Cost Deductibility Rules For Upstream Petroleum Companies Under The NTA: Distinction Without A Difference?

Prior to the issuance of the Executive Orders on cost efficiency and project execution timeline, on the average, there was an additional 40% cost premium on petroleum exploration in Nigeria compared to peer countries.¹ Quite recently, several International Oil Companies (IOCs) have divested their onshore assets, partly due to high production costs and lower profitability. Petroleum exploration and production are highly capital intensive because huge investments are required both at the pre-production and production phases. Consequently, in making investment decisions in the upstream petroleum sector, the ease of cost recovery is a major consideration for investors. The Petroleum Industry Act (PIA), which was enacted in 2021, made some key changes to the Petroleum Profits Tax Act (PPTA) on deductibility of costs by companies that are engaged in upstream petroleum operations. This was part of several sweeping changes made to the petroleum industry, to create an improved and efficient, investor-friendly industry. More recently, the Nigerian Tax Act (NTA) has made further updates to the rules on cost deductibility by upstream petroleum companies.

This article chronicles the changes in the deductibility rules from the PPT to the PIA, and currently, the NTA. It also examines whether the changes introduced by the NTA are materially different from the PIA's position and the likely effects on the upstream petroleum industry.

Cost Deductibility rules under the PPTA and PIA

In Nigeria, the Wholly, Reasonably, Exclusively, and Necessarily (WREN) test has been a longstanding cost deductibility principle. The crux of the principle is that for an expense to be allowed for tax purposes, it must meet the four conditions of being wholly, reasonably, exclusively and necessarily incurred for the purpose of generating a company's profit. This concept is contained in the Companies Income Tax Act (CITA), generally applicable to companies' doing business in Nigeria.² Under the PPTA, the equivalent principle is the WEN test³ which requires an expense to be Wholly, Exclusively, and Necessarily incurred for petroleum operations, for it to qualify for tax deductibility. Given that upstream petroleum companies (with converted licences) are now subject to CIT and HCT, the PIA in effect, updated the WEN test as contained in the PPTA with the addition of another condition, reasonability of costs. The PIA also introduced a ceiling on the maximum amount that can be deducted as costs for Hydrocarbon Tax (HCT) purposes, via the Cost Price Ratio (CPR) limits. Essentially, in determining chargeable profits for HCT purposes, the maximum amount that can be allowed as costs, is sixty-five per cent (65%) of the gross revenues determined at the measurement points, (i.e., at the production head, prior to any adjustments in revenue). Any cost in excess of the CPR limit will be carried forward to subsequent periods, provided that such costs do not exceed the CPR limit in any particular year.

Under the PPTA, qualifying capital expenditure could be amortized for five (5) years with a 1% retention value.⁴ The PIA maintained this requirement of amortization for a period of 5 years with a 1% retention value until the asset is disposed of. The PIA, however, included the condition that the disposal or write off must be with the consent of the Nigerian Upstream Petroleum Regulatory Commission (NUPRC) or anyone authorised by it.⁵ In practice though, the Licensee/Lessee would typically notify the national oil company before such disposal.

Cost Deductibility rules under the NTA

The NTA amended the requirement that costs should be WREN incurred for tax deductibility purposes and retained only the requirements that such costs be Wholly and Exclusively⁶ incurred to qualify for deductibility. This appears quite simple and straightforward, when juxtaposed with the subjectivity that accompanied the Reasonability and Necessary test, in some instances. Given that the NTA has effectively repealed the PPTA and CITA, and amended the PIA, upstream petroleum companies will simply need to provide evidence that such costs were wholly and exclusively incurred to qualify for deduction. Nonetheless, the costs are still subject to the CPR limit for HCT purposes. This is because the CPR ratio prescribed in the PIA was retained in the NTA.⁷

Curiously, the NTA introduced an additional restriction that no deduction will be allowed for any expense on which VAT is due but not charged, or on which the applicable import duty or levy was not paid. The NTA also provides that for Decommissioning and Abandonment (D&A) Costs to be tax deductible, the Licensee or Lessee must deposit a minimum of thirty percent (30%) of the fund with a Nigerian Bank, in the form of an escrow account accessible by the NUPRC.⁸ This provision effectively amends the NUPRC D&A Regulations made pursuant to the PIA. The D&A regulations prescribe a minimum of fifteen (15%) of funds to be deposited with a Nigerian bank.

The NTA has also retained the 5 years limitation for asset claims under the PIA. Curiously, the 1% retention value, and the requirement of consent of the NUPRC for the disposal of assets on which capital allowance has been claimed was retained in the NTA.⁹

Implications of the Cost Deductibility Rules in the NTA

The deletion of the "reasonability" and "necessity" tests, for petroleum mining licences (PMLs) and the "necessity" test for oil mining licences (OMLs) may have significant positive implications for expense deductibility for tax purposes for upstream petroleum operations companies. This is because the application of the WREN test for PMLs, or the WEN test for OMLs has been a subject of dispute between the tax authority and taxpayers over the years, with the contention on the reasonability and necessity of certain expenses. In some instances, the matter has been a subject of judicial interpretation in several cases such as SPDC V Federal Board of Internal Revenue¹⁰ wherein the Court held that some disputed expenses, whose necessity were being questioned by the Nigerian tax authority were "WEN" incurred, because there was a statutory duty on the appellant (i.e., the tax payer) to incur the expenditure. Conversely, in some other cases the Courts have based their decision on other factors apart from the existence of a statutory duty and ruled in favour of the taxpayers. Thus, the modifications to the "WREN" test by the NTA has further clarified and simplified the concept by removing the subjectivity that may be associated with 'the reasonability and necessity" conditions. Although the 5-year limit on asset claims retained in the NTA is more of an amortization issue, it may impact cash flow of an upstream petroleum company.

Also worthy of note is the increased threshold for domiciliation of D&A funds, which appears to be a local content initiative. Interestingly, under the PIA, there was no restriction on deductibility of D&A funding, provided that only the funded cost was deductible for tax purposes. However, any surplus or residue of the fund returned to the lessee would be subjected to tax. Notably, the apparent conflict between the threshold under the NTA and the threshold in the D&A Regulations seems to defeat the objective of the NTA which is to provide a unified and harmonised fiscal legislation. The apparent policy shift occasioned by this becomes more glaring considering that the average life span of oil fields in Nigeria is about 15 to 30 years and the NUPRC Regulations was just signed in 2023. Consequently, Final Investment Decisions modelled based on the NUPRC D&A regulations will have to be adjusted, with significant cash flow implications for lessees. Given that the NTA is an enactment by the National Assembly, its provisions are superior to those of the NUPRC regulations.

The restriction on deductibility of expenses for which VAT was not charged, or import duty was not paid is compliance driven. Although some are of the view that this amounts to double jeopardy, it only becomes so where the Licensee or Lessee is in default. It is expected that every Licensee will take all necessary steps to remain compliant with its tax compliance obligations.

Comparison with Tax Deductibility Rules in Select Jurisdictions

When compared with select peer countries, the updated cost deductibility rules may appear slightly more favourable, given that the necessity and reasonability tests are no longer obtainable. Furthermore, the recent introduction of incentives such as the incentives for onshore shallow water, Non-Associated Gas (NAG), midstream gas investments, and the Deep offshore oil and gas production incentives, would gradually continue to improve the economic viability of the upstream petroleum industry. Relatedly, the Upstream Petroleum Operations (Cost Efficiency Incentives) Order, 2025 which was signed into law earlier this year, is expected to address some underlying issues contributing to the high cost overrun in the upstream petroleum industry in Nigeria.

Conclusion

Although the NTA has grandfathered the key provisions of the PIA relating to fiscals for upstream petroleum operations, the highlighted provisions on D&A costs and deductibility of expenses on which VAT was not charged or import duty not paid are significant policy changes that can impact upstream petroleum companies' operations. It is expected that with the implementation of the NTA, the combined effects of these provisions and its impact on cash flow and further investments in the upstream petroleum industry can be ascertained. Where necessary, further adjustments may be required to improve the global competitiveness of the Nigerian upstream petroleum industry.

Footnotes

1. Keynote address by the Special Adviser to the President on energy, at an executive session of Energy Institute Nigeria and the Nigerian Association of Petroleum Explorationists (NAPE), reported in NUPRC Upstream Gaze May 2025 Vol 9.

2. Section 24 of the Companies Income Tax Act (CITA)

3. Section 10 of the Petroleum Profits Tax Act, CAP P13 LFN 2004

4. Paragraph 6 Second Schedule to the Petroleum Profits Tax Act, CAP P13, LFN 2004

5. Paragraph 5(2)&(3) 5th Schedule to the PIA

6. Section 68(1) Nigerian Tax Act (NTA)

7. Section 71(2) NTA, Paragraph 2(1) of the 6th Schedule to the NTA

8. Section 86(1) Nigerian Tax Act (NTA)