Countries around the world are undergoing an energy transition in a bid to combat climate change and achieve net zero carbon emission targets. This is the main driver for the switch from a fossil-fuel-dominated energy industry to one focused on cleaner and renewable energy sources. Due to its competitiveness when compared with other fossil fuel types and its ability to enhance renewable energy integration into the energy mix, natural gas appears to be the most suitable energy type for the move towards cleaner energy for most countries.

The good news is that Nigeria has one of the largest natural gas reserves in the world and is said to be a gas province with some oil reserves. According to the Department of Petroleum Resources, Nigeria had proven natural gas reserves of 206.53 trillion cubic feet as at June 2021. Natural gas is undoubtedly critical to Nigeria's economic development, given its uses in power generation, petrochemicals & fertilizers, auto-gas, industrial heating, liquefied natural gas (LNG) and liquefied petroleum gas (LPG) projects, amongst other uses. It is, therefore, important that the government's policies, including tax policies, are geared towards encouraging investments in gas development.

Taxation remains a viable source of government revenue and just like every other sector, the Federal Government is able to assess and collect both direct and indirect taxes in Nigeria's gas sector. As such, the supply of taxable goods and services in the gas sector are liable to indirect taxes such as Value Added Tax (VAT). The newly introduced VAT (Modification) Order 2021 ("the Order") imposes VAT on the supply of natural gas to most gas-based industries with the exception of the power generation companies.

This article provides a brief overview of the VAT regime in Nigeria and examines the potential implications of the imposition of VAT on natural gas for LPG producers operating in Nigeria.

Overview of VAT

The VAT Act (as amended) provides the legal basis for the imposition of VAT on the supply of all goods and services in Nigeria except those specifically listed as exempt in the First Schedule to the VAT Act or VAT Modification Orders. VAT is a multistage consumption tax, which is charged at 7.5% and collected at each stage of the production process.

The VAT paid on goods and services purchased or goods imported into Nigeria is known as input VAT, while the VAT on goods and services sold is referred to as output VAT.

Based on Section 17 of the VAT Act, some companies are able to recover the input VAT incurred during the production process. Recoverable input VAT is restricted to VAT 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 VAT is charged. However, input VAT cannot be recovered when the good or service is exempt from VAT and such input VAT must be expensed by companies through the income statement.

The Honourable Minister of Finance, Budget and National Planning recently issued the VAT (Modification) Order 2021 which modifies and expands the list of exempt items provided in the First Schedule of the VAT Act. The Order revokes and supersedes the VAT (Modification) Order 2020 and all other VAT (Modification) Orders issued before the commencement of the Order. Prior to the issuance of the Order, natural gas and LPG were exempt from VAT based on the VAT (Modification) Order 2020. However, based on the amendments introduced by the Order, only locally produced LPG is now exempt from VAT, which implies that natural gas and imported LPG will now attract VAT.

Natural gas serves as an input in the production of LPG and would now attract VAT based on the Order. However, LPG producers would not be allowed to charge output VAT on their invoices, as locally produced LPG remains exempt from VAT. This implies that LPG producers would not have an output VAT against which the input VAT incurred on the purchase of natural gas can be offset. Consequently, the input VAT incurred will have to be expensed.

Expensing the input VAT will increase the cost of doing business for LPG producers, as the tax cost benefit will be only 32% of the input VAT incurred. This is because the maximum recovery of the VAT expense against taxable profits is limited to 32%, given the Companies Income Tax and Tertiary Education Tax rates of 30% and 2% respectively. Thus, there is a likelihood that the domestic producers will consider the input VAT incurred on natural gas in arriving at the selling price of LPG and the resulting implication is that the input VAT will be passed on to final consumers in form of higher prices.

Meanwhile, the continuous increase in the price of LPG across Nigeria poses a challenge to the government's plan to increase domestic gas usage, as some Nigerians are now switching to conventional energy sources such as firewood and charcoal. For instance, the cost of filling a 12.5kg cylinder of LPG which sold for about ₦4,000 earlier this year has risen to almost ₦10,000 and is now beyond the reach of many Nigerian households.

We believe that the objective of imposing VAT on imported LPG and exempting locally produced LPG from VAT is to make the price of locally produced LPG competitive in comparison with imported LPG. Ordinarily, this should encourage investment in the domestic production of LPG. However, the imposition of VAT on the feedstock of domestic LPG plants contradicts this objective, as Nigerian consumers will indirectly pay VAT on the consumption of locally produced LPG. Curiously, the new VAT rules appear to be more favourable to LPG importers given that they will be able to recover the input VAT payable at the port of importation from the output VAT to be charged on the subsequent sale of LPG to end users, since imported LPG is now liable to VAT.

Interestingly, the Nigerian government has always attempted to incentivize domestic gas production and utilization. For instance, plant, machinery and equipment purchased for the utilisation of gas in downstream operations are exempt from VAT. In addition, companies engaged in gas utilisation (downstream operations) can also get a tax holiday of 3 to 5 years. Also, the recently enacted Petroleum Industry Act (PIA) introduces tax incentives for midstream and downstream petroleum operations, including additional five years tax holiday for investors in gas pipelines. However, these incentives have been inadequate in attracting the much needed investment to the sector due to the capital intensive nature of gas projects and other factors.

Recent actions by the government have been geared towards maximizing domestic gas utilisation in the country. For instance, earlier in the year, the government declared 2021 to 2030 as Nigeria's "Decade of Gas", with the goal of boosting the widespread utilisation of gas products and having an economy entirely powered by gas by 2030. To support this plan, policies and projects such as the Natural Gas Expansion Programme, Autogas Policy and the reconstruction of the 614-km Ajaokuta-Kano gas pipeline have been launched.

Despite the actions and policies highlighted above, the gas sector may be worse off because of the imposition of VAT on natural gas, which increases the retail price of domestic LPG and has an adverse effect on returns of retailers due to reduced demand for products.

Can LPG Producers Avoid Paying Input VAT on Natural Gas?

Under the existing fiscal regime prior to the implementation of the newly enacted PIA, a company could be involved in both upstream and downstream activities by holding the licence to an oilfield and also operating a gas processing plant. Where this is the case, input VAT will not be incurred on the acquisition of natural gas, as the gas will be produced directly by the entity. Conversely, where natural gas is purchased from third parties, VAT will be charged on the invoices to the LPG producers.

However, based on the PIA, companies intending to be involved in more than one stream of petroleum operations are required to register a separate company for each stream. The exploration for, appraisal of, development of and winning or obtaining of petroleum (which includes natural gas) is deemed to be upstream operations, while activities with respect to construction and operations of gas processing facilities producing propane and butane (which are LPGs) are considered to be midstream operations. The PIA therefore requires companies to separate any existing integrated operations into distinct legal entities. This implies that the sale of gas between the newly separated entities will attract VAT.

Although the PIA provides that an upstream company can carry out midstream operations if it is established as an integrated strategic project, the natural gas obtained from the upstream petroleum operations will be deemed to be sold or transferred to the midstream petroleum operations at an arms-length transfer price. This also implies that VAT will be payable, notwithstanding that the natural gas is being produced and processed into natural gas by the same entity.


Successive governments have made efforts to develop the gas sector and encourage domestic usage of gas as part of an overall goal of promoting diversification, minimising gas flaring and transitioning to cleaner energy. However, the imposition of VAT on natural gas may ultimately reverse the progress already made in this regard due to its impact of increasing LPG prices.

Hence, government may need to reconsider the current VAT rules on natural gas and weigh the objective of increased government revenue against the need to encourage the use of cleaner energy and diversification of the economy away from oil.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.