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INSIGHT: Taxation of the Digital Economy in Nigeria and the 2019 Finance Bill

Dec. 31, 2019, 8:00 AM

Multinational enterprises (MNEs) such as Amazon, eBay, Twitter, Uber, Facebook, YouTube, Google, Netflix, Spotify, Alibaba, PayPal, etc., have over time leveraged the internet to expand their cross-border reach without establishing physical presence in all the countries where they earn their revenues. For instance, about 2.8 billion people globally purchased consumer goods via e-commerce in 2018, representing about $1.8 trillion in revenue and 14% year-on-year growth rate. While the U.S. and the U.K. account for the largest share of e-commerce activities for consumer goods, there is still a significantly large untapped e-commerce market, especially among developing countries.

Beyond e-commerce, the scope of the digital economy is limitless. Digital technology has been a major catalyst for the growth of business services, such as payment solutions, financial intermediation, computing hardware and software, telecommunications and networking, professional services, media and advertising, gaming, film, ride hailing services, among others.

Overall, the digital economy was estimated to account for about $11.5 trillion globally as far back as 2016, equivalent to 15.5% of world GDP, and is projected to reach 25% in less than a decade. Africa, with its youthful population and internet penetration, is not left out of the pace of growth, even though its average fixed broadband penetration as at December 2018 was 0.6%, while the global average stood at 13.6%.

The rising profile of digital businesses with huge capitalization, accelerated expansion, revenues and profits, without corresponding tax payments in the countries where they generate their revenues, has stimulated global debate on how they should be taxed.

Taxation Challenges of the Digital Economy

The major challenge for policy makers in tax is the potential risk for MNEs to shift profit away from jurisdictions where underlying economic activity took place, thereby eroding the value created in such jurisdictions. The ubiquitous operating model of digital businesses has also raised questions about how taxing rights on income derived from cross-border trade should be allocated among participating jurisdictions to address under- or over-taxation.

The ongoing Base Erosion and Profit Shifting (BEPS) project of the Organization for Economic Cooperation and Development (OECD) and the G-20 seeks to address the shortcomings of the current national and international tax framework with a view to establishing new rules that match the current realities of the global economy.

However, several countries have taken the following unilateral measures in an attempt to fix the tax challenges of the digital economy:

  • Israel—introduction of significant economic presence (SEP) test which is applicable only to foreign enterprises that are resident in countries that have no double tax agreements with Israel;
  • India—adoption of 6% “equalization levy” which applies to outbound payments to nonresident companies for digital advertising services and introduction of the concept of SEP to the Income Tax Act;
  • U.K.—introduction of the 25% Diverted Profits Tax on profits deemed to be artificially diverted away from the U.K. Also, the U.K. has proposed the adoption of a digital services tax (DST) which should take effect on April 1, 2020;
  • a DST has also been introduced by the governments of Austria, France and Italy;
  • in Africa, Kenya automated its tax administration system in 2013 by introducing an “iTax system” to capture direct and indirect taxes on a real-time basis. In 2014 and 2015, South Africa and Kenya, respectively, adopted the destination principle for collection of value-added tax (VAT) on services and intangibles supplied by a foreign company to a consumer in each country. By implementing this principle, South Africa collected as much as 585 million South African rand ($40.6 million) for 2016–2017. Rwanda also introduced electronic cash registers in 2013 to improve its VAT collection.

Nigeria’s National Assembly is currently at the advanced stage of enacting Finance Bill, 2019 (the Bill), which was recently presented by the President. The Bill seeks to amend various tax laws and introduce a framework for taxing the digital economy, and we examine this in more detail below.

Nigeria’s Finance Bill and the Digital Economy

To address the tax challenges of the digital economy, the OECD Inclusive Framework proposes different approaches for allocating taxing rights among jurisdictions. These proposals include:

  • User contribution—this allocates taxing rights based on value created by an entity in a jurisdiction by focusing on user base, data and content generation in a highly digitized business. The U.K. has adopted this principle for taxing the digital economy.
  • Marketing intangibles—this has a broader application by focusing on aspects of commercial exploitation of a product or service, and includes trademarks, customer list, proprietary market, etc. This principle is favored by the U.S.
  • Global minimum tax—this represents a prescriptive approach to allocating taxing right by which jurisdictions impose a minimum tax threshold to revenue derived therein by foreign companies. This has been adopted by both Germany and France.
  • SEP—this allocates taxing rights based on evidence of a combination of factors that create purposeful and sustained interaction with the economic life of a jurisdiction via digital means. India and Israel have adopted SEP.

With the benefit of the foregoing, the Bill contains the following proposed amendments to the provisions of the Nigerian Companies Income Tax Act (CITA) and the Value Added Tax Act (VATA) to tax the digital economy.

CITA and the SEP

Section 13 of the CITA contains provisions relating to taxation of economic value derived in Nigeria by nonresident companies (NRCs). Under this provision, an NRC is deemed to have derived taxable economic value in Nigeria only if such company has a fixed base of business in Nigeria under any of the following circumstances:

  • it has a dependent agent who habitually executes contracts on its behalf in Nigeria;
  • it maintains stock of goods or merchandise in Nigeria from which supplies are made;
  • it executes a single contract for surveys, deliveries, installations or construction in Nigeria; and
  • it is deemed to have carried out an artificial or fictitious transaction with related parties in Nigeria.

The taxable profit in Nigeria, in any of the above instances, is the profit attributable to that fixed base. Thus, with technologically-propelled changes in business models, it is obvious that the existing nexus and taxation rules in the CITA are not primed for the digital economy.

To address the challenges of the digital economy for corporate tax purposes, the Bill proposes the adoption of the SEP approach to expand the basis of taxing profits derived in Nigeria from digital services provided by NRCs. The proposed amendments provide that the profits of a company, other than a Nigerian company, from any trade or business shall be deemed to be derived from Nigeria:

a. “If it transmits, emits or receives signals, sounds, messages, images or data of any kind from cable, radio, electromagnetic systems or any other electronic or wireless apparatus to Nigeria in respect of any activity, including electronic commerce, application store, high frequency trading, electronic data storage, online adverts, participative network platform, online payments and so on, to the extent that the company has significant economic presence in Nigeria and profit can be attributable to such activity.”

Given the nature of services described above, NRCs which have customers resident in Nigeria but previously had no tax obligations in the country may be deemed to have a fixed base on the basis of SEP. Thus, such NRCs may be required to register for taxes and file income tax returns with the Federal Inland Revenue Service (FIRS).

b. “If the trade or business comprises the furnishing of technical, management, consultancy or professional services outside of Nigeria to a person resident in Nigeria, to the extent that the company has significant economic presence in Nigeria and the profit can be attributable to such activity”.

In this instance, the tax payable on the activities stated above shall be limited to the withholding tax deducted by the Nigerian recipient of the services.

Although the Bill is yet to be enacted and SEP will be defined by a Ministerial Order, it is expected that the elements of SEP documented in the OECD Public Consultation documents on BEPS Action 1 of February 2019 will be the reference point for what may constitute SEP in Nigeria. According to the documents, a taxable presence in a jurisdiction would arise when a nonresident enterprise has an SEP based on factors that evidence a purposeful and sustained interaction with the jurisdiction via digital technology and other automated means.

While revenue generated on a sustained basis is the basic factor, it would not be sufficient alone to establish a nexus. Thus, for the revenue to be used to establish the nexus required for SEP in the country concerned, one or more of the following factors may be considered relevant to constitute the kind of purposeful and sustained interaction with the jurisdiction via digital technology and other automated means:

  • existence of a user base and the associated data input;
  • volume of digital content derived from the jurisdiction;
  • billing and collection in local currency or with a local form of payment;
  • maintenance of a website in a local language;
  • responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services such as after-sales service or repairs and maintenance; or
  • sustained marketing and sales promotion activities, either online or otherwise, to attract customers.


Value-Added Tax

Similar to the CITA, the extant VATA does not have adequate provisions to capture cross-border transactions, particularly in the digital economy. For instance, there have been uncertainties on whether Nigeria’s VAT system is based on the “origin principle” where goods and services are charged to VAT in the jurisdiction where value is created (i.e., where goods are produced and services are rendered), or whether the system is based on the “destination principle” where VAT is applicable in the jurisdiction where the consumer is based.

Also, there is no clarity on what constitutes “exported services” for VAT purposes. Equally, the VAT (Amendment) Act 2007 defines “imported service” as services rendered in Nigeria by a nonresident person to a person inside Nigeria. This implies that the provider and consumer of a service must be physically present in Nigeria for the service to qualify as imported in Nigeria.

The Courts’ Approach

These lacunas have, expectedly, led to legal disputes between taxpayers and the FIRS where the courts appeared to have neglected the provisions of the VATA, and gone ahead of the legislature to adopt the OECD’s VAT/GST destination principle (which ought not to be binding, but persuasive) in determining chargeability of cross-border transactions to VAT.

For instance, in FIRS v. Gazprom Oil & Gas Nigeria Limited (Suit No: FHC/ABJ/TA/1/2015), Gazprom contracted various NRCs to supply it with consultancy and advisory services. These services were provided from outside Nigeria and Gazprom did not account for VAT on the basis that the NRCs were not carrying on business in Nigeria.

The Federal High Court (FHC) held that “carrying on business” is not limited to the physical presence of an NRC in Nigeria and that the service was chargeable to VAT in Nigeria because it was consumed by Gazprom in Nigeria. Similarly, the Court of Appeal (Suit No: CA/L/556/2018) upheld the decision of the FHC in Vodacom Business Nigeria Limited v. FIRS (Suit No: FHC/L/4A/2016). The basis for the decision was that “the physical presence of the NRC in Nigeria is of no moment … since its services are used in Nigeria.” While the OECD’s persuasive Guidelines are desirable, they are non-binding recommendations which countries are advised to domesticate in their respective laws before implementing.

Similarly, the FIRS appears to hold the view that a service provider must be physically present outside Nigeria for a service rendered to a person outside Nigeria to qualify as “exported services.” This is notwithstanding that the VATA does not have provisions relating to the “place of supply,” though it provides for reverse charge, requiring Nigerian customers of NRCs to withhold and remit VAT on services provided by the NRCs.

The VAT proposals in the Bill on “place of supply” are, therefore, a welcome development that will put paid to the perennial controversies on the matter. Specifically, Nigerian VAT will apply to services received by a person in Nigeria, whether or not the services were physically rendered within or outside Nigeria. The Nigerian recipient of the services will also be required to deduct the VAT at source and remit it directly to the FIRS even where the NRC fails to include VAT in its invoice.

The Bill also introduces “place of supply” in the definition of “exported service” to address the current controversy on the subject and the impact of the digital economy by defining exported service as “a service rendered within or outside Nigeria by a person resident in Nigeria to a person resident outside Nigeria.”

Planning Points

The Bill, when enacted, will introduce major changes that will capture the digital economy in the taxation framework in Nigeria. MNEs will need to proactively review and obtain specific tax advice on their operating models in relation to their Nigerian customers. Such advice will extend to applicability of the SEP rule, and respective tax compliance obligations under the CITA and VATA.

Nigerian companies which conduct business with NRCs will also need to review their commercial agreements and obtain specific tax advice on their obligations based on the proposed tax law amendments.

Meanwhile, prospective investors in Nigeria will need to proactively evaluate the impact of the proposed tax law changes on their business strategies and institute necessary measures for tax planning and compliance.

We also expect the Minister of Finance to issue an Order defining what will constitute SEP in Nigeria for NRCs soon after the Bill is enacted to signal the enforcement of the provisions of the Bill to the digital economy.

Overall, the Bill is a major step forward in Nigeria’s fiscal history and it is hoped that it would mark a turning point for tax administration and practice in Nigeria, being the first Finance Bill to be presented to the National Assembly for enactment at the same time as the passage of the budget since the return to democracy in 1999.

Wole Obayomi is Partner, Victor Adegite is Senior Manager, and Ademola Idowu is Manager, Tax, Regulatory & People Services, KPMG in Nigeria.

The authors may be contacted at: wole.obayomi@ng.kpmg.com; victor.adegite@ng.kpmg.com; ademola.idowu@ng.kpmg.com

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

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