The Federal Government of Nigeria (FGN) recently published the Companies Income Tax (Significant Economic Presence) Order, 2020 (the Order).
The Finance Act, 2019 (the Finance Act) introduced the concept of significant economic presence (SEP) to expand the scope of Nigerian tax on foreign companies deriving income from their activities in the country, which were hitherto not captured in the tax net. The Order provides clarification on what would constitute an SEP for foreign companies doing business or providing services to customers in Nigeria, in line with Section 13(2)(c) and (e) of the Companies Income Tax Act (CITA).
Overview of the SEP Order
The Order provides that a foreign company shall have an SEP in Nigeria in any accounting year where it derives 25 million Nigerian naira ($65,400) annual gross turnover or its equivalent in other currencies from any or a combination of digital activities, such as:
- streaming or downloading services of digital contents;
- transmission of data collected about Nigerian users which has been generated from such users’ activities on a digital interface, including websites or mobile applications; or
- provision of intermediation services through a digital platform, website or other online applications that link suppliers and customers in Nigeria.
Also, a foreign company shall have an SEP where it uses a Nigerian domain name (i.e., .ng) or registers a website address in Nigeria; or has a purposeful and sustained interaction with persons in Nigeria by customizing its digital page or platform to target persons in Nigeria, including reflecting the prices of its products or services in Nigerian currency or providing options for billing or payment in Nigerian currency.
The Order provides that the activities carried out by connected persons in any accounting year shall be aggregated in order to determine whether the 25 million naira annual gross turnover threshold was met. (The Order also defines connected persons as: (a) persons that are “associates” as defined in the Companies and Allied Matters Act, Cap C20, LFN 2004 (as amended); or (b) persons that are business associates in any form, such that one person participates directly or indirectly in the management, control or in the capital of the other, or the same person or persons participate directly or indirectly in the management, control or in the capital of both enterprises.)
In addition, the Order specifies that a foreign company providing technical, professional, management or consultancy services shall have an SEP in Nigeria in any accounting year where it earns any income, or receives any payment from a person resident in Nigeria, or a fixed base or agent of a foreign company in Nigeria.
Issues Arising from the SEP Order
The issuance of the Order brings into focus a number of issues, and its effectiveness or otherwise may depend on how these issues are handled.
Exemption from SEP
The Order exempts certain payments from SEP, if made by a:
- foreign company to its employees under a contract of employment;
- foreign company for teaching in an educational institution or for teaching by an educational institution; or
- foreign fixed base of a Nigerian company.
Similarly, the Order exempts from SEP any foreign company under a multilateral agreement and consensus arrangement to address tax challenges arising from the digitalization of the economy which will be treated under such agreement or arrangement. This appears to be an exemption tailored to make room for any consensus that may be reached by the Organization for Economic Co-operation and Development (OECD) in the ongoing negotiations on the taxation of the digital economy. This will provide for a seamless transition and potentially eliminate the administrative process of issuing another Order to implement any consensus reached by the OECD.
Modalities for Compliance
The Order has a commencement date of February 3, 2020 whereas it was published on May 29, 2020. Thus it would be impossible to expect Nigerian companies to retrospectively account for withholding tax on payments already made to foreign vendors subject to the SEP rule. It is expected that an operational date would be communicated for effective transition and compliance with the provisions of the Order. Otherwise, May 29, 2020, when the Order was published, could be the earliest date that taxpayers might be held accountable for compliance with the Order.
In addition, the Order did not give any guidance on whether the corporate income tax (CIT) returns filed by qualifying companies will be based on actual or deemed income basis. This is very important given the recent disputes between the Federal Inland Revenue Service (FIRS) and nonresident companies since the FIRS’ 2015 directive requiring such companies to file their CIT on actual income basis in the same manner as Nigerian companies. However, there have been recent cases where the FIRS disregarded the actual income-based CIT returns and assessed nonresident companies to CIT on deemed income basis because it yielded higher tax. It is therefore important that adequate clarifications are provided on the above issues to minimize disputes by the affected taxpayers with the FIRS.
Interplay between SEP and Double Tax Treaties
There are concerns about the interplay between Nigerian double tax treaties (DTTs) and the Order. Based on international norms, the provisions of the DTT supersede local tax laws: the Order, being an extension of the CITA, should not apply to companies based in countries with which Nigeria has a DTT. Hence, the need for revisions to existing treaties to address this new nexus. It is very likely that the outcome of the current negotiations at the OECD may trigger another round of negotiations to amend the Multilateral Instrument (MLI) (the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting is a multilateral convention of the OECD to combat tax avoidance by multinational enterprises through prevention of base erosion). Since the work on the taxation of the digital economy continued well after the conclusion of the MLI, this vital aspect of the BEPS Project was unavoidably left out of the MLI.
Digital Services Value Chain
The value chain for provision of digital services varies and can be very complex. Over the years there have been several disputes where the core relates to the complexity in the digital services value chain. A case in point is Vodacom Business Nigeria Limited v. Federal Inland Revenue Service (CA/l/556/2018) where the subject of litigation was whether the bandwidth services provided via a satellite (in space) which was controlled by a nonresident company were liable to value-added tax in Nigeria. Unfortunately, the Order was silent on the ownership or control of the electronic or wireless apparatus, such as satellite or other connected servers, receivers or transponders, used in the provision of digital services. This is a significant omission given the complexity of the value chain of digital services involving the use of satellites and associated equipment.
Definition of ”Connected Person”
The Order limited its definition of “connected persons” to associates as defined by the Companies and Allied Matters Act, or business associates, i.e., persons controlled by or under common control. This appears to be at variance with the definition of connected persons in paragraph 6(a) of the Seventh Schedule to the CITA which is more expansive, and includes any person under common control, ownership or management, any person not connected but who receives implicit or explicit guarantee or deposit for a debt and any related party as described in the Income Tax (Transfer Pricing) Regulations, 2018. Therefore, there is a risk that the above varying definitions could result in potential disputes between the taxpayers and the FIRS. In the final analysis, if the definition of the term in the Order is not revised, the definition in paragraph 6(a) of the Seventh Schedule to the CITA would prevail to resolve the conflict.
The FGN has taken a bold step to tax the digital economy ahead of the OECD consensus. It is, however, important that relevant guidelines are issued quickly to address the gray areas identified in this article.
Correspondingly, the FIRS may consider how it can leverage the OECD’s recent work on model rules for reporting by operators in the sharing/gig economy with a view to having access to high quality data on the digital economy as it relates to Nigeria.
Most importantly, NRCs and their counterparties in Nigeria are advised to review their business arrangements and transaction flows to determine the additional compliance obligations that the SEP Order imposes on them.
Wole Obayomi is a Partner and Victor Adegite is Senior Manager, Tax, Regulatory & People Services, KPMG in Nigeria.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.