Once again, the vexed issue of the tax treatment of gas flaring penalties paid by companies that flare associated gas came under the judicial review of the Federal High Court (FHC) in the case of Federal Inland Revenue Service v. The Shell Petroleum Development Company of Nigeria Ltd (FHC/L/1A/2017). In a judgment delivered on June 25th 2018, the FHC (Justice Aikawa) did not only overturn the decision of the Tax Appeal Tribunal (TAT) that expenses incurred for flaring gas (penalties) are tax deductible but also held that it is ultra-vires the TAT to attempt to classify such expenses/penalties as royalty.
The Shell Petroleum Development Company of Nigeria Ltd (SPDC) had treated the fees it paid to the Ministry of Petroleum for gas flared by it as allowable deductions in its tax computation for the period between 2006 and 2008. This treatment was disallowed by the Federal Inland Revenue Service (FIRS) based on FIRS’ contention that the fees paid for flared gas without the approval of the Minister of Petroleum amount to penalties – not allowable for tax purpose. This decision of the FIRS was challenged by SPDC before the TAT, Lagos Zonal Division which overruled the decision of the FIRS thus giving rise to this appeal at the FHC.
In resolving the dispute, the court adopted the following two issues:
On the first issue, the FHC held that while it is within the power of the TAT to determine what amount of tax is payable, the TAT acted outside the scope of its power by substituting the payment from penalty to royalty. The FHC held in respect of the above as follows:
…it [the Tax Appeal Tribunal] would be acting ultra vires if it proceeds to substitute the class of payment from penalty to royalty. This would be a direct encroachment on the administrative powers of the minister.”
– page 7 of the Judgement
On the second issue on the tax treatment of penalties incurred for flared gas, the FHC held as follows:
While I do not agree with the Learned counsel to the Appellant that gas flaring is out rightly illegal in Nigeria in view of statutory provisions and decided cases, I will however agree with him that fees for gas flaring is not within the category of expenses incurred wholly, exclusively from the Respondent’s petroleum operations as envisaged by section 10 of the petroleum profit tax act.
– page 12 of the Judgement
The FHC has been consistent in holding that the fees paid by companies that flare gas without the approval of the Minister are not tax deductible. It is important to note that 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.
In our opinion, the decision of the FHC on the tax treatment of fees paid for gas flared without the written permission of the Minister, does not reflect the position of applicable laws for the following reasons:
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