Hydrocarbon tax and company income tax of petroleum companies: deductions, losses, allowances and the cost price ratio

An oil company sells crude for US$1,000 million in the year. It paid royalty of US$100 million, spent US$400 million on operations and US$300 million of capital allowances fall due. The company assumes it can deduct all of it against hydrocarbon tax. It cannot.

A cost price ratio caps the deductions at 65% of revenue, apart from some costs that sit outside the cap, and the part that cannot be deducted is carried forward. The same company then does a second, different computation for company income tax, with no cap. Two taxes, two profit figures, one set of accounts. This is the heart of upstream petroleum taxation.

This topic covers the sources of income of petroleum companies, the basis period, allowable and non-allowable deductions, allowances, adjusted and assessable profit, losses (including the treatment of transited companies), the income and exemptions for hydrocarbon tax, qualifying capital expenditure, the production allowance, the cost price ratio, chargeable hydrocarbon tax, company income tax, the development levy, pre-production costs, sale and transfer of a business, consolidation and partnerships.

The previous topic covered the industry structure, licences and conversion. The next covers incentives, royalties and the host community fund.

Key terms in plain English

Syllabus check

This topic is in syllabus area F (taxation of incomes of extractive industries, 20% of marks). It covers:

• sources of income, basis period, deductions, allowances, adjusted and assessable profit;
• losses, unrecouped allowances, hydrocarbon tax and its exemptions, the cost price ratio;
• company income tax, the development levy, pre-production cost, transfer of a business and partnerships.

CAMA 2020 and petroleum company tax

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Sources of income

• Upstream: sales of crude oil, natural gas, condensate and natural gas liquids.
• Midstream: gas processing, pipeline transport tariffs, storage and liquefied natural gas.
• Downstream: refining, petrochemicals, retail and wholesale of products.
• Other: profit oil and gas under production sharing contracts; service fees under technical service contracts; trading and marketing; export sales; joint venture dividends and equity lifts; investment income.

Basis period

A company in upstream operations uses the accounting periods for hydrocarbon tax, an actual year basis, for its income tax as well. The year ends on 31 December.

Allowable deductions (NTA s. 68)

The test is that the expense is incurred wholly and exclusively in the period. The list includes:

• rents under a petroleum mining lease or prospecting licence;
• royalties incurred and paid on crude oil and associated gas, including payments to the Federation Account under production sharing, profit sharing or risk service contracts;
• repairs of plant, machinery and fixtures used in production, and renewal or repair of production implements;
• expenditure on the first exploration well and the first two appraisal wells in the same field, productive or not (later wells are qualifying drilling expenditure);
• contributions to a decommissioning and abandonment fund approved by the Commission (any surplus returned is taxed at the end of the field’s life);
• levies, stamp duties and fees paid to federal, state or local government;
• costs of gas reinjection wells for gas that would otherwise be flared, if ratified by the Commission; and
• contributions to a host communities development trust, the Environmental Remediation Fund, the Niger Delta Development Commission and similar funds.

Deductions not allowed (NTA s. 69)

• Purchase of information on petroleum deposits, other than geological, geophysical and geochemical data.
• Penalties, gas flare fees, financial and bank charges, arbitration and litigation costs, bad debts and interest on borrowing.
• Head office or affiliate costs, shared costs, research and development, and other shared indirect production costs.
• Production and signature bonuses, fees for renewing or assigning a lease, licence or marginal field.
• Tax put into a contract on a net-of-tax basis and paid for the vendor.
• Capital withdrawn or employed as capital, and improvements.
• Sums recoverable under insurance, other than the amount not recovered.
• Rent or repairs of premises not used for the operations.
• Income tax, development levy, profits tax and similar taxes, in Nigeria or elsewhere.
• Depreciation of premises, structures, plant and machinery.
• Payments to provident or similar funds, and contributions to approved pension funds for production staff that are not approved by the National Pension Commission.

Costs on which VAT was not charged, or import duty not paid, are not allowed in some provisions, so the VAT position of suppliers needs care.

Allowances

• Acquisition costs of petroleum rights (s. 81(1)): 20% a year until fully written off, with the value of the rights and of the assets reported separately to the revenue service; the assets are depreciated at the rates in Part II of the First Schedule.
• Capital allowance: upstream assets under Part II of the First Schedule; midstream and downstream under Part I.

Adjusted, assessable and chargeable profit

Adjusted profit is the profit of the period after the deductions allowed. Assessable profit (s. 70) is adjusted profit less losses of earlier periods, worked out separately for each of the two classes of chargeable tax. Chargeable profit (s. 71) is assessable profit less capital allowances and the production allowance, subject to the cost price ratio.

Losses (s. 70)

• A loss is carried forward and deducted from the adjusted profit of the next period. Later periods until it is used up, with no time limit while the company stays in petroleum operations.
• Losses can be used only in the same class: Class A, profits from petroleum mining leases onshore and shallow water; Class B, profits from prospecting licences. They cannot cross between the classes.
• Losses from penalties, fines or disallowed expenses, and costs above the cost price ratio limit, are not relievable as losses; the excess costs are carried forward under the ratio.
• For company income tax, losses are deducted first in, first out, and upstream losses can be consolidated across onshore, shallow water and deep offshore terrains. Midstream and downstream losses stand apart.
• On a transfer of a trade, losses do not pass to the buyer unless the restructuring rules allow it. On cessation, unused losses cannot be carried forward. For production sharing contracts, losses are consolidated across prospecting licences and mining leases after the Act and applied to the two classes separately.

Transited companies. A company taxed under the old Act just before the PIA took effect carries forward all unrecouped capital allowances and losses into both hydrocarbon tax and company income tax. Writing-down allowances and balancing allowances are available for both taxes; the investment tax credit is not available for either after conversion.

Income chargeable to hydrocarbon tax

Hydrocarbon tax is charged on profit from crude oil, field condensate, natural gas liquids from associated gas measured upstream of gas processing, and balancing charges. The value of chargeable oil is the sale proceeds plus the imputed value of oil disposed of, at the same price the Commission uses for royalty.

Not chargeable:

• associated gas (not processed for liquids)
• non-associated gas and liquids from it measured downstream
• condensate or liquids produced downstream of the measurement points
• frontier acreage until reclassified or converted

The old exemption for deep offshore operations no longer stands: s. 65(4) of the NTA keeps the frontier exemption only.

Fields not yet producing carry no tax until production begins, and costs of the host community trust (3% of annual operating expenditure) and the Frontier Exploration Fund are outside the tax.

Qualifying capital expenditure and allowances

Capital allowance is given on qualifying plant, pipeline, building and drilling expenditure at 20% a year for five years, on the straight line, with 1% of cost kept as a notional residue in the records. The petroleum investment allowance has been abolished. For hydrocarbon tax, capital allowance is worked out per field; for company income tax it is added up at company level.

Production allowance

The production allowance replaced the investment tax credit and is tied to output, not spending. Its rate depends on the lease:

The allowance also applies to condensate and natural gas liquids.

The cost price ratio

Costs deductible for hydrocarbon tax, other than royalty, rents and the host community and similar contributions, are limited to 65% of gross revenue at the measurement points. Gross revenue means the fiscal value of crude oil sold, condensate and natural gas liquids from associated gas. Excess costs are carried forward but stay subject to the limit; costs still over the limit when upstream operations end are lost.

Chargeable hydrocarbon tax (NTA ss. 72 and 73)

Hydrocarbon tax is a percentage of chargeable profit: 30% for petroleum mining leases and 15% for petroleum prospecting licences, onshore and shallow water, assessed on an actual year basis. It does not apply to associated or non-associated gas. The estimated tax is paid in 12 equal instalments, and a final instalment is due on or before the due date of the self-assessment (five months after the year end).

If oil is sold between connected persons, or disposed of, and the tax comes out lower than the amount fixed by s. 72, the company pays the difference as additional tax (s. 73).

Company income tax and the development levy

Upstream companies also pay company income tax at 30% on their profit, on the actual year basis. The computation starts with total income (oil, condensate and liquids, associated and non-associated gas, exchange gains, interest and other income) and deducts royalty, the operating costs in s. 68, and the ordinary deductions of company law, including rent, finance cost, administration and indirect costs; then losses and capital allowances.

The cost price ratio does not apply, and only the s. 68 costs are used for hydrocarbon tax, while both sets are used for company income tax. The development levy is 4% of the assessable profit for company income tax from 1 January 2026. It is not allowed in the hydrocarbon tax computation, and the levy is not charged on hydrocarbon tax profits.

Pre-production cost (s. 74)

Costs incurred wholly and exclusively before production starts, subject to ss. 68 and 69, are treated as qualifying pre-production capital expenditure once production and sale begin, and are written off over five years.

Sale or transfer of a business (s. 75)

• Merger: no new business starts and cessation rules do not apply; gains do not arise; assets pass at the residue of qualifying expenditure; capital allowances, losses and withholding tax credits pass to the surviving business.
• Sale with cessation: cessation rules apply; assets are taken at sale value; allowances, losses and tax credits do not pass.
• Sale of an asset without cessation at or below residue and unused allowance: allowance on the residue only; unused allowance goes to the buyer; no gain; no VAT.
• On a restructuring into a new company, the new company’s accounting period begins on the date of transfer, or a date in that month with the revenue service’s approval, and ends on 31 December. The revenue service must be told before the restructuring.

Consolidation and partnerships

A company with upstream operations in several terrains may consolidate costs and income for income tax (s. 76). For hydrocarbon tax it can consolidate only across assets in the same category of chargeable tax. A person who is not a company and who engages in upstream operations alone or in partnership commits an offence, and is taxed on the profits and penalised (s. 77).

Where companies work together in a partnership or joint venture, profits, costs, allowances and tax are apportioned by equity interest under a signed agreement, or as the Commission advises. Regulations may set the method, but cannot put a greater burden on a company than if it had done the work alone.

Worked examples

1. Pipeline 20% × 12,000 = 2,400
   plant 20% × 9,000 = 1,800
   fixtures 20% × 8,000 = 1,600
   building 20% × 11,000 = 2,200
   plant (fifth year) 20% × 6,000 = 1,200.
2. Total allowance = ₦9,200m.
3. Each asset keeps a notional residue of 1% of cost in the records.

1. B = 100 + 10 + 15 + 400 + 300 = 825.
   C1 (exempt) = 100 + 10 + 15 = 125.
2. Net costs for the ratio.
   825 − 125 = 700.
   65% of revenue = 650.
   C2 = lower = 650.
3. D = 125 + 650 = 775.
   Excess carried forward = 825 − 775 = US$50m.

1. Production allowance per barrel.
   lower of US$2.50 and 20% × 80 = US$16, so US$2.50.
   Allowance = 10m × 2.50 = US$25m.
2. Chargeable profit.
   1,000 − 775 − 25 = US$200m.
3. Hydrocarbon tax at 30% = US$60m.

1. Deductions = royalty 100 + rentals 10 + host community fund 15 + operating costs 400 + finance and administration 50 = 575.
   Assessable profit = 1,000 − 575 = US$425m.
2. Total profit.
   425 − 300 = US$125m.
   Company income tax at 30% = US$37.5m.
3. Development levy.
   4% × 425 = US$17m.
   No cost price ratio applies.

1. Class B losses cannot be used against Class A profit.
2. Hydrocarbon tax on the mining lease is charged on the US$90m before any allowance, at 30%.
3. The US$40m loss is carried forward against future Class B profit.

How to score full marks

• Set out two computations, one for hydrocarbon tax and one for company income tax, side by side.
• Apply the cost price ratio only to hydrocarbon tax, and show C1, C2 and the excess.
• Quote the section: s. 68 allowed, s. 69 not allowed, s. 70 losses, s. 72 rates.
• State the rate of capital allowance and the notional 1% residue you use in the fifth year, and show the working.
• Add the production allowance rate as the lower of two figures.

Common mistakes in the exam

• Applying the 65% limit to royalty and rents.
• Allowing interest and head office costs for hydrocarbon tax.
• Applying the cost price ratio to company income tax.
• Using a loss from a prospecting licence against mining lease profit.
• Charging the development levy on hydrocarbon tax profit.
• Using the old petroleum profits tax rates for a converted lease.

Quick revision

• HT: 30% PML, 15% PPL; CIT 30%; levy 4% of CIT assessable profit.
• CPR 65% of gross revenue; exempt costs outside; excess carried forward.
• Capital allowance 20% a year for five years; production allowance replaces the investment tax credit.
• Losses by class; carried forward without limit.
• s. 65 to s. 78 NTA: the petroleum chapter.
• CAMA 2020: ss. 119, 305, 308, 377(1), 378, 426, 427, 433.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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