National media platforms have been awash with the debates around the legality of claiming Value Added Tax (VAT); the state or the federal government. VAT is the consumption tax paid on all goods and services provided or imported into Nigeria. The 1999 Constitution sets that the Federal Government (FG), through laws of the power of the National Assembly, are to make legislative orders on matters contained in the exclusive list. To this end, the exclusive list states that the power of the Federal Government shall collect ‘taxation of income, profits and capital gains, except as otherwise prescribed’ with no mention of VAT collections.
The Federal Inland Revenue Service (FIRS) is mandated for revenues accruing to the FG but has also solely been responsible for administering and managing VAT. The Federal High Court (FHC) recently ruled in favour of the Rivers State Government (RSG), while the Court of Appeal (COA) granted the appeal by the FIRS to stay execution on an earlier judgement of the FHC. As a result, the decision on who collects VAT, State or the Federal Government, still linger. Following the FHC ruling that the federal government or any of its agencies lacks the powers to impose and collect VAT or any other tax not explicitly provided for in the Constitution, uncertainty remains in taxpayers’ minds regarding compliance. A ruling by the Apex court in favour of the RSG will usher in a different era for VAT collection in Nigeria driven by state governments. Individual states will then appoint their respective tax agencies to supervise the collection of taxes.
Little is being thought about what state VAT collection could mean for the Electricity sector. Nigeria’s electricity sector value chain comprises generation, transmission and distribution sub-sectors that support the delivery of electricity to end-users connected to the national grid. Distinct in their functions, these sub-sectors collaborate and have assets, operations, and networks that transcend state boundaries. Historically, VAT has been a topical issue in the electricity market following the privatization of the distribution and generation segment of the value chain. The distribution segment is the main point of revenue collection from customers, with the funds collected flowing down the value chain to other market participants. However, there have been intermittent disagreements with the federal tax authority on VAT treatment from electricity sales and attendant compliance approach.
From the “Cash” vs “accrual” method of accounting for VAT, the argument of whether electricity is a “good” or “service” to the argument of whether DisCos should claim Input VAT against Output VAT. What we have seen is maturity, tact, consideration, and professionalism in the Federal Inland Revenue Service (FIRS) ‘s approach to dispute resolution under the guidance of the Ministry of Finance (MOF). While some of these issues have been resolved via a clear Federal Government (FG) directive through the 2018 VAT modification order – highlighting that VAT in the Nigerian Power Sector should have one collection point – in this instance, the DisCos – it is obvious that understanding of the liquidity challenges of the sector at the federal level helped the FG take such stance.
State collection of VAT is expected to impact the electricity market in several manners, from the DisCos to state tax officials and possibly electricity end-users in the following ways:
- VAT Remittance: Currently, VAT is remitted by the DisCos to a single collection authority – the FIRS. However, the new VAT regime may necessitate some additional administrative burden for the DisCos and other market participants. The burden is because they must account for VAT to remit to the various tax authority of states where they operate. Note that nine (9) of the eleven (11) DisCos in Nigeria operates in more than one state. Therefore, holistically, this will mean a DisCo in State A (which operates state B, C, D) will have to introduce an administrative structure that remits VAT on electricity payments made in state D to State D’s government.
- Energy Accounting: Given that VAT is a consumption tax, it should be computed based on energy consumed by customers in a state’s geographical area. But the market reality is that energy consumed may not translate to cash collected from energy sales due to commercial and technical loss for post-paid customers and advance payment for prepaid customers. Therefore, it makes sense that DisCos’ VAT remittance should be cash-based given liquidity constraints and the above peculiarity. However, state tax authorities may hold a different view from this cash-based approach favouring the accrual approach that focuses on receivables as a base. Nonetheless, the VAT to be remitted to states will likely be determined based on energy consumed by customers in the state’s geographical area. It is expected that economically and commercially more active states like Lagos and Rivers will get more VAT based on this approach, given that more economic activities impact positively on load demand and productive use of power.
- The Resurrection of Old issues: The 2018 VAT modification order was meant to put to rest the debate between the FIRS and DisCos on the subject of a claim on Input VAT vs Output VAT. However, this issue may likely resurrect in a new frontier between the state tax authorities and electricity market operators. For instance, a Generation Company (GenCo) in state A may be required to issue a VAT invoice for energy supplied to the grid. At the same time, the DisCo in state B will be required to remit VAT while purchasing electricity for resale. More so, gas suppliers to GenCos may not be excluded in the requirement to issue a VAT invoice. This is as the various state tax authorities will likely take positions that will be more favourable to their revenue profile from VAT independently, not considering that the electricity value chain is interlinked across geographical boundaries. This will result in incidences of double taxation and increased cash strain in a sector that already has acute liquidity constraints.
- Reversal of Progressive VAT Exemptions: The power sector has traditionally enjoyed various incentives under the current VAT regime. Most recently, the exemptions under the 2020 VAT modification order extended to renewable energy equipment that supports the promising off-grid power sector. However, the state governments may view these exemptions differently and reverse them in their various tax laws.
- Tax Dispute Resolution: The electricity market is a unique sector that requires a deep understanding of its issues and constraints for successful collaboration. While tax compliance is the responsibility of every taxable entity and corporate body in a state, managing this relationship between the tax authority and electricity market players require a sound knowledge of the sector. The power sector has thrived on the FIRS understanding and appreciation of the sector and instances of the principal ministry – the Ministry of Finance remaining abreast with the sector issues. These have been evident through active involvement in resolving the liquidity crisis in the sector via various intervention funds in collaboration with the Central Bank of Nigeria and other multilateral agencies. However, this place of understanding will likely evaporate in a new state VAT collection regime in the event of tax dispute resolution between power sector participants and the state tax authorities. The state tax authorities may be limited in understanding the end-to-end operation of the power sector and the far-reaching effect their enforcement actions may have on a participant’s operation during tax disputes. We are aware of gross misconduct (with experiences where power sector staff have been restrained from premises and substations) with officials of state tax authorities towards state taxes and levies like business premises, personal income taxes etc. Therefore, to ensure state authorities are cordial towards tax collections, investments into enlightenment on power sector issues must be paramount.
- Revenue Flow: It is anticipated that the current move by state governments will improve the states’ revenue profile, which will enable them to participate in more power project investments. While this is true, there is some blindside to this argument. A State-imposed VAT collection regime will be unfavourable to many not commercially vibrant states and will make them worst-off. Again, some poor states are likely to be more aggressive given new powers and little technical know-how. As a result, DisCos operating in such states are likely to be seen as cash cows, possibly precipitating bureaucracy and disputes. The potential aftermath of the new VAT regime on less commercially viable states will drive states to explore more ideas to be more economically viable.
- Power Sector Interventions: It is important to note that derivation from the VAT treasury is helpful for the FG to fund power sector interventions that are beneficial to all states of the federation. According to the National Bureau of Statistics, VAT contributed N1.53 trillion to the federation account in 2020, shared between the FG and the 36 states. Where this revenue source is unplugged and disrupted, the FG may struggle to fund various power sector interventions.
While there are valid pros and cons on both sides of the argument, consideration must be given to provisions of the law and capacity for collection. This will ensure that there is no revenue leakage, given the dire funding needs in the power sector. Furthermore, depending on the final position reached on the matter, proper power sector stakeholder engagement is crucial during implementation to enable stakeholders to maintain current incentives to the sector, ease VAT administration, and prevent more constraints on the already burdened power sector.