Petroleum profits tax and production sharing contracts: the 85% regime for unconverted licences

An oil company has held an old oil mining lease since the 1990s and never converted it. It pays tax at 85% of chargeable profit, not 30%, and there is no cost price ratio, no hydrocarbon tax and no production allowance. Instead it has a limit that stops capital allowances wiping out the profit, and an extra allowance whose rate depends on the depth of the water.

Another company works under a production sharing contract in deep water, and pays 50% in oil, not in cash. These older regimes still produce tax returns and exam questions, because licences that did not convert stay under them until they end.

This topic covers the petroleum profits tax for licences that have not converted: how the tax is charged, the classification of costs, posted prices, revenue, adjusted, assessable and chargeable profit, allowable and non-allowable deductions, capital allowances and the petroleum investment allowance, the 85% and 65.75% rates, additional tax, partnerships, incentives for gas, the memorandum of understanding, and production sharing contracts with the allocation of royalty, cost, tax and profit oil.

The previous topic covered offences, filing and enforcement. The next two cover mining.

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:

• petroleum profits tax: costs, revenue, deductions, allowances and rates;
• additional tax, partnerships, gas incentives and the memorandum of understanding;
• production sharing contracts and the allocation of oil.

CAMA 2020 and petroleum companies

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

Who is taxed and on what basis

Part II of Chapter Three of the NTA (from s. 90) applies to oil prospecting licences and oil mining leases that have not converted to the Petroleum Industry Act. Part III (from s. 102) applies to deep offshore and inland basin production sharing contracts that have not converted or have been renegotiated under the Act; the Deep Offshore and Inland Basin Production Sharing Contracts Act itself is repealed.

The assessment is on the actual year: the basis period is the company’s own accounting period, so the 2026 assessment is on the year from 1 January to 31 December 2026. Upstream activities cover acquiring licences, exploration, development and production, treating oil, processing gas and moving it to terminals; downstream activities cover transport, refining, liquefaction, distribution and marketing. Both are taxed under the NTA.

The Nigeria Revenue Service administers the tax and may hold property taken as security for tax.

Classification of costs

Revenue, posted prices and profit

The revenue of a period is the proceeds of chargeable oil sold, the value of chargeable oil disposed of (valued as for royalty), incidental income from petroleum operations and gains on disposal of assets. Chargeable oil is crude oil and casinghead petroleum spirit.

A posted price is the price free on board at the Nigerian port, in US dollars per barrel, for a stream and gravity, agreed with the government and bearing a fair relationship to comparable crude oils. It is measured in degrees of the American Petroleum Institute scale and adjusted for each degree above or below the standard.

Adjusted profit is the revenue less the allowed deductions; assessable profit is adjusted profit less earlier losses (and, on a restructuring, losses allowed to the new company); chargeable profit is assessable profit less capital allowances and the petroleum investment allowance. A company may, with approval and within five months of the period end, elect to defer part of a deduction to later periods.

Allowable deductions (s. 92)

Expenses wholly and exclusively incurred, including: rents for land and buildings used under the licence or lease; non-productive rents; royalties on natural gas sold and on crude oil and casinghead spirit; customs and excise and similar charges on equipment; repairs; interest on money borrowed for the operations, within the Third Schedule limit and the Transfer Pricing Regulations; intangible drilling costs of development wells; the first exploration well and the next two appraisal wells in a field; approved pension contributions; levies, stamp duties and fees; contributions to the approved decommissioning fund (the residue is taxed at the end); bad and doubtful debts, with recoveries taxed; and the development levy.

Deductions not allowed (s. 95)

Capital withdrawn or employed; improvements; amounts recoverable under insurance; premises not used for the operations; income and profits taxes; depreciation; payments to unapproved funds; customs duty on goods bought for resale or staff use, or available locally at a lower or equal price; the purchase of information on deposits; qualifying expenditure that earns capital allowance; tax or penalty borne for another; and any expense on which VAT was due but not charged, or import duty or levy was not paid.

A sum paid to a related party that does not meet the Transfer Pricing Regulations is not allowed.

Losses and capital allowances (ss. 97 and 98)

A loss is deducted from the next period and later periods until recouped. Capital allowances are 20% of qualifying expenditure a year, for five years on the straight line, given only if the asset is qualifying, wholly and exclusively used for petroleum operations, and owned and used at the end of the period (temporary disuse counts as use).

An asset bought in one period and used in the next may qualify in the period of purchase. The allowance deducted is the lower of the aggregate of the allowances due, and 85% of assessable profit less 170% of the petroleum investment allowance. Tax chargeable cannot be less than 15% of the tax that would arise with no deduction.

Any allowance not used is carried to the next period as if due then. Expenditure on which VAT was not charged is not qualifying.

Petroleum investment allowance

The allowance is given once for an asset, in the period when the spending is incurred, and is not taken into the residue. The older investment tax credit stays only for deep offshore and inland basin production sharing contracts.

Rates of the tax (s. 99)

The assessable tax is 85% of chargeable profit. A company that has not started continuous sales, and has not fully written off its pre-production capital spending, pays 65.75%, but only for up to five years from its first accounting period, whatever other incentive it has. A company that is granted or buys an interest in an asset that already had that rate pays 85% from its first accounting period.

A deep offshore production sharing contract pays 50% of chargeable profit for the life of the contract (s. 104).

Additional tax (s. 100)

If oil is sold between connected persons, or disposed of, and the tax comes out lower than the tax that would arise if the revenue were taken as barrels at the measurement point × the fiscal oil price, the company pays the difference with the final instalment. Where no price is set for a stream, the Commission sets one that bears a fair relation to comparable Nigerian streams or international prices.

Where oil is exported or sold by another company for the company, it is treated as the company’s own sale.

Partnerships (s. 101)

A person who is not a company and who engages in petroleum operations alone or in a partnership with a view to sharing profit commits an offence and is taxed on the profits and penalised.

For companies in a partnership or joint venture, the revenue service may make regulations to apportion profits, costs, allowances and tax, or to compute the tax as if one company did the work and share it. The regulations cannot impose a heavier burden than if each company had acted alone.

Incentives for associated and non-associated gas (ss. 93 and 94)

• Investment to separate oil and gas from the reservoir into usable products is part of oil field development, and so is capital spending on facilities to deliver associated gas in usable form at the custody transfer points.
• Condensate re-injected into the crude stream is treated as oil.
• The company pays the minimum charge set by the Minister for gas flared.
• Expenses for gas should be kept apart; those that cannot be separated are allowed against crude oil income; those only for gas are allowed against gas income taxed under Chapter Two.
• Natural gas liquid facilities that supply gas to downstream projects (aluminium smelting, methanol and similar) benefit; gas-to-liquids plant spending is capital allowance recovered against crude oil income; gas passed from the liquids plant to the gas-to-liquids plant bears 0% tax and 0% royalty.
• A company that has had one of these incentives cannot claim a similar one for the same project, including the economic development incentive. The same incentives apply to non-associated gas.

The memorandum of understanding

From 1 January 1986 joint venture companies with NNPC received a margin guarantee of US$2 a barrel, after tax and royalty, at a notional technical cost of US$2 a barrel, for realisable prices between US$12.50 and US$23, with a mechanism for lower prices. The goals were to increase exports, exploration, enhanced recovery, gas use and lifting of NNPC’s equity crude.

The companies undertook to lift crude that NNPC cannot lift, and to carry out a work programme. A barrel not lifted costs 2% of the average realisable price, not deductible. If the work programme is not met within three months of a notice, the incentive stops and the tax is worked out on the old basis. The MOU amount is deducted from the assessable tax to give the chargeable tax.

Production sharing contracts (Part III)

• Scope (s. 102). Deep offshore and inland basin contracts that have not converted or have been renegotiated under the Petroleum Industry Act.
• Licence term (s. 103). An oil prospecting licence under a contract lasts at least five and not more than ten years, as the Minister decides.
• Tax rate (s. 104). 50% of chargeable profits for the life of the contract. No holder or contractor is excused any other federal, state or local tax, duty or levy.
• Investment tax allowance (s. 105). 50% of qualifying capital expenditure, in the period the asset is first used.
• Royalty (s. 106). As in the Seventh Schedule to the Petroleum Industry Act.
• Currency (s. 107). Estimated and final tax are worked out in US dollars on the dollar returns.
• Royalty oil (s. 108). Enough oil to generate the royalty payable each month and the concession rental payable yearly.
• Cost oil (s. 109). Enough to recover the operating costs, in US dollars, as the contract provides.
• Tax oil (s. 110). Enough to equal the petroleum profits tax payable that month.
• Profit oil (s. 111). What remains after royalty, cost and tax oil, shared as the contract says.
• Payment (s. 112). The holder pays royalty, concession rentals and tax for itself and the contractor out of royalty oil and tax oil. The revenue service issues separate receipts to each for the tax paid on its behalf.
• Tax split (s. 113). Chargeable tax is shared between holder and contractor in the same ratio as the profit oil.
• Realisable price (s. 114). The price in the contract is used for royalty and tax on the crude oil produced and lifted.

Rates compared

Worked examples

1. Deductions = 7,560.
   Adjusted profit = 12,100 − 7,560 = ₦4,540m.
   Assessable profit = 4,540 − 22 = ₦4,518m.
2. Allowances due.
   400 + 30 + 45 = 475.
   Limit = 85% × 4,518 − 170% × 45 = 3,840.3 − 76.5 = 3,763.8.
   The lower is 475.
3. Chargeable profit.
   4,518 − 475 = ₦4,043m.
   Tax at 85% = ₦3,436.55m.

1. Annual allowance.
   20% × 210 = ₦42m.
2. Petroleum investment allowance.
   150 × 5% + 30 × 10% + 20 × 15% + 10 × 20% = 7.5 + 3 + 3 + 2 = ₦15.5m.
3. The investment allowance is not taken into the residue of the asset.

1. Adjustment = 1.15 × (37 − 33) = US$4.60.
2. Adjusted posted price.
   31.70 − 4.60 = US$27.10.

1. It pays 65.75% × 1,000 = ₦657.5m, instead of ₦850m at 85%.
2. The lower rate stops five years after its first accounting period, even if the spending is not written off.
3. A buyer of an interest from a company that had this rate pays 85% from its first period.

1. Royalty oil.
   12m ÷ 80 = 150,000 barrels.
   Cost oil = 30m ÷ 80 = 375,000.
   Tax oil = 20m ÷ 80 = 250,000.
2. Profit oil.
   1,000,000 − 150,000 − 375,000 − 250,000 = 225,000 barrels: holder 90,000 and contractor 135,000.
3. The tax of US$20m is shared 40:60, so US$8m for the holder and US$12m for the contractor, with separate receipts.

How to score full marks

• Say first which regime applies: unconverted lease (85%) or contract (50%).
• Follow the order: revenue, adjusted profit, loss, assessable profit, allowances, chargeable profit, tax.
• Apply the allowance limit and show both figures.
• Calculate the petroleum investment allowance by band and by depth.
• Use the oil allocation order: royalty, cost, tax, profit.

Common mistakes in the exam

• Using hydrocarbon tax rules, such as the cost price ratio, for an unconverted lease.
• Forgetting the 170% deduction in the allowance limit, or computing it wrongly.
• Putting the petroleum investment allowance into the residue.
• Using 65.75% for longer than five years.
• Giving the profit oil split to the tax instead of to the profit oil.
• Allowing interest on borrowing without the Third Schedule limit.

Quick revision

• PPT 85%; 65.75% for up to five years from the first period; PSC 50%.
• Capital allowance 20% for five years; limit 85% of assessable profit less 170% of PIA.
• PIA 5, 10, 15, 20% by depth.
• PSC: royalty oil, cost oil, tax oil, profit oil; US dollars.
• NTA Part II from s. 90; Part III from s. 102.
• 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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