The former US President, Barack Obama during the lunch of Power Africa once declared “Access to electricity is fundamental to opportunity in this age. It’s the light that children study by; the energy that allows an idea to be transformed into a real business. And it’s the connection that’s needed to plug Africa into the grid of the global economy. You’ve got to have power.”
The Nigerian power sector is one of the sectors in the Nigerian economy that is in urgent need of significant investment as its utility-scale electricity generation capacity is unable to meet domestic demands. Nigeria currently has an installed electricity generation capacity for supply to the national grid of approximately 12,500 megawatts (MW), with available capacity between 3,500MW to 5,000MW for onward transmission to the final consumer. The available capacity has continually failed to meet the needs of Nigeria’s population of nearly 200 million people. This pales in comparison to South Africa, which has an installed electricity generation capacity for supply to the national grid of approximately 50,000 MW with a population of just about one-third of Nigeria’s.
In the past, efforts have been channeled towards stimulating the power sector to deliver greater available capacity. The passage of the Electric Power Sector Reform Act (EPSRA) in 2005 is an example. The main thrust of the Act was the unbundling of the then government-controlled monopoly, the Power Holding Company of Nigeria (PHCN). Despite these reforms, the industry still faces a myriad of issues; though such issues are mostly tied to liquidity of the companies operating in the sector, thereby inhibiting the growth of the sector.
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Some of these issues relate to an increase in foreign exchange losses resulting from foreign exchange differences, an increase in the cost of power equipment and cables, and a high import duty on power equipment.
Of significant importance is the non-applicability of a cost reflective tariff which has also been a factor hindering the growth and ultimately the substantial shortfall in the revenue of companies operating in that sector, specifically power distribution companies (Discos).
To address this issue, the Government had approved the adoption of the cost reflective tariff effective 1 April 2020, though there has been resistance on the part of the consumers based on the impact of the COVID-19 pandemic. This moved the Government to issue an order suspending the implementation of the tariff system.
Notwithstanding the general operational issues highlighted, there are also tax and regulatory issues specific to companies operating in this sector which have also negatively impacted the growth and development of the sector and its ability to attract foreign direct investment (FDI).
Prior to the extension of the value-added tax (VAT) exemption list by the Minister of Finance, power- generating companies ( Gencos) operating gas fired plants were not able to recover the input VAT incurred on the purchase of natural gas. This led to an increase in operation costs as the companies had to expense the input VAT incurred on such transactions. With the extension of the VAT exemption list by the Minister of Finance via the VAT Modification Order 2020 ( the Order) to include natural gas, the Gencos now should be able to buy the requisite gas for electricity generation without having to incur the additional cost arising from input VAT.
While this was a welcomed development by these companies in alleviating the additional VAT cost being borne by them, the Federal Inland Revenue Service (FIRS) recently issued a public notice stating that contrary to the Order, natural gas should not be treated as VAT exempt and all such transactions should still be subject to VAT. There are debates as to whether a public notice issued by the FIRS can override the provisions of the Order signed by the Minister of Finance. This continues to create uncertainty on the application of VAT and its attendant cost borne by the Gencos.
Prior to the enactment of the Finance Act 2019, the foreign shareholding interest in most of the power companies, which was mostly above 25%, previously exempted some of the power companies from minimum tax payable in any assessment year. The Finance Act amended this criterion, exempting only companies with a turnover threshold of less than NGN25 million from the payment of minimum tax. Due to the nature of companies operating within this sector, it is unlikely that these companies will have a turnover threshold less than NGN25 million. The implication of this is that these companies should now be subject to a minimum tax payment, thereby negatively impacting a business which is currently undergoing liquidity and profitability issues.
Prior to the enactment of Finance Act 2019, Company Income Tax Act (CITA) exempted interest paid on foreign loans from withholding tax (WHT) up to a maximum of 100% depending on the repayment and moratorium period. With the enactment of the Finance Act 2019, the 100% maximum WHT exemption on interest has been amended to 70%, implying that the WHT exemption on interest payment to the providers of foreign loans should no longer enjoy the 100% tax exemption benefit.
Further, with the introduction of thin capitalisation rules, interest payments to foreign connected persons in excess of 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA) will be adjusted for tax purposes, increasing the tax expense of these companies despite the poor profitability reported by these companies. The greater risk here is the potential of the unexpensed interest expiring and not being tax deductible after the threshold number of years in line with the Finance Act 2019.
These significant changes in the treatment of interest on foreign loans and tax deductibility on the payment of such interest may negatively impact the ability of these companies to finance projects that should enhance the development of the sector.
The benefit of tax incentives in stimulating economic growth cannot be over-emphasised as tax incentives play a strategic role in attracting investment in certain sectors of the economy. The power sector in Nigeria should benefit from attracting such investments, specifically FDI, to enhance and stimulate growth within the sector.
Some of these tax incentives should be directed at improving participation in this sector. For instance, given the restrictions on the deductibility of interest payments made to foreign connected persons and the WHT exemption on interest payments made on foreign loans, power companies should be exempted from these provisions to encourage ease in sourcing for finance to carry out power generation and distribution projects which should ultimately develop the sector.
Further, given the liquidity and profitability issues being tackled by the companies operating in the sector, they should be exempted from minimum tax. The CITA grants an exemption on the payment of minimum tax for companies operating in the agricultural sector of the Nigerian economy. The exemption was granted to stimulate growth and encourage participation within that sector. In the same vein, the benefit should also be extended to companies operating within the power sector given the Government’s goal to stimulate growth in that sector.
The Nigerian power sector is pivotal to the industrialisation of Nigeria. Growth of companies operating within all other sectors of the Nigerian economy is heavily dependent on the success of the power sector as they all need power to run effectively. The inconsistent power supply in Nigeria has caused some companies in Nigeria to relocate to other countries.
These tax incentives, if considered, can play a pivotal role in encouraging both domestic and foreign investment. How useful they can be, and at what cost, will depend on how well the tax incentive programmes are designed, implemented and monitored.
