INSIGHT: Key Implications of the Finance Act 2019 on Foreign Investment in Nigeria

The President of the Federal Republic of Nigeria signed the Finance Act, 2019 (the Finance Act) into law on January 13, 2020. The Finance Act amends various sections of the Companies Income Tax Act (CITA) and Petroleum Profits Tax Act (PPTA) among other tax laws in Nigeria. The strategic objectives of these amendments include the following:

• to raise tax revenue by closing existing loopholes in the law, restricting tax concessions and clarifying ambiguous provisions of the law;
• to promote fiscal equity by amending tax law provisions that were hitherto beneficial to only a small group of taxpayers;
• to incorporate international tax trends recommended by the Organization for Economic Co-operation and Development into domestic law;
• to stimulate capital market activity and promote infrastructure development; and
• to improve the ease of doing business in Nigeria.

The passage of the Finance Act is a significant milestone for Nigeria, as it marks a return to an era of active fiscal supervision—in line with global best practice—that is geared towards stimulating the economy, creating an enabling environment for sustainable development and increasing investor confidence. Investors, however, need to understand the key tax changes introduced by the Finance Act which may affect their business and the returns they generate from such operations in Nigeria.

Key Provisions Impacting Equity Investment by Foreign Investors and Repatriation of Dividends

• Excess Dividend Tax (EDT)

A company which has no total profits, or total profits that are less than the dividend it distributes in a given period, may be exposed to income tax at 30% on the dividends distributed. This is an anti-tax avoidance rule that obliges companies to treat the dividend they distribute in such a period as their total taxable profit. This provision has often resulted in companies paying tax on profits that have already suffered tax. It also sometimes involves companies paying Companies Income Tax (CIT) on distributions from tax exempt income as well as franked investment income. The controversies with this provision have resulted in adjudications in which the courts have ruled that EDT provisions apply irrespective of the source of the dividend distributed.

Hence, the amendments made by the Finance Act, which exempt distributions from after-tax profits, franked investment income and tax-exempt income from EDT, are a welcome development. Consequently, it may be useful for investee companies to properly track and possibly disclose the source of dividend distributed on their financial statements to avoid unnecessary tax exposure.

• Requirement to pay advance CIT prior to distributing interim dividend

An investee company may pay interim dividends to its shareholders provided that such interim dividends are justified by the profits of the company which are available for distribution. Under the previous provisions of the CITA, Section 43(6) required such companies to pay an advance CIT prior to distributing interim dividends. The CIT paid is deemed to be a deposit against the tax due from the company on the profits out of which the dividend is distributed. Most companies had not, in practice, complied with this provision since 1993, when the scope of transactions liable to withholding tax was significantly extended to cover payments relating to active business transactions. This was based on the understanding that the withholding tax (WHT) deducted on companies’ income from business transactions made the advance payment of CIT prior to distributing dividends redundant.

However, this became a gray area and an item of controversy when, on October 15, 2015, the Federal Inland Revenue Service issued a public notice requesting companies to commence the payment of advance CIT on interim dividend. Companies had to make provision for this advance CIT on interim dividends, thus limiting the funds available for distribution to their shareholders. This provision has now been deleted.

• Exemption of dividend from unit trust from withholding tax

A unit trust scheme is established for the purpose of providing facilities for the participation of the public (including foreign investors), as beneficiaries under a trust, in profits or income arising from acquisition, holding, management or disposal of securities or any other property. The trusts are treated as a company whose business consists mainly in the making of investments with the rights of the unit holders treated as shares in the company. The income available for payment to the unit holders is treated as dividend on such share.

Dividends, being franked investment income, are only subject to WHT at 10%. Based on Section 23f of the CITA, dividends received and redistributed by unit trusts are exempt from any tax at redistribution. However, the old provisions (Section 23n of the CITA) contained a contradiction which required a unit trust to deduct WHT upon distribution of such dividends to its beneficiaries. The Finance Act has resolved this contradiction by deleting Section 23n.

• Export Proceeds

The CITA previously required a Nigerian company involved in exportation to repatriate proceeds and use the proceeds exclusively for the purchase of raw materials, plant, equipment and spare parts, for the profits to be exempt from income tax. The requirement to repatriate the full proceeds from exports typically imposes an unnecessary administrative burden on exporters who wish to claim the exemption available. Hence, the amendment by the Finance Act of Section 23q which removes the requirement to repatriate the export proceeds is a welcome development.

However, companies are still required to demonstrate that they have re-invested the entire proceeds to benefit from the tax exemption. This may discourage investors who are interested in receiving a portion of the proceeds as dividend, because the profit will then be subject to tax, which undermines the return on the investment.

• Withholding tax on dividend in specie (i.e. scrip issue)

Companies distribute dividends in specie when they issue additional shares to existing shareholders. This is typically funded by the company’s retained earnings or share premium account. The advantage of a scrip issue is that the company will be able to distribute dividend even when it is short of cash and its shareholders can get regular income as they can sell the additional shares.

Prior to the Finance Act, dividends distributed in specie were exempt from WHT. However, as a result of the amendments introduced by the Finance Act, WHT will now apply on dividends distributed in specie. This is an important consideration for foreign investors whose investee companies may pay dividends in the form of scrip issue.

• Removal of WHT exemption on Petroleum Profits Tax (PPT) dividends

Petroleum companies involved in upstream operations in Nigeria are exposed to significantly higher taxes on their profits (i.e. 85% for joint venture arrangements and 50% for petroleum sharing contracts) than other companies in Nigeria. Hence, the PPTA provided incentives to investors, such that dividends received from after-tax profits of upstream petroleum operations are exempt from WHT.

However, the Finance Act has deleted this section and the exemption no longer applies. Investee companies involved in upstream petroleum operations will be required to deduct WHT prior to distributing such dividends to investors. This may impact the amount available as returns to investors/shareholders.

Key Provisions Impacting Debt Investment by Foreign Investors and Repatriation of Interest

• Moderation of WHT exemption on interest from foreign loans

The CITA previously provided that foreign loans could qualify for full or partial exemption from WHT depending on the grace and repayment period (including moratorium) of the loan. These provisions had hitherto informed the financing model of several foreign investors who had been able to recoup the returns on their debt investment without suffering WHT.

However, the Finance Act has legislated amendments that ensure that WHT will invariably apply upon repatriation of interests on foreign loans as the maximum exemption available is now 70%. This is an important consideration for foreign investors, as their financing model must be evaluated vis-à-vis this amendment, as the provision ultimately reduces the return on investment available to such investors.

• Restriction of deductibility of interest on related party loans

The Finance Act introduces thin capitalization rules for Nigerian companies and the permanent establishment of a foreign company in Nigeria. The rules restrict the quantum of interest companies can deduct in respect of debt issued by a foreign related party to 30% of the company’s earnings before interest, tax, depreciation and amortization (EBITDA). Any excess of the interest claimable will be disallowed in the current year but can be carried forward for a maximum of five years of assessment after the interest was recognized.

These provisions do not apply to a Nigerian subsidiary of a foreign company which is engaged in the business of banking or insurance. Investee companies will now be required to review and track their interest deduction in every year of assessment with respect to their related party loans to ensure the limit is not exceeded.

Going Forward

The Finance Act has introduced certain provisions which could impact investor confidence and affect the level, volume and value of their investment in Nigeria. It is, therefore, important for investors to study these changes to continue to understand them and know how to manage them. They should also engage the expertise of tax professionals to enable them to make the most of the new provisions of the Nigerian tax laws vis-à-vis their strategic investment objective.

Oreoluwa Akinboboye is a Senior Tax Adviser with KPMG in Nigeria.

The author may be contacted at: oreoluwa.akinboboye@ng.kpmg.com

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.