Project Finance, Nigeria's '007' Executive Order, and the Creation of a New Tradable Instrument

Image Courtesy: Resource Planning Group Georgia

Resolving the infrastructure deficit in Nigeria has been a major point of discuss over the last decade with several roundtables, conferences, and stakeholder meetings brainstorming viable and sustainable financing options for bridging the infrastructure gap. In 2018, the African Development Bank had estimated that a whopping $3Trillion would be required to fund the infrastructure deficit in Nigeria over the next 26 years.

Financing infrastructure development projects in Nigeria has, in the past and till date, largely been through debt. However, with a rising debt profile of $73.21Billion as at September 2018, and the call by international stakeholders for the country to focus more on domestic loans, the Nigerian government appears to have devised an innovative way of funding a class of infrastructure projects – Roads.

The ‘007’ Order

On January 25, 2019, the Nigerian President signed Executive Order 007, an order aimed at improving road infrastructure by establishing the Road Infrastructure Development and Refurbishment Investment Tax Credit Scheme.

The Order provides a framework for eligible participants to partner with the government in developing road infrastructure, by constructing and/or refurbishing approved road infrastructure projects, without any advanced sum from the government. The objective is to facilitate the timely delivery of solid infrastructure projects. This may be a creative way for the government to fund infrastructure projects through debt without increasing its debt profile per se and without the bureaucracies associated with procurement.

As consideration for the construction and/or refurbishment of approved road projects, eligible participants would be entitled to tax credits in an amount equal to the project cost, and ‘an uplift’ on the project cost at a rate equal to the prevailing MPR+2%. This tax credit, dubbed as the Road Infrastructure Tax Credit (‘RITC’) can be netted off the amount payable as companies’ income tax by the participant in a given year, subject to a maximum of 50% of the value of the RITC per year. There is however an exception to the 50% rule. The threshold of 50% may be exceeded where the RITC is with respect to an approved project in an Economically Disadvantaged Area.[1]

Other features of the Order include the establishment of a Committee to manage the Scheme, categorization of the RITC as an asset, ability to carry forward unutilized credits and the exclusionary nature of the RITC to making claims on other tax incentives for the same project.

The RITC Certificate

Perhaps, of more interest is the creation of a new tradable instrument called an ‘RITC certificate.’

Pursuant to the scheme and upon approval of the project cost claimable as tax credit by the Committee, the Federal Inland Revenue Service is authorized to issue an RITC Certificate to every participant on an annual basis as it relates to on-going approved Road projects and the uplift on the relevant project cost.

According to the order, the Certificate, which should denote the RITC due to a participant, can be registered by the participant as a tradable instrument on a relevant securities exchange and sold to a willing buyer on such exchange or by means of other approved transactions. Every sale must be reported to the Committee, which shall de-register the participant, and register the new beneficiary of the certificate.

In effect, the order designates a certificate representing tax credits as a tradable instrument on a relevant exchange, with the Committee as the registrar of such instruments. The beneficiary of a traded certificate may utilize the certificate in any year of assessment subject to the 50% threshold rule and may presumably also trade the certificate.

Reviewing this in the context of existing securities regulations in Nigeria, the Order appears to create a new ‘order’ by:

• 1.      designating a financial contract not backed by cash or equity as a tradable instrument;
• 2.      placing the onus of registration of a tradable instrument on the exchange as against the regulator; and
• 3.      designating a body without legal personality as the registrar of a “tradeable instrument”

Tradable Instruments

The London Stock Exchange defines a tradable instrument as a security for which, once assigned to a market segment and currency, orders and trade reports may be entered.[2] If this definition were to be applied to the RITC Certificate it would presume the existence of more than one RITC Certificate or an RITC Certificate capable of being purchased in units.

The relevant International Accounting Standards (IAS 32 and 39) define a financial instrument as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. This questions what asset class of tradable instruments the RITC would be categorized, given the absence of a cash or debt element.

Financial instruments which are typically traded on an exchange are categorized as either capital market or money market instruments, with the latter being short term instruments. The tenor of an RITC certificate is undefined and may extend beyond one financial year in view of the 50% rule as well as the ability to trade and assign the benefits of the RITC to a third party. This makes it more likely that the RITC Certificate would be categorized as a capital market instrument.

The law governing the Nigerian capital market defines Government securities[3] to mean securities which are direct obligations of and guaranteed as to principal and interest repayment by the Federal Government of Nigeria, or a state or local government. While recouping the cost of a project in addition to the uplift is guaranteed, it involves no payment or expenditure on the part of the government and expected cash receivables on the part of the participant.

I would attempt to distinguish between the RITC Certificate as constituting a debt obligation on the part of government from a regime which constitutes a mere entitlement on the part of the participant.

If Company A undertakes the construction of an eligible Road Project at N1Billion, it would be entitled to N1Billion as principal sum from the government and 16% as interest (current MPR+2) over a certain number of years, payable semi-annually or quarterly. In effect Company A would receive cash inflows by virtue of the debt obligation by the Government evidenced by a certificate. Under the RITC Regime, if Company A undertakes the same project at the same cost, it would be entitled to claim the sum of N1Billion + 16% of the project cost as Tax Credits. This credit will be netted off the amount due from the Company as Companies Income Tax to the government. There is therefore no expected cash flow from the government. If in FY1, the Companies Income Tax due from Company A is N1.1Billion, Company A will (in view of the 50% rule) only be entitled to claim N550Million of its N1.16 Billion as Tax Credit while still remitting N550Million to the government as Companies Income Tax for the year. Recovering the costs of a project is therefore entirely dependent on the ability of the participant to generate significant tax payables. This further raises questions on the treatment of such tax credits in the event of insolvency of a participant and may conceivably be the rationale for the designation of the RITC as a tradable instrument.

Various definitions of a tradable instrument all regard such instruments as contracts or medium which serves as a vehicle for an exchange of some value between parties. The RITC would appear to be more of an instrument of entitlement to a course of action.

The Order further defines a relevant securities exchange to mean the FMDQ OTC Securities Exchange or any other relevant securities exchange duly authorized and regulated by the Securities and Exchange Commission. The FMDQ OTC Securities Exchange is traditionally a fixed income and FX exchange, facilitating trades in Bonds, Commercial Papers, Treasury Bills, Foreign Exchange and Derivatives. While it is clear that the RITC Certificate is not a Bond, CP, T-Bill or FX, the possibility of constituting a tradable derivative may be explored.

Derivatives are securities which derive their value from an underlying asset or benchmark. Although the definition of a derivative may be stretched to cover such things as the RITC certificate, it would conceivably have been more appropriate to designate the RITC as being, at best, tradable over the counter in the absence of a standardized contract. This nonetheless raises further questions of pricing, and ability to split certificates into units.

As against designating the RITC Certificate as tradable, it may have been more appropriate to designate it as assignable without more. The implication of this action would be that anything which confers an interest or entitlement may be tradable on an exchange simply by designation. And perhaps in no distant future, such things as land certificates which are transferable, shopping vouchers, gift certificates and perhaps dividend warrants, may become tradable on a recognized exchange.

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[1] Economically Disadvantaged Area means any area or location in any geopolitical zone or State designated as “Economically Disadvantaged” by the President, on the advice of the Minister of Finance. For the purpose of advising on the designation of an area as Economically Disadvantaged, the Minister of Finance shall give due consideration to such factors as: whether the average income level of the inhabitants of such areas fall below the minimum wage; the availability of infrastructure such as electricity, water, sewage, telecommunication, transportation facilities etc; the volume and nature of economic activity being undertake in such areas; and any other factors as may be considered relevant for the determination of an Economically Disadvantaged Areas by the Minister of Budget and National Planning.

[2] Tradelect and Infolect Services Glossary – London Stock Exchange - https://definedterm.com/tradable_instrument

[3] Section 315, Investments and Securities Act, 2007

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[1] Section 315, Investments and Securities Act, 2007