Value Added Tax (VAT) is a consumption tax levied at each stage of the supply chain and ultimately borne by the consumers.
The tax was introduced in Nigeria in 1993 via the Value Added Tax Act (VATA), after a recommendation by a study group that was set up in 1991 to review the Country's entire tax system. It is worth knowing that before the introduction of VAT, sales tax was in operation in Nigeria. However, VAT is different from sales tax, as it has a broader scope and includes most supplies, professional services and banking transactions.
The Tax is managed by the Federal Inland Revenue Service (FIRS) and is charged on the supply of goods and services other than those exempted in the first schedule to the VATA. It operates on a credit mechanism such that each producer along the value chain can claim the tax paid at the previous stage of production, when passing the product of his effort to the consumer at the next stage (provided that the producer and the merchant deal in goods on which the input VAT is claimable). The operation of the credit mechanism, however, stops at the stage where the item is purchased by the final consumer, who bears the full tax burden. In essence, merchants offset the total VAT paid on purchases (called 'input tax') in a given period (usually one month), against the total VAT charged on sales (i.e. 'output tax') and pay the excess to the FIRS.
For companies operating in the oil and gas industry however, the law requires service recipients to withhold the output VAT charged by their vendors and remit it, directly to the FIRS. This requirement of the law has pitched the tax authorities against oil service companies who are legitimately entitled to claim their valid input VAT against the output, before remitting the excess to the Federal Inland Revenue Service (FIRS). In response, the latter has always maintained that the affected companies should file a claim for the refund, for processing and payment. However, there has been some controversies on the process for the recovery of such input VAT, given the provision of the VATA. Thus, this article is focused on breaking the myth of the challenges faced by companies operating in the Nigerian oil and gas sector, in recovering valid input VAT on cost incurred against the output VAT on their supplies.
Allowable Input VAT
In 1998, the VAT Act was amended to restrict the scope of allowable input VAT
T through section 6 of the Finance (Miscellaneous Taxation Provisions, Act No. 18, 1998, which introduced section 13(a) (now section 17) of the VAT Act, Laws of the Federation of Nigeria (LFN), 2004). Section 17 of the amended VATA provides that:
"... ... ... ..the input tax to be allowed as a deduction from output tax shall be limited to the tax on goods purchased or imported directly for resale and goods which form the stock-in-trade used for the direct production of any new product on which the output tax is charged".
The provision also excluded the input VAT incurred on overheads, services and general administration of any business from being claimed against a company's output VAT. Rather, such input VAT should be expended through the company's profit or loss account. The input VAT on capital items and fixed assets are to be capitalized with the cost of the items.
Deduction at Source
VAT charged by a vendor is expected to be paid to it by the service recipient, together with the invoice value for the goods sold or services received. However, section 13(2) of the VATA provides that for companies operating in the oil and gas sector, VAT charged them by their vendors should be deducted at source and remitted directly to the FIRS. This position was further clarified and corroborated by the FIRS via paragraph 13(2) of its information circular .
The implication of the above is that companies that incur allowable input VAT as defined by the VATA, are unable to offset it against their output VAT, and therefore, they are denied the opportunity to claim valid input VAT suffered on their purchases against their output VAT. The argument put forward to justify this position was that most oil and gas service companies typically provide "services", rather than trade in "goods". Therefore, they would not incur any allowable input VAT! On the contrary however, this is not always the case, as some of the companies do purchase goods and materials (such as drilling fluids, spare parts, and chemicals) for onward sale to companies operating in the same sector. They therefore incur allowable input VAT but would be unable to offset it against their output VAT when such goods/ finished products are sold, based on the provision of the VATA and the above-referenced FIRS' Circular.
It is interesting to note that the above Circular places an obligation on companies operating in the oil and gas industry to prepare and forward to the FIRS, relevant schedules showing complete details of the contractors and transactions, and demand relevant receipts covering all VAT payments from the FIRS. In addition, the companies are required to account for both the VAT they have deducted at source from vendors' invoices, and the output VAT charged on their own sales. These additional requirements increase the compliance burden for companies in the sector, as they are mandatorily required to file two sets of monthly VAT returns, amongst other statutory disclosures and filings.
Right to Claim VAT Refund
Based on the provisions of the relevant laws, a VATable person has the right to request a VAT refund where the input tax genuinely exceeds the output tax for a transaction period, or where, based on the provision of section 13(2) of the VAT, it is unable to recover its input VAT from its output VAT.
However, section 23 of the FIRSEA provides that for a refund to be approved for a taxpayer, the FIRS will need to properly audit such company requesting the refund, to validate the request. Thus, a refund is not automatically granted on request by the FIRS to the tax payer on request. In practice, such audits have lasted for unreasonably long period, and thus, dissuaded would-be claimants from pursuing their refund claims due to the increased administrative costs of such endeavor and the potential time value of money lost.
The consequence of the above was that some service providers opt to expense such input VAT in the statement of Profit or Loss Account. However, this approach reduces the inherent tax benefit to only 32% (the effective corporate and education tax rate), instead of 100%, where it is offset against the output VAT, as provided for in the VATA. This practice puts most companies in the oil and gas service industry in a perpetual input VAT refund position.
Impact of the Directive
The Nigerian oil and gas sector is still the mainstay of the economy. According to data from the Central Bank of Nigeria (CBN), the sector contributes about 95% of the country's export earnings and 60% of the Nigerian Government's revenue. As at the end of 2017, there were about 3,000 companies operating in the Nigerian oil and gas sector. Approximately 40%of these companies are engaged in the supply of spare parts and equipment, which are either imported for resale or purchased locally. Some of the companies also source raw materials used for manufacturing finished products e.g. chemicals, paints, drilling mud, etc., for onward supply to end users in the sector.
As a result of the conundrum created by the VAT deduction at source directive of the FIRS, majority of these companies are carrying huge VAT receivable balances in their books, with the hope of being able to utilize it or get a refund from the FIRS in future; or have expensed it, thereby losing the benefit of taking a 100% tax credit on it against their output VAT. This has affected such companies' cash flow and is hurting business operation. Furthermore, it has resulted in a perceived apathy in tax payer's behavior, leading to potentially, reduced voluntary compliance rate, amongst others.
Based on the World Bank - Ease of Doing Business report for 2019, Nigeria ranks 146 out of 190 countries. For the parameter "paying taxes" which measures "payments, time, total tax and contribution rate for a firm to comply with all tax regulations as well as post-filing processes", the country ranked 157, almost 10 points below its overall ranking. Given that one of the strategic objectives of the Economic Recovery and Growth Plan (2017 - 2020) of the current administration is to build a globally competitive economy, it has become imperative for the relevant government agencies to review the impact of the above provisions of the VAT law and FIRS' directive, on the oil and gas sector and mitigate the potential consequences.
Practices in other Jurisdictions
A review of the South African VAT structure revealed that there is no restriction on the scope of allowable input VAT that can be offset against output VAT. Thus , there is no distinction between goods and services acquired for consumption by a business and those acquired for supplying another person. Input VAT incurred on manufacturing overheads, administrative expenditures such as audit fees, office rentals, and on fixed asset can be deducted from output VAT on taxable supplies.
In the same vein, where a tax payer applies for a refund and it is approved, interest on such refund, payable by the government, begins to accrue where the taxpayer is not refunded after twenty-one (21) working days from the date the refund becomes due, (i.e. when the verification/ audit report gets finalised and refund approved).
In developed countries like Canada, the administrative process for tax refund is quite simple and straightforward. The taxpayer makes an online application using a template form designed for that purpose. The form shows the applicant's personal profile, details of payment (e.g., interest, dividend, etc.) and amount withheld, reasons for the refund, some mandatory attachments, certification of the tax withheld and other information relating to the tax. Once the online application is completed, the Canadian Revenue Agency ("CRA") reviews the basis of the refund and the relevant support documents. Depending on the time the tax returns were submitted prior to making the application, it usually takes between two to eight weeks for the refund to be processed.
It is important to note that the CRA does not require any physical interaction with the taxpayer in order to carry out its review of the refund application or process the refund. Furthermore, once the refund amount is established, the taxpayer can elect to receive a cash refund or transfer the credit to its account for the next tax period.
The Way Forward
The additional requirements placed on companies operating in the oil and gas sector regarding VAT deduction at source, is detrimental to the operation of service providers and a needless burden. This problem has now been compounded by the recent public notice issued by the FIRS, extending the deduction of VAT at source to commission, rebates, etc. paid by companies operating in the Fast-Moving Consumer Goods (FMCG) sector to their distributors, dealers and agents, in clear contradiction of the provision of the VATA!
However, Given the Federal Government of Nigeria's drive for improving the ease of doing business in the country, for which "paying taxes" is a key and important pillar, the relevant regulatory authorities (the FIRS and the Ministry of Finance) should consider the following:
1. Providing additional guidance on the operation of the deduction of output VAT at source by companies operating in the oil and gas sector, by isolating "supply of goods" from this omnibus provision. Thus, the provision should apply only to companies that render services, strictly.
2. Improving the Nigerian tax refund process. Nigeria can take a lead from countries like Canada and South Africa, which have successfully made the refund procedure seamless. To achieve this however, the authorities must deal with the trust deficit, which has characterized tax administration. In effect, any refund application should not be viewed as "spurious", leading to protracted refund audit exercise.
3. Processing VAT refund on a periodic basis. The FIRS may consider designating an office that will oversee the VAT refund process. This will ensure that taxpayers applications are processed speedily, and solve the problem caused by prolonged tax audit and verification exercises.
4. Allowing oil and gas companies with valid input VAT to offset such against the "output" VAT deducted at source from their vendors. The balance could then be paid over to the FIRS.
5. Completely automating the entire VAT operation system, such that the input/output process is embedded in an Enterprise Resource Planning (ERP) system, which could be deployed within the FIRS. Thus, once a tax payer submits its monthly returns, online, the net amount payable is notified to the tax payer for settlement within the time limit stipulated in the VATA.
In order to stimulate a vibrant economy, transparency and fairness in policy cannot be overemphasized. Therefore, the Ministry of Finance and the FIRS may need to consider a holistic review of the VATA, to ensure that no sector of the Nigerian economy is unduly disadvantaged because of sector-based directives/practices.
Furthermore, for Nigeria to earn more confidence from foreign and local investors, the tax environment must be deemed to be in line with the global canons of taxation - equity, convenience, productivity and simplicity, amongst others. This would in turn impact positively on the ease of doing business in the country.
Ojo is a Senior at KPMG in Nigeria, while Jegede is Manager, KPMG in Nigeria