INSIGHT: The Finance Act and the Expectation Gap in the Nigerian Tax System

Although taxation is a fundamental source of revenue to government, it also reduces the disposable income of individuals as well as profits of businesses. Therefore, there are existing expectation gaps between taxpayers and the tax authority in terms of:

• what the tax authority expects to generate as tax revenue from the taxpayer and actual taxes collected;
• what taxpayers expect the tax revenue to be used for and what obtains in reality;
• what the taxpayer considers an administrative burden and what constitutes compliance requirements;
• taxpayers’ interpretation and application of the existing legislation and the tax authority’s interpretation.

The Nigerian Finance Act 2019 (the Finance Act) proposes key amendments to the following tax legislation:

• Companies Income Tax Act (CITA) Cap C21;
• Laws of the Federation of Nigeria (LFN), 2004;
• Value Added Tax (VAT) Act LFN 2007;
• Customs and Excise Tariff etc. (Consolidation) Act;
• Personal Income Tax Act (PITA) Cap P8, LFN 2007;
• Capital Gains Tax Act (CGTA) Cap C1, LFN 2007;
• Stamp Duties Act Cap S8, LFN 2007; and
• Petroleum Profits Tax Act (PPTA).

This article seeks to examine the amendments in the Finance Act in light of the principles of a good tax system and provide insight on how these amendments are likely to bridge the expectation gap in the Nigerian tax system.

In The Wealth of Nations (1776) Adam Smith presented the four principles of a good taxation system. These principles, commonly called the “canons of taxation,” still form a basis upon which tax systems are built.

Canon of Equality

The canon of equality states that there should be justice in the form of equality when it comes to paying taxes. The amount of tax paid by taxpayers should be proportionate to their income. This is to ensure the tax burden borne by the taxpayers is distributed equally as well as to promote equitable distribution of wealth in an economy.

Based on the provisions of the Finance Act, companies have been categorized according to turnover as small, medium and large companies and progressive tax rates levied on these classes of companies. Small companies with turnover of less than 25 million Nigerian naira ($63,900) in any tax year are exempted from corporate income tax (CIT), medium companies with turnover between 25 million and less than 100 million Nigerian naira are subject to CIT at a rate of 20%, and large companies with turnover from 100 million Nigerian naira at a rate of 30%.

The application of a progressive tax rate under the CITA as amended by the Finance Act is also applicable in the existing PITA, as a progressive rate is applied on income bands within certain thresholds.

Also, the provision of Section 33(b) of the CITA, which exempts companies with at least 25% imported equity from paying minimum taxes, has been removed. Therefore, these companies will now be liable to minimum tax in Nigeria. This will provide a level playing field for indigenous companies as compared to foreign-owned businesses.

As the above leans towards a progressive tax system, where a greater percentage of tax is charged on higher income levels rather than a single rate applied irrespective of the level of income, it indicates that the government is seeking to ensure fairness in the tax system.

Notwithstanding this, the increase in the value-added tax (VAT) rate from 5% to 7.5% may have a counter-productive effect. VAT is often seen as regressive in nature, given that it is passed on to the final consumer upon consumption of goods and services. Typically, low income earners pay a greater percentage of their income on VAT based on their consumption compared to high income earners. As income increases, the marginal propensity to consume decreases and saving and investments increase.

There are several considerations to curb the regressive nature of VAT and these include expansion of the VAT exemption list, zero-rating goods, ease of claiming refunds on credits, etc. However, much remains to be done in order to ensure equality and fairness in the Nigerian tax system.

Canon of Certainty

Taxpayers should be adequately informed about the various taxes they bear, and why and how the taxes are levied.

The Finance Act provides certainty to the following provisions:

• Section 19 of the CITA—excess dividend tax rule

Prior to the amendments in the Finance Act, companies were liable to tax (at the appropriate rate) on the dividend paid in any year of assessment where they reported no total profit or the total profit in the period was less than the dividend paid. The provision did not consider that, for instance, the source of the dividend paid could be from retained earnings that had been subject to tax in prior periods and thus should not be subject to tax again.

The Finance Act eliminates the uncertainties associated with interpretation and application of this section by clearly stating four conditions that exempt companies from being subject to the excess dividend tax rule. These include:

• dividend from retained earnings that have suffered taxes under the CITA, PPTA or CGTA;
• dividend from profit that is tax exempt under the CITA, the Industrial Development (Income Tax Relief) Act, PPTA, CGTA or any other legislation;
• profit or income that is regarded as franked investment income;
• rental income distributed by a real estate investment company to its shareholders and dividend income received by these companies on behalf of these shareholders.

Therefore, dividend paid out of profits in the above categories would not be liable to excess dividend tax.

• Sections 22 and 27 of the CITA—artificial transactions and deductions not allowed

The Income Tax (Transfer Pricing) Regulations, 2018 give effect to Section 22 of the CITA and other relevant Acts as specified in the Transfer Pricing Regulations. Section 22 was more or less a general anti-avoidance provision in the CITA. However, the amendments to Section 27 of the CITA clearly state that for a related party expense to be considered as tax deductible it must be consistent with the TP Regulations. This provides certainty in the treatment of such expenses in determining the taxable profit in any relevant year of assessment.

• Definition of exported and imported services in the VAT Act

There has been much controversy surrounding the interpretation of what constitutes “exported” and “imported” services and the applicability of VAT on the variants resulting from these interpretations.

For exported services, it was often interpreted that the services must be provided by a Nigerian resident in Nigeria to a person outside Nigeria in order to qualify as exported services: the Finance Act however specifies that the services could be provided within or outside Nigeria by a Nigerian resident to a nonresident outside Nigeria, provided the latter does not constitute a permanent establishment or fixed base.

For imported services, there was considerable controversy surrounding the origin or destination principle. The Finance Act has however expunged the definition of “imported services” from the VAT Act. Any service received from a nonresident is liable to VAT and the Nigerian resident is expected to withhold/self-account for the VAT.

However, despite the provisions in the Finance Act, there is still a degree of uncertainty in the Nigerian tax administration system. For instance, the exemption from VAT based on certain thresholds is likely to create some ambiguity, especially when it comes to manufacturing organizations which have different distributors categorized as small, medium or large.

While the manufacturer would charge VAT to its distributors irrespective of their turnover, the “small distributors” which are not required to register for VAT, issue VAT invoices and collect VAT, would suffer VAT that they were unable to pass on to the final consumer. In addition, keeping track of the revenue thresholds may create some uncertainty and burden for the small- to medium-scale distributors, especially in periods where price and demand variance is high.

It is also worthy of note that for trading arrangements (between the distributor and its customers) that entail locked-in fees for bulk supply at specified periods (e.g. quarterly), tracking these thresholds and the compliance obligations will create some uncertainty.

We expect that circulars, guides and further amendments from the relevant regulatory authorities will provide some clarity to the above.

Canon of Convenience

This provides that the process for collecting or paying taxes should be simple, such that it is easy to comply. How convenient is the current Nigerian tax system?

Currently, the completion of the CIT self-assessment form can be done online; however, taxpayers face challenges in accessing the portal and are still required to physically submit hard copies of the forms to the tax authorities. Other returns, such as the Tertiary Education Tax (TET) and the National Information Technology Development Agency (NITDA) Levy, have yet to be deployed online for ease of submission and must still be manually completed and submitted physically.

To apply for the Companies’ Tax Clearance Certificate (TCC), taxpayers complete the TCC forms online, but must still physically follow up with the tax authorities, a process which can be cumbersome and time-consuming. Transfer pricing forms, which are also expected to be completed online, are yet to be fully deployed and accessible to taxpayers.

The Finance Act contains a number of proposals that provide some convenience for taxpayers, such as:

• simplification of the bases for computing minimum tax returns, assessable profits for a new trade or business and cessation of business or trade;
• responding to tax audits via electronic email to facilitate the ease and convenience of the process.

Notwithstanding the above, a single platform where the relevant self-assessment forms (CIT, TET, NITDA Levy etc.) can be completed, and other documents uploaded directly to the relevant tax authority’s portal and payment of the self-assessed tax liabilities made through same portal (if possible), would go a long way in easing the process of collection and payment.

Canon of Economy

The administration of tax collection should not cost more than the taxes generated.

In 2018, the Federal Inland Revenue Service’s Executive Chairman stated that while tax revenue had steadily increased from 2016 to 2018, the cost of collection had also reduced over the period. The cost of collection to actual taxes collected was 2.60% in 2016, 2.49% in 2017 and 2.14% in 2018.

Where the principles of equality, certainty and convenience are effectively implemented and managed, this is expected to enhance and improve the tax administration system and drive tax revenue generation, which is a key focal point for the Nigerian government. Consequently, the downtrend in the cost of collection to actual taxes should show significant improvement from the current dip.

Conclusion

The Finance Act, apart from its objective to raise revenue for the government, also seeks to promote fiscal equity and reform Nigerian domestic tax laws to ensure they conform with global best practice. This can only be achieved if the expectation gap between the taxpayer and tax administration is reduced or eliminated.

This can best be achieved through constant communication between the parties, such that the tax authorities understand the issues faced by industry players, increased and evident development projects that support taxpayers, and a perception of an inclusive, non-biased and progressive tax framework geared towards greater effectiveness and efficiency of the tax administration.

Nana Abu is a Tax Manager at KPMG Nigeria.

The author may be contacted at: nana.abu@ng.kpmg.com

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