INSIGHT: Tax Deductibility of Fines and Penalties in Nigeria

The Finance Act 2019, which came into force on January 13, 2020, has clarified the rule on the tax deductibility of statutory penalties in Nigeria. There was no clear statutory provision on the tax deductibility of fines and penalties prior to this clarification: however, the general practice had been that fines and penalties were not tax deductible.

One reason given for this was that penalties are deterrents for which companies should be solely responsible, and allowing tax deductions would allow such companies to indirectly share the punishment with the public.

Another reason given for the practice was that fines and penalties do not satisfy the criteria for tax deductibility of valid business expenses, that is, they are not wholly, reasonably, exclusively and necessarily incurred for business operations (the WREN test). This view was reiterated recently by the Tax Appeal Tribunal (TAT) in disallowing MTN Communications Plc from taking a tax deduction for a $330 million fine imposed by the Nigerian Communications Commission (see MTN Nigeria Communications Plc v. Federal Inland Revenue Service Appeal No: TAT/LZ/CIT/001/2018, delivered on February 7, 2020).

Significantly, the practice of disallowing fines and penalties for tax did not distinguish statutory fines from mere commercial penalties, or mere levies, which although imposed by governmental authorities still qualify as commercial fines such as demurrage.

Against this background, the clarification provided by the Finance Act’s amendment of Section 27 of the Companies Income Tax Act (CITA), is a welcome development. The amendment to Section 27 reads as follows:

“Notwithstanding any other provision of this Act, no deduction shall be allowed for the purpose of ascertaining the profits of any company in respect of any penalty prescribed by any Act of the National Assembly for violation of any statute.”

The law is now clear on the nature of penalties that would be disallowed expenses for tax purposes. This law change also codifies the ruling of the Federal High Court (FHC) in the case of National Oil Spill Detection and Response Agency v. Mobil ((2018) lpelr-44210(ca)), that only the National Assembly can impose penalties on companies. The amendment also seems to settle the controversy generated by the judicial decisions under which oil producing firms were not allowed to take gas flaring payments as tax deductible expenses in the cases of Federal Inland Revenue Service v. The Shell Petroleum Development Company of Nigeria Ltd (Suit No: FHC/L/1A/2017), and Federal Inland Revenue Service v. Mobil Producing Nigeria Unlimited (Suit No: FHC/L/3A/2017).

Uncertainty of Outcome

However, all is not well in Camelot. The specificity of the wording of the Finance Act’s amendment may lead to uncertain outcomes.

The general rule on the interpretation of such “deterrent sections” is that punishment for infraction of any law should be limited to the punishment expressly provided under the law (see Section 17, Interpretation Act, Cap I23, Laws of the Federation of Nigeria 2004).

The applicable principle of statutory interpretation, due to the precision of the language of the Finance Act’s amendment, is “the express mention of one thing is the exclusion of all others” (expressio unius est exclusio alterius). This connotes that once certain items are clearly mentioned in a law, one can infer that the lawmakers deliberately intended to exclude all others that were not mentioned. Adopting this appropriate rule of statutory interpretation may even lead to the conclusion that the CITA now permits most “fines and penalties” to be allowable expenses for tax.

Lord Denning’s oft-quoted quip that “the draftsman … conceived certainty but has brought forth obscurity; sometimes even absurdity” seems to be the case here. The National Assembly’s precision in limiting the non-deductibility to penalties (excluding fines, damages or forfeitures, etc.), that are prescribed in an Act of the National Assembly (excluding commercial fines or penalties; penalties and fines imposed by State Houses of Assembly; fines and penalties imposed by regulators, government authorities or other bodies) due to the violation of any statute (excluding the violation of regulations, directives, rules, orders, etc.) has led to an extremely open-ended result. The endless possibilities of variants of penal tools, and the various nuances and contexts which are not covered by such restrictive language used by the Finance Act are many, leading to ambiguity in how it should be applied.

In Nigeria, the prevailing rule on ambiguities in tax laws is that they should be resolved in favor of taxpayers (see Ahmadu v. Governor of Kogi State [2002] 3 NWLR (Pt. 755) 502 at 522), meaning that taxpayers are free to adopt the interpretation most favorable to them, following the English common law tradition (see Russell v. Scott [1948] 2 ALL ER 1 at 30).

Although there is a Court of Appeal judgment (see Phoenix Motors Limited v. National Provident Fund Management Board [2012] TLRN 89) to the effect that such ambiguities should be resolved in favor of the Revenue, the general position of the law as established by a superior ruling of the Supreme Court remains that all ambiguities in tax statutes should be construed strictly (see In Re: Chief M.A. Okupe v. Federal Board of Inland Revenue SC/281/72); that is, resolved in favor of taxpayers.

The logical deduction then, from the Finance Act’s being deliberately restrictive is that many classes of fines and penalties might now be tax deductible.

Deductibility of Fines and Penalties in Other Jurisdictions

A summary of the rule on the tax deductibility of statutory and commercial fines from four diverse legal traditions is set out below:

• Armenia

Commercial fines and penalties are deductible for company income tax purposes. However, fines and penalties paid to the state or municipal budgets are not deductible.

• Canada

Fines and penalties that are not imposed by the government are generally deductible if they were made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property. This position was elucidated in British Columbia Limited v. Her Majesty The Queen [1999] 3 S.C.R 804. However, most government-imposed fines and penalties are not deductible.

• Germany

Fines and other penalty payments levied by a court or other authority, with an intent to punish, are not deductible. By contrast, those levied to confiscate ill-gotten gains or to relieve damage to the victims or to the public good, are tax deductible. Penalty payments levied for attempted tax evasion are not tax deductible, but late payment surcharges are deductible if the underlying tax itself is tax deductible, e.g. value-added tax (VAT).

• India

Expenditure incurred by a taxpayer that is illegal is deemed not to have been incurred for the purposes of the business or profession, and no deduction of such expenditure is allowed. Note that the position was qualified in Nanhoomal Jyoti Prasad v. Commissioner of Income Tax (1980 123 ITR All Allahabad High Court), where the High Court decided that demurrage was allowable because it did not qualify as a fine for the infraction of any law, but, made by the taxpayer to preserve its stock-in-trade, was laid out wholly and exclusively for its business.

Implications for Nigerian Companies

The tax deductibility of contractual and commercial fines and penalties is now clearly acceptable. Such contractual fines and penalties are distinguishable from the statutory fines disallowed under the Finance Act. Such expenses also satisfy the WREN test so that there is no question of their being deterrents or punishments imposed by the government. This view accords with the practice in the other jurisdictions considered.

This is also congruent with the position of the Tax Appeal Tribunal (TAT) in the MTN Case, mentioned above. In that case, the TAT posited that although the fine had been wholly, reasonably and exclusively incurred for MTN’s business, the fine should be disallowed because it was not “necessarily” incurred, as MTN could have avoided the fine imposed by its regulator. Consequently, an inference can be drawn that the TAT’s decision would have been different had the fine arisen under normal commercial arrangements because of the TAT’s reasoning that the fine was of a regulatory character.

Note that what qualifies as a “commercial fine or penalty” is determined by the intrinsic nature of the levy and not by the body imposing such payment; for instance, demurrage and other such charges levied by governmental bodies may qualify as commercial fines and penalties.

Due to the federal system in Nigeria, another important application may be for companies with operations across several states in Nigeria. The fines and penalties imposed under laws of the various states and local governments as enacted by their respective Houses of Assembly may also now be tax deductible. Such fines and penalties are likely to pass the WREN test because they are often imposed arbitrarily, and companies are forced to comply to avoid business disruption.

This would ameliorate the problem of multiple taxation currently faced by such companies, although a permanent resolution of the incidence of multiple taxation would be more desirable than merely taking tax deductions for such state/local government fines.

Another important area of application is for the upstream oil and gas industry. Although upstream companies are not subject to the CITA but are taxed under the Petroleum Profits Tax Act (PPTA), they may nonetheless be impacted by the change. This is because oil exploration and production companies can now validly assert that the omission of a similar section on the non-deductibility of penalties in the PPTA may be taken as a warrant to fully deduct such costs. Indeed, the National Assembly was at liberty to stipulate that the Finance Act’s amendment of Section 27, CITA should also apply to Section 13 of the PPTA, but refrained from doing so.

The conclusion above derives from an implicit assumption that penalties and fines satisfy the WREN test, as the TAT seemed to hint in the MTN Appeal that it disallowed the fine only because the fine was “unnecessary” in the specific circumstances of the matter.

Another suite of fines and penalties which may become tax deductible by this amendment are those which are prescribed by regulatory bodies, provided that such fines or penalties are not for the infraction of an Act of the National Assembly.

In circumstances where regulators which lack the statutory powers to impose fines and penalties do so, taxpayers often comply due to the fiat power of the regulators and the potential adverse consequences on their business continuity. Companies can now take comfort that such fines and penalties may now be fully deductible, provided that the penalty is not enacted in an Act, especially in circumstances where they can be shown to be arbitrary.

In an ironic twist, it is possible that the recent significant penalties introduced by the FIRS in two of its regulations, the Transfer Pricing Regulations and Common Reporting Standards, may now be validly deducted by companies that breach their provisions. This rule change came too late to influence the TAT’s decision on the newsworthy penalty of $330 million imposed on MTN Communications Plc by the Nigerian Communications Commission in 2015. Nonetheless, it will be interesting to see how similar cases would be determined in future due to this rule change.

Overall, the Federal Government of Nigeria should be commended for re-introducing a Finance Act after an interregnum of 20 years. The clarity on the type of penalties which are not tax deductible is a boost to ensuring that the tax canon of certainty is closer to being achieved, and ultimately the business climate in Nigeria is made more investor friendly.

Olatoye Akinboro is a Manager with KPMG Advisory Services, Nigeria

The author may be contacted at: olatoye.akinboro@ng.kpmg.com

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