INSIGHT: Key Tax and Regulatory Considerations for Foreign Investors in Nigeria

What is Driving the Interest of Foreign Investors?

Over the years, foreign investors have persistently shown interest in participating in the Nigerian economy. Despite recent economic upheavals, the country had received foreign direct investments (“FDI”) of around $118 billion as at December 2017. This puts the country in the top 30 percent of global investment destinations. What is driving and sustaining the interest of foreign investors in Nigeria?

Nigeria is an economy that is rich in natural resources and has a huge population. As the seventh largest population in the world and one of the richest countries in natural resources, Nigeria presents the ideal climate for investment to thrive. In practical terms, considering that supply and demand drive enterprise, Nigeria’s diverse natural resources (supply) and huge population (demand) present an attractive investment location for foreign investors.

Investors’ and Exporters’ Foreign Exchange Window

The federal government’s introduction of the investors’ and exporters’ foreign exchange window, which is meant to boost liquidity in the foreign exchange market and ensure timely execution and settlement of eligible transactions (which include dividends), has further improved the investment climate in the country. The window, which opened in April 2017, allows authorized dealers to source foreign exchange for eligible transactions at the prevailing market rates. Consequently, supply of foreign exchange for investment and export has increased, and the open market exchange rate has improved since the window opened. In 2018, merger and acquisition transactions in Nigeria are expected to rise by 455 percent, from $716.4 million to a level of about $4 billion.

However, foreign investors should ensure that they pay attention to certain key tax and regulatory considerations often overlooked. These can undermine the return on their investment, and are considered below.

Key Tax and Regulatory Considerations

Excess Dividend Tax

Excess Dividend Tax (“EDT”) is a tax exposure that crystallizes when a company distributes dividends which are higher than its total profits. Sometimes, foreign investors channel their investment in Nigeria through holding companies, which can either be set up outside or within Nigeria. Foreign investors who seek to accommodate local investment may prefer to set up holding companies in Nigeria, which could serve as ultimate or intermediate holding companies depending on the preferences of the local investors being targeted. The use of a holding company is simple and less expensive; however, the tax exposures that may arise in a bid to distribute profit to ultimate investors may undermine these advantages.

The provisions of section 80 of Companies Income Tax Act (“CITA”) require an investee to withhold tax at 10 percent upon distribution of dividends. In addition, section 80(3) of CITA stipulates that such dividends should be treated as franked investment income, which is not subject to further tax as part of the profits of the company receiving the dividend. These tax provisions are very relevant to Nigerian holding companies which have minimal operations and also act as intermediary between the investee and the investors.

Section 80(3) implies that the holding companies should not be liable to Companies Income Tax (“CIT”) on the dividends it receives from the investee. However, section 19 of the CITA stipulates that a company which has no total profits, or total profits that are less than the dividend it distributes, may be exposed to income tax at 30 percent on the dividend distributed, i.e. EDT. This implies that the Company will be required to treat the dividend it distributes in such a period as its total taxable profit; irrespective of the source of that dividend.

The provisions of section 19 seem to contradict that of section 80(3) and in practice this has resulted in various controversies. Some companies in the financial services sector have been able to obtain a ruling from the Federal Inland Revenue Service (“FIRS”) that exempts their non-operational holding companies from EDT, while others have had to pay this liability, which can run into billions. The EDT obligation, to which these investment portfolios are exposed, may represent a classic situation of double taxation of the investment portfolio which appears inappropriate.

Developments, such as the judgments issued in the case between Oando and the FIRS in 2016, also support this matter. Oando had distributed dividends to shareholders from its retained earnings—on which it had initially paid CIT. However, the total profit in the period the dividends were distributed was less than the dividend distributed; hence, the FIRS assessed Oando to EDT. Oando appealed to the Tax Appeal Tribunal (“TAT”) and lost the case; subsequently it appealed to the Federal High Court (“FHC”), which upheld the decision of the TAT.

The basis of the FHC’s decision was that EDT would apply in any period dividend distributed exceeded the total profit, regardless of the source of the dividend paid. The FHC also ruled that the source of the dividend was immaterial and that the provisions of section 80(3) of the CITA could not supersede the provision of section 19 of the CITA merely because a portion of such dividend came from franked investment income.

It therefore becomes incumbent for investors to take into proper consideration the various ways to manage this potential tax exposure to ensure they are not shortchanged on the returns from their investments.

Certificate of Capital Importation

Optimizing returns on investment in the Nigerian economic space also involves careful attention to certain regulatory requirements, such as the need to process and obtain a Certificate of Capital Importation (“CCI”). Where a foreign investor seeks to invest in a Nigerian company, the Nigerian regulations require such investor to process a CCI as evidence of its investment in the investee. This certificate is essential because it enables the investee company to access foreign exchange at the official rate from the regulatory authorities, which is oftentimes cheaper than the open market rate. In situations where the investee is not aware of this requirement or experiences severe difficulty in obtaining CCI, it has typically experienced challenges when trying to repatriate dividends and interests to the investors at the best rate available. With the recent deployment of the e-CCI, it is encouraging to know that the federal government is out to improve the efficiency of the process involved in obtaining a CCI. Minimum Tax

Foreign investment through holding companies may also be exposed to minimum tax where a CCI, which serves as evidence of capital importation, is not obtained, or where the CCI amount is less than the prescribed threshold. As stated earlier, a holding company may have minimal operations, and as such have no taxable profit. However, such a holding company may be liable to minimum tax where it has no tax payable or tax payable that is less than its minimum tax. Based on the provisions of the CITA, a company is exempt from paying minimum tax where its imported equity is at least 25 percent of its total equity. Consequently, a holding company that satisfies this requirement should not be exposed to minimum tax. However, the FIRS may require a CCI to substantiate a claim of exemption from minimum tax by the holding company.

Impact of Multilateral Convention

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“MLI”) seeks to implement tax treaty related measures to prevent base erosion and profit shifting where international transactions are structured to artificially minimize tax exposures. Nineteen countries are on Nigeria’s list of tax agreements covered by its MLI and thirteen of these treaties are already in force. Consequently, the MLI articles should be interpreted alongside the double tax treaties in force to determine the tax implications of relevant international transactions.

Key provisions of the MLI convention include prevention of treaty abuse, improvement of dispute resolution, prevention of artificial avoidance of a permanent establishment (“PE”) status, and neutralization of hybrid mismatch arrangements which result in double taxation. The provisions that may be most relevant to foreign investors are those that prevent treaty abuse and the artificial avoidance of PE status.

In an attempt to prevent treaty abuse, Article 7 of the MLI provides the principal purpose test (“PPT”) as an approach to determine if the international transaction is economically driven and of commercial substance. In practice, the level of substance is determined on a case-by-case basis using an entity’s activity level. For example, the PPT examines if the major drivers of an international business arrangement are the treaty benefits available in Nigeria. The parameters to determine this are not very clear; however, an entity will typically pass the PPT when it exercises substantive economic functions using real assets and assuming real risk through its own personnel in the relevant jurisdiction.

It appears the overriding principle here is that valid economic transactions must be conducted by the entity with the evidence of committed resources and processes established to facilitate such transactions.

The artificial avoidance of PE status provisions clarify arrangements that may expose a nonresident company (“NRC”) to taxes in Nigeria as a result of its operations. Article 12 of the MLI speaks to commissionaire arrangements and similar arrangements that are typically used to avoid creating a PE and paying taxes in a jurisdiction. It explains that when a person is acting on behalf of a NRC, “and in doing so, habitually concludes contracts, or habitually plays a principal role leading to the conclusion of contracts that are routinely concluded without material modification by the NRC in providing such services in its name and with respect to its property,” such activities may create a PE status for the NRC. Foreign investors must bear in mind these requirements of the MLI as they plan their investment approach and operations to avoid a breach in compliance.

Planning Points

• Maximizing foreign investment in Nigeria involves, among other things, careful consideration of key tax and regulatory provisions such as those discussed above, which may clearly have significant impact on the investment portfolio.
• It also involves keeping track of developments in the tax and regulatory space.
• To overlook these key tax and regulatory provisions may lead to challenges such as lower returns on investment, a complete inability to repatriate returns on investment, exposure to unnecessary taxes and a possible breach in reputation.
• Consequently, it is in the best interest of foreign investors to engage reputable tax and regulatory experts in ensuring that these issues are properly addressed in planning and executing their investment transactions.

Oreoluwa Akinboboye is Senior Consultant, Tax Deal Advisory, KPMG in Nigeria.
The author may be contacted at: oreoluwa.akinboboye@ng.kpmg.com