On 26th March 2018, in Federal Inland Revenue Service v. Mobil Producing Nigeria Unlimited (FHC/L/3A/2017), the Federal High Court (FHC) sitting in Lagos, Nigeria delivered judgment on the vexed issue of the tax treatment of gas flaring penalties paid by companies which flare associated gas. The FHC overturned the decision of the Tax Appeal Tribunal (TAT) that expenses incurred for flaring gas (penalties) are tax deductible.
Mobil Producing Nigeria Unlimited (MPNU) having flared gas made payments for the gas flared to the Ministry of Petroleum which in turn issued receipts titled "gas flaring penalty". MPNU treated these gas flaring penalties as allowable deductions. However, FIRS disallowed this treatment and subjected the gas flaring penalties to tax as part of the revenue of MPNU in the years 2006 – 2008.
MPNU challenged the decision of the FIRS at the TAT. The TAT ruled in favour of MPNU and set aside the additional taxes which prompted the present appeal. The decision of the TAT was based on the fact that the Associated Gas Re-injection Act (AGRA) and other applicable laws have no provision for monetary penalties where gas is flared without the written permission of the Minister.
Position of the Parties
In summary, FIRS argued as follows:
- MPNU did not have any written permission or certificate from the Minister authorizing MPNU to flare gas in the years of assessment;
- The Ministry of Petroleum through the DPR labelled the monies paid by MPNU as "gas flaring penalties". Penalties are not allowable deductions.
The position of MPNU is summarized as follows:
- Where gas cannot be utilized or re-injected, it must be flared. When MPNU flared gas, it had a statutory duty under the AGRA to pay gas flaring fees, thus the sums were incurred wholly, exclusively and necessarily in its petroleum operations.
- Pursuant to Section 10 PPTA, all payments to the Federal, State, and Local Governments are allowable deductions. Thus payments for flaring gas are allowable deductions having been paid to the Federal Government irrespective of whether they were paid without first obtaining a permit/certificate from the Minister.
- MPNU should not be punished for the failure of the Minister to respond timeously to its application for a gas flaring permit.
- The Minister could not have intended to classify the sums paid by MPNU as penalties because Section 4 of the Associated Gas Re-injection Act (AGRA) does not envisage monetary penalties for breach of AGRA provisions. In effect, the DPR acted in error when it labelled the sums paid by MPNU as "gas flaring penalties", rather than as "gas flaring fees".
Decision of the Court
In resolving the dispute, the Court formulated two issues for determination as follows:
- Whether MPNU complied with the provisions of Section 3 of the AGRA; and
- Whether payments for gas flared without first obtaining certificates/written permits from the Minister are allowable deductions
The court held that MPNU could not validly flare gas without a written permission/certificate from the Minister. A written permission or certificate from the Minister is a condition precedent to flare gas in Nigeria. The court added that the Minister has the discretion on whether to grant permission or a certificate for gas flaring as it is not granted as a matter of course. The court concluded, that the delay or failure by the Minister to respond to the application for a permit or certificate for gas flaring should not be presumed as an approval– tacit or otherwise.
The court held that by failing to first obtain a written permit or certificate from the Minister before flaring gas, all payments by MPNU in respect of gas flared in 2006 – 2008 are invalid and illegal. The court further held that MPNU cannot rely on these illegal payments to claim tax deductions under Section 10 PPTA.
Implications of this Decision
For many years the Minister failed to give written permission to companies to flare gas despite the fact that these companies duly applied for the permission. These companies were compelled to pay fees (penalties) to flare gas. It is our respectful opinion that the decision of the court that gas flaring fees are not tax deductible if paid without the written permission of the Minister, does not reflect the position of applicable laws for the following reasons:
- Applicable laws on gas flaring in Nigeria do not provide for monetary penalty when gas is flared without the written permission of the Minister. The penalties paid by MPNU are compensatory (not punitive) and such penalties have been held to be tax deductible in other jurisdictions;
- Assuming the payments by MPNU are penalties – the PPTA does not provide that penalties are not tax deductible.
- On the issue of illegality, the Minister is not expected to receive payments from an illegal act. What the Minister is expected to do if it considers the act of flaring gas illegal is to suspend or withdraw the license of the person guilty of the illegality.
Having said that penalties are allowable deductions, it is also clear that the labelling of payments by MPNU for gas flaring as "gas flaring penalty" has influenced the mind of the court in ruling that the "gas flaring penalties" are not allowable deductions. If the payments had merely been labeled as "gas flaring fees" as provided in the AGRA, the decision of the court would have be different. Thus, taxpayers are advised to ensure that transactions and payments are labelled consistently and accurately both in their books and in the books of the recipient. This can be a deciding factor in determining the tax treatment of such transactions or payments.
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