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Power Sector Update Special Edition (Volume 2) – Renewables

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Value Added Tax (VAT) and its impact on uptake of Renewable
Energy Products in Nigeria

It is no news that the national grid has failed to provide a
sustainable and reliable source of electricity supply for domestic
and industrial consumers in order to sustain a rapidly growing
Nigerian population and economy. The World Bank reports that
though, about 55.4% of Nigeria’s population is connected to the
energy grid as at 2020, they are typically without power for about
85% of the time and almost nonexistent in certain
areas1. Over the past years, several off-grid power
companies have emerged to try and bridge this gap. A number of
these entities have typically used renewable energy sources which
serves the dual purpose of not only supplementing the grid
shortfall but also assisting the country in meeting its climate
change obligations under the various international agreements. It
is therefore important that Government develop policies which
support the continued growth of these renewable energy companies
(RECs).

Today, the bulk of the market for the RECs are in rural areas
where several of them have set up mini-grids or focused the sale of
their Solar Home Solutions (SHS). Pricing and affordability,
therefore, remains a key issue. One of the key sources of air
pollution in urban areas is small fossil generators in use by Small
and Medium Scale Enterprises (SMEs). It is important that a pricing
model be developed that encourages the transition of these SMEs
from the fossil fuel generators to the various solutions provided
by the RECs.

It is in view of the above, that the Government moved to exempt
the sale of renewable energy equipment from the application of VAT
in the VAT (Modification) Order 2021 (“the Order’).
However, the jury is out as to the impact of the exemption on the
pricing and affordability of the available solutions.

We have therefore decided to review the concept of VAT, the
provisions of the Order, and its potential impact on the various
renewable energy solutions on offer by RECs.

The Concept of VAT

VAT is charged and payable at a flat rate of 7.5% on all
supplies of goods and services in Nigeria other than those listed
as exempt or zero-rated in the First Schedule to the VAT Act. The
VAT Act defines goods as all forms of tangible properties, moveable
or immovable, but does not include land and building, money or
securities, and services as anything other than goods, or services
provided under a contract of employment and includes any intangible
or incorporeal (product, asset or property) over which a person has
ownership or rights, or from which he derives benefit, and which
can be transferred from one person to another, excluding interests
in land and building, money or security.

A supply is deemed to take place, under the VAT under the
following scenarios:

  1. At the time an invoice or receipt is issued by the supplier, or
    payment for consideration is due to, or received by the supplier in
    respect of that supply, whichever comes first;

  2. Where goods are supplied under any rental agreement or law
    which provides for periodic payments, they shall be deemed to be
    successively supplied for successive parts of the periods of the
    agreement or as determined by such law, and each of the successive
    supplies shall be deemed to occur when payment becomes due or is
    received, whichever is earlier;

  3. Where, and to the extent that, supply of taxable goods and
    services are progressively or periodically made under any agreement
    or law which provides for the consideration for that supply to be
    paid in instalments or periodically and in relation to the
    progressive or periodic supply, those supplies shall be deemed to
    be successively made, and each such successive supply shall be
    deemed to take place whenever any payment becomes due or is
    received or an invoice relating to only that payment is issued,
    whichever occurs first;

  4. Where goods are supplied under an instalment credit agreement,
    that supply shall be deemed to take place at the time the goods are
    delivered or the time any payment of consideration is received by
    the supplier in respect of the supply, whichever occurs first.

The Order, which has a commencement date of 30 July 2021,
replaces the erstwhile VAT (Modification) Order 2020. It modifies
the First Schedule to the VAT Act by expanding the list of exempt
goods and services and updated the definition of some terms to
ensure consistency with the amendments introduced to the VAT Act by
Finance Act, 2020. One of the additions to the list of exempt goods
under the Order is renewable energy equipment (REE). Consequently,
the supply of REE is an exempt transaction for VAT purposes in
Nigeria.

Review of the various energy solutions by RECs and the
potential impact of the Order on pricing

We have discussed below, the various solutions/models in use by
RECs and the potential impact of the Order on their pricing:

  1. Outright or Cash Sales: This is the simplest implementation
    model. Here, the RECs sell equipment to end users. The customers
    pay in cash for their system, and ownership and risk are
    transferred immediately. The operation and maintenance of the
    system also become the responsibility of the customer although the
    REC may provide any requested maintenance service for a fee. In
    this model, the sales value of the SHS will be exempt from VAT in
    line with the Order which may have the potential of reducing the
    cost by 7.5%. However, the fee charged for maintenance and other
    services will be subject to VAT.

    Only a few customers though, can afford the outright purchase of
    the equipment. There is a strong argument that the life cycle cost
    of these equipment compares favorably to that of any fossil fuel
    generator, though it is difficult to make this argument where
    customers can only relate to their immediate cash outflow rather
    than a life cycle cost. It therefore, is debatable if the removal
    of VAT on the sale of the equipment will lead to improved uptake of
    the product through this means.


  2. Lease to Own Model: Here, the equipment is provided to the
    customers under a lease agreement. There is in most cases, an
    intention to transfer ownership at the end of the lease period.
    However, financing considerations typically impact the
    classification of the lease into finance or operational leases. A
    lot of the RECs obtain funding from lenders who like to retain a
    lien over the equipment. Consequently, in a number of these cases,
    the equipment remains in the books of the REC until the customer
    completes its payment at the end of the lease period.

    This therefore causes confusion as to whether this is a hire
    purchase transaction or purely a rental transaction. The key
    question has always been whether it is possible to sell a piece of
    equipment under a hire purchase arrangement whilst retaining the
    same asset in your books as a fixed asset on which capital
    allowance is claimed on an annual basis? Yes, the intention is to
    transfer ownership, but this does not happen until the last
    instalment of the agreed monthly lease rental is received. So, are
    the equipment inventory or fixed assets?

    The sale of these equipment, whether they are classified as
    inventory or fixed assets, would be exempt from VAT under the
    Order, but would the monthly rentals where they are classified as
    fixed assets be treated as sales proceeds, rather than service fees
    which do not appear to enjoy the exemption provided under the
    Order? Given that there is a significant number of RECs which
    operate this model, it is important that this issue is given
    adequate consideration otherwise, the objective of reducing cost
    and therefore increasing uptake may not be achieved.


  3. Energy-as-a-service (EaaS): Here, the REC owns the system, and
    provides energy as a service to the customer, who pays a connection
    and periodic fees (e.g., monthly) to the REC or a fee per kWh. The
    customer is not responsible for the maintenance of the system and
    never becomes the owner. In the EaaS model, the periodic fees
    should be liable to VAT as it does not qualify as a sale of REE
    under the Order. This is also similar to what we have with grid
    power where power sold by the Distribution Companies (Discos) to
    final consumers are liable to VAT.

    However, this raises the question again of pricing and
    affordability. Given that a number of mini grids are in underserved
    or unserved areas which are mostly populated with low income
    earners, would it make sense to extend the VAT exemption to cover
    these set of consumers? This is especially because the source of
    the power in a lot of these mini-grids are renewable and
    sustainable so we are able to achieve a dual goal of extending
    energy access whilst meeting our climate change obligations.

Conclusion

The objective of improving energy access and meeting our climate
change obligations require that we consistently evolve innovative
solutions. We need to do things differently to achieve these
objectives. Addressing the VAT challenge in the sector is one of
the issues we need to resolve to unlock more of the potential in
the renewable energy sector. Dealing with the challenges
highlighted above is a good way to start. We may not be able to
resolve the issue of high cost of equipment as long as we continue
to import a significant portion of these equipment, but we can make
little changes which helps in addressing the overall cost and
improve uptake of these renewable energy solutions as means of
improving energy access through sustainable means.

Footnote

1. https://data.worldbank.org/indicator/EG.ELC.ACCS.ZS?locations=NG

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.

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