that injected or reformulated and reasonable evaporating losses. The royalty rates under the PSCs vary depending on the area of the concession and are graduated on a sliding scale depending not on production, but on water depth as shown in table 4. Production costs are not deductible for purposes of calculating royalty. Table 4 Royalty Rates under the PSC

5.1.1

Sharing formula:

Royalty oil is allocated in kind to the NNPC or the Holder, the proceeds of which shall be equal to actual monthly royalty payment and annual rental fees in accordance with the PSC terms.

Cost oil is allocated to the Contractor in kind to offset his operating costs. Tax oil is allocated in kind to the NNPC or the Holder and is to equal the amount of monthly PPT liability. Profit oil, the balance of oil after the above allocations is split between NNPC and the contractor in accordance with the terms of the PSC. The NNPC or the Holder is to pay all royalty, rental fees and PPT51 from the royalty and tax oil. 5.2 THE JOINT VENTURES

Under the JVs, NNPC has 55% working interest in the Shell JV and 60% in the others. All operating costs are financed jointly in the proportion of the equity shareholdings, by a system of monthly cash calls. Each of the JV partners can lift and separately dispose of its share (proportional to the equity holdings) of crude oil production subject to the payment of royalty and tax. The operator (usually the MNOC) prepares and proposes

programme of work and budget, which is subject to the approval of the major shareholder. Each party can opt for and carry out

sole risk operations. The partner is exempt from corporate income tax on its profit but subject to taxation under the PPTA. The right of the parties with respect to the concession, the assets, including the working capital used to develop the concession is defined by the joint operating agreement. The other obligations of the companies under the fiscal regimes include the following, contribution to the Education Trust Fund (ETF) and Industrial Training Fund (ITF), payment of value added tax (VAT) on goods and services with the exception of exports. Dividends are exempted from withholding tax. The companies are to pay other taxes, duties and levies imposed by the different tiers of government. The realisable There are no domestic supply obligations. price is used for tax assessment. market

Exploration obligations are contained in the MOUs and relate to minimum work commitments and expenditure for each phase of the exploration period. 5.3 ALLOWANCES AND INCENTIVES IN THE NIGERIAN

PETROLEUM INDUSTRY To cushion some of the tax burden flowing from the above arrangements the following allowances and incentives were provided. 5.3.1 Allowable Deductions

All allowable deductions are treated as charges against income and not as tax offsets and must be expenses wholly, exclusively

and necessarily incurred for petroleum operations. The categories are royalties, operating costs, tangible expenses and all intangible drilling costs. Expenses incidental to petroleum operations are Losses occurring in also to be treated as allowable deductions.

any accounting period are required to be carried forward. 5.3.2 Capital Allowances

Outside the allowable deductions, capital allowances are granted annually for qualifying capital expenditure at a depreciation rate of 20 % (first four years), 19 %( 5th year) and 1% of the asset value is retained in the books until it is disposed off. The capital allowances are not allowed to reduce a companys tax liability below 15%-the remainder is carried forward indefinitely. 5.3.3 Petroleum investment tax allowance/Investment

tax credit Further qualifying capital expenditure is granted in respect of any asset used for the purposes of petroleum operations in the year in which the asset is first used, as follows:

For contracts other than PSCs, and PSCs executed after 1/7/98, the qualifying capital expenditure is to be treated as Investment Tax Allowance (PITA) deductible from the assessable profit. For

PSCs executed before 1/7/98, the qualifying capital expenditure is to be treated as an investment tax credit deductible from the tax base. The MOUs contain fiscal stability clauses and provide for a guaranteed profit margin of $2.50 bbl. An offset is gran ted where the capital investment costs for that year exceeds $3.50 bbl. Other incentives include current expensing of Exploration &Development costs, limited head office overhead recovery, exemption of imports of equipment and capital goods from duties, graduated sliding scale royalty, ring fence by contract area. Why have these allowances and incentives been unable to promote investment in the industry to achieve the overall objective of Government?

6. PROMOTING AND SUSTAINING INVESTMENT The allowances and incentives have been unable to promote and sustain investment to the level desired by government because the fiscal regime and the allowances and incentives neither encourage marginal investments nor adequately enhance the present value terms of the i nvestors post tax returns due to some inherent constraints and limitations. 6.1 CONSTRAINTS AND LIMITATIONS

The PPT of 85% even without other levies and taxes is among the highest in the world. The 50% rate under PSCs is also on the high side. The 15% minimum tax liability is a big burden to a company that is yet to break even especially after paying bonuses, royalties and other charges. The 20% royalty for onshore fields is also not in line with global trends. The distinction between petroleum investment tax allowance and investment tax credit is a disincentive to exploration and production for those under it (pre- 1/7/98 PSCs) who are denied the benefits of an investment credit. A PSC that is subject to review only to ensure that governments take goes up in line with any price increase above $2072 and does not take care of the contractors take in line with any fall in price will not encourage potential investors especially during steady fall in price. This is because bonuses, royalties and tax burden will remain the same. The cost recovery limit and limited ring fence, act as disincentives to the promotion of investment.

All these when added up are enough to make the allowances and incentives unworkable especially as these are against global trends in the industry. 6.2 GLOBAL TRENDS.

The global trend is to de-emphasise high tax rate, tie tax rate to additional profit or impose low but flat tax on all activities. Abu Dhabi, Dubai, Tunisia and Venezuela that have similar high tax rate do not share in production, while Qatar, Egypt, Yemen and Argentina that share in production have tax rate ranging from 040%. Most countries have done away with royalty while others have rates ranging from 1 -12%, which is based on the R-factor or sliding scale tied to production. 6.3 THE WAY FORWARD.

As an improvement on the above models, Nigeria can adopt a flat tax rate of 40% and an additional profit tax based on the companys IRR. This will promote and sustain investment; and also provide an incentive to pay more tax that can be used to develop other sectors of the economy. Governments interest both as resource owner and risk taker (under JVs) will also be satisfied. Royalty when treated as a tax offset, deductible from assessable tax will mitigate its negative i mpact on investment and also satisfy governments quest for early revenue.

The tax regime should be flexible enough to accommodate any change affecting the global industry especially in the face of growing foreign tax credit system. A tax holiday of 5 years for investors in marginal fields and frontier areas coupled with flow through shares will encourage investment in small exploration companies. Absence of ring-fence or loss carry backward will induce more exploration activities since the cost of digging a dry hole can be offset against discoveries made. To arrest gold plating that may arise from this; the government should improve its auditing and monitoring processes. The Reserve Addition Bonus (RAB) should be re- introduced to increase reserves and enhance investors post tax returns. Loss carry forward enhanced by interest has the capacity to increase exploration activities especially in the deep offshore and inland basin. A reinvestment and local content obligation supported with a tax credit will also promote investment in the industry. Crypto taxes like bonuses being front- loaded should be reduced. Other issues like political risks, corruption, and state of infrastructure, rule of law and security of oil industry personnel should also be positively addressed as allowances cannot work in isolation. This is the only way that tax allowances can put Nigeria on the competitive edge in attracting and promoting investment in its petroleum industry.

BIBLIOGRAPHY Shell Petroleum vs. F.B.I.R [1996] 8 N.W.L.R Companies Income Tax Act Cap 60 Laws of the Federation of Nigeria (LFN) 1990. Deep Offshore and Inland Basin Production Sharing Contracts Decree No. 9 of 1999. Deep Offshore and Inland Basin Production Sharing Contracts Decree No.26 of 1999. Education Tax Fund Decree No 7 of 1993. Industrial Training Fund Act Cap 182 Laws of the Federation of Nigeria. Petroleum Act Cap 350 Laws of the Federation of Nigeria (LFN) 1990. Petroleum Profits Tax Act Cap 354 Laws of the Federation of Nigeria (LFN) 1990. Petroleum Technology Development Fund Act Cap.355 Laws of the Federation of Nigeria (LFN) 1990