The applicability of value-added tax (VAT) on commercial and residential lease rental has become a subject of perennial tax disputes between taxpayers and the Federal Inland Revenue Service (FIRS)—the tax authority responsible for the administration of VAT in Nigeria. At the heart of the dispute is the interpretation of Section 2 of the VAT Act 2004 (as amended) which is the legal basis for charging VAT on supply of goods and services in Nigeria. While taxpayers opine that the provision does not apply to rent of buildings because a building is neither a “good” nor a “service,” the FIRS posits that:
- any transaction that is not expressly exempted from VAT in the First Schedule to the Act, such as rent, is liable to VAT; and
- to the extent that only rent on residential property is exempted from VAT under paragraph L(C)(6) of its Information Circular No. 9701 of January 1, 1997 titled Detailed List of Items Exempted from Value Added Tax (hereafter referred to as “the FIRS Circular”), VAT applies on commercial lease rentals.
The FIRS took this position even though there is no provision in the VAT Act that specifically addresses building lease rentals or creates the distinction between commercial and residential leases as posited by the FIRS.
Tax disputes are undoubtedly a normal part of a progressive system based on the rule of law. It is for this reason that the Nigerian tax system provides for resolution of tax disputes by the Tax Appeal Tribunal (TAT). The TAT sits in eight zones and each panel is independent of the other. It is on this basis that two panels of the TAT sitting in Benin and Lagos arrived at different decisions in resolving two tax appeals where taxpayers disputed the assessment of VAT on commercial rent by the FIRS.
The first TAT panel sitting in Benin, on September 9, 2020, ruled in Chief J.W. Ellah, Sons & Company Limited and FIRS (hereafter referred to as “Ellah’s case”) that rent on commercial buildings is liable to VAT, consistent with the FIRS’ position in the Circular. However, one day later, on September 10, 2020, another TAT panel sitting in Lagos gave a contrary judgment in Ess-Ay Holdings Limited and FIRS (hereafter referred to as the “Ess-Ay Holdings case”) to the effect that rent on both commercial and residential buildings is not subject to VAT.
In this article, we will review the relevant provisions of the VAT Act 2004 (including amendments introduced by the Finance Act 2019) on the application of VAT on supply of goods and services in Nigeria with emphasis on rent of buildings. We will then examine the merits of the arguments of both the taxpayers and the FIRS and the reasoning of both TATs in the recent conflicting decisions on the subject matter, by addressing a number of salient issues arising from the provisions of the VAT Act.
VAT Act 2004 as Amended by Finance Act 2019
The VAT Act 2004 provides the legal basis for charging VAT on transactions in Nigeria. Specifically, Section 2 of the VAT Act defines VAT as “The tax charged and payable on supply of all goods and services (in this Act referred to as ‘taxable goods and services’) other than those goods and services listed in the First Schedule to this Act.”
The First Schedule to the VAT Act provides the list of exempt and zero-rated goods and services. However, while it did not define “goods” or “services,” Section 43 of the Act defines some of the key words in Section 2, such as “supplies,” “supply of goods” and/or “services“and “taxable goods and services” as follows:
- “supplies” means any transaction, whether it is the sale of goods or the performances of a service for a consideration, that is, for money or money’s worth;
- “supply of goods” means any transaction where the whole property in the goods is transferred or where the agreement expressly contemplates that this will happen and in particular includes the sale and delivery of taxable goods or services used outside the business, the letting out of taxable goods on hire or leasing, and any disposal of taxable goods;
- “supply of services” means any service provided for a consideration;
- “taxable goods and services” means the goods and services not listed in the First Schedule to this Act.
The Finance Act 2019, which came into force in February 2020, amended the VAT Act, among other tax laws in Nigeria. The amendments include the deletion of “taxable goods and services” in Section 2 of The VAT Act 2004 and replacement of “supplies” in Section 43 with “taxable supplies.” The Finance Act, 2019 further defines “goods,” “services” and “taxable supplies” as follows:
a) all forms of tangible properties that are moveable at the point of supply, but does not include money or securities; or
b) any intangible product, asset or property over which a person has ownership or rights, or from which he derives benefits, which can be transferred from one person to another excluding interest in land.
“services” means anything other than goods, money or securities which is supplied excluding services provided under a contract of employment;
“taxable supplies” means any transaction for sale of goods or performance of a service, for a consideration in money or money’s worth.
Review of Taxpayers’ and FIRS’ Conflicting Positions
As noted earlier, the crux of the dispute between taxpayers and the FIRS on the applicability of VAT on commercial lease rental stems from the varying interpretation of Section 2 of the VAT Act by both parties.
Without successfully classifying rent on buildings as either a “good” or “service” under Section 2 of the VAT Act, the FIRS’ position is that all goods or services that are not expressly exempted in the First Schedule to the VAT Act, 2004 are liable to VAT. Therefore, since rent on buildings is not listed as one of the exempt transactions, it is liable to VAT.
Taxpayers on the other hand contend that for VAT to be chargeable a transaction must qualify as either a supply of goods or services. In the absence of the definition of “goods” and “services” in the VAT Act until the Finance Act, 2019 was enacted, taxpayers limited the goods to which VAT applied to tangible goods, while incorporeal properties, such interests in asset or property, were treated as non-VATable, on the basis that they were neither a good nor a service.
This position was upheld by the Federal High Court (FHC) in CNOOC Exploration and Production Nigeria Limited and FIRS & Others, which held that the contractor’s rights in an oil and gas production sharing contract were neither a “good” nor a “service” as contemplated by the VAT Act 2004 and their assignment was not covered by the VAT Act. However, notwithstanding the FHC judgment in this case, the FIRS has stuck to its position as recently seen in the Ellah’s and Ess-Ay Holdings’ cases.
Conflicting TAT Decisions
On September 9, 2020, the TAT Benin Zone decided in Ellah’s case that rental income derived from the lease of commercial properties is liable to VAT, to the extent that rent on buildings is not expressly exempt in the First Schedule to the VAT Act.
The Appellant is involved in the business of maintaining and leasing buildings to commercial and residential customers. It alleged that the Respondent in its revised assessment of December 18, 2018 unlawfully and erroneously assessed VAT on commercial lettings of its premises, being transfer of choses in action which do not qualify as supply of goods and services and are not VATable under Section 2 of the VAT Act, 2004 as amended.
The TAT in its judgment referenced Section 2 of VAT Act 2004 and held that:
- all goods or services that are not expressly exempted as listed in the first Schedule are liable to VAT;
- rent of building is not listed as one of the exemptions for VAT purposes and is therefore subject to VAT.
In its reasoning, the TAT relied on:
- the definition of “supply of goods” in the VAT Act which includes “the letting out of goods on hire or leasing”; and
- the Longman Dictionary of Contemporary English and Cambridge Dictionary definitions of “let out” and “hire”
to conclude that the rents paid on commercial buildings are liable to VAT.
Interestingly, the TAT noted that only commercial rent, in its opinion, is liable to VAT, while rent on residential buildings is not. However, the TAT did not provide any legal basis for the distinction but rather cited the FIRS Circular to arrive at this conclusion.
On September 10, 2020, another TAT sitting in Lagos decided in the Ess-Ay Holdings case that rental income derived from the lease of real estate properties, whether for residential or commercial purposes, is beyond the scope of the VAT Act. It also relied on the provisions of Section 2 in arriving at its decision as follows:
- For VAT to be chargeable, the transaction must qualify as a supply of goods or service.
- The VAT Act did not define the term “goods.” However, the definition of the term in credible materials affirms that for an item attached to land to qualify as goods, such item must be severable or moveable from the land either before sale, or under a contract of sale. Consequently, as real properties by their nature do not qualify as goods, a transaction relating to them cannot qualify as a supply of goods.
- A lease agreement in respect of real properties does not amount to rendering of “service.” Rather, it is a transaction for the transfer of an interest or right of access/use of the property to the lessor. Further, the right transferred, assigned or granted to the tenant is an incorporeal right, and is not liable to VAT.
- Rent derived from lease of real properties, whether for residential or commercial purposes, is not a supply of goods or services and is therefore not liable to VAT.
- The FIRS Circular is not a delegated or subsidiary legislation. Rather, it is an opinion of the FIRS on a point of law which has no legally binding effect. Therefore, non-compliance with the Circular cannot create any liability for the taxpayer.
Review of the Key Issues
To determine the applicability or otherwise of VAT on commercial and residential lease rental, we have addressed some relevant questions below to analyze and appropriately interpret the provisions of Section 2 of the VAT Act.
What is VAT Levied on?
For ease of reference, we have restated the provision of Section 2 of the VAT Act 2004, as amended by the Finance Act 2019 as follows:
“The tax charged and payable on supply of all goods and services other than those goods and services listed in the First Schedule to this Act.” (emphasis added)
As VAT is to be levied on supply of goods and services, it must first be determined whether an item of supply qualifies as a good or service before it can be concluded that it is subject to VAT or not. This was the approach followed by the TAT Lagos Zone in the Ess-Ay Holdings’ case.
However, the TAT Benin in the Ellah’s case skipped this fundamental step and adopted an “inclusionary approach” focused on subjecting to VAT any item that is not included on the list of exempt items in the First Schedule to the VAT Act.
Is a Building a “Good”?
The Finance Act 2019 tried to resolve the ambiguity in the VAT Act 2004 for ease of identifying items subject to VAT by defining “goods” and “services.” “Goods” is defined by the Finance Act as
a) all forms of tangible properties that are moveable at the point of supply, but does not include money or securities (emphasis added), or
b) any intangible product, asset or property over which a person has ownership or rights, or from which he derives benefits, which can be transferred from one person to another excluding interest in land. (emphasis added)
Although examples of “tangible” goods or properties were not provided, the Finance Act 2019 offers guidance that such properties must be movable at the point of supply. Buildings, by their nature, are not movable and their sale or transfer should, therefore, not qualify as supply of goods for the purpose of VAT. Likewise, interest or right in a building is similar to interest in land, which is exempt from VAT, and should equally not qualify as an intangible good under the VAT Act.
On this point, both the FIRS and the TAT Benin in Ellah’s case erroneously equated a “building” with a “good” on the basis that a building or a part thereof can be let out, just as a good (movable in this context) can be let on hire or lease. However, the fact that both “buildings” and “goods” can be “let out” does not and cannot make a building a good, as the similarity of the nature of a transaction affecting buildings and goods cannot change the intrinsic nature of a building, and thus make it a good. Therefore, if a building is not a good, it means that rent on a building should not be liable to VAT. Thus, the non-inclusion of rent on buildings in the list of exempted items in the First Schedule to the Act as the basis of making it VATable would be a moot point.
Relatedly, since the TAT in the Ellah’s case concluded that a “building” is a VATable good (because it is not exempted from VAT in the First Schedule to the Act), it had no legal basis for distinguishing a commercial lease rental from a residential lease rental, and exempting the latter from VAT in the absence of an express provision in the VAT Act to that effect. The distinction is a clear evidence that its conclusion was based on a flawed premise because tax, or tax exemption, is statute-based and cannot be determined based on administrative instruments issued by tax authorities, such as a circular, as further discussed below.
Can FIRS Circular be Basis for Taxation or Exemption from Tax?
The categorical answer to the above question is no. Based on the Constitution of the Federal Republic of Nigeria, only the National Assembly has the power to enact, vary or modify tax laws except in instances where such powers are delegated to agents of the executive arm of the government, such as the Minister of Finance. No such power has been delegated to the FIRS in this instance.
Therefore, the FIRS’ circulars, which are mere administrative instruments that express the FIRS’ opinions on the interpretation and application of tax laws, are not a delegated or subsidiary legislation and have no enforceable legal basis. While we recognize that the FIRS and other state tax authorities may issue guidelines and circulars to provide clarifications on tax matters, such administrative instruments cannot be used as tools to amend, vary or alter the provisions of the law.
Applicability of VAT on Rent on Buildings in Other Jurisdictions
In the U.K., for the purposes of VAT, the term “land” includes any buildings, civil engineering works, walls, trees, plants and any other structure or natural object in, under or over it as long as they remain attached to it. A supply of land by making a grant, assignment or surrender of an interest in, right over or license to occupy the land in return for a payment or consideration is normally exempt from VAT. However, if the landlord has “opted to tax” the land (including buildings) for VAT purposes, then the rental payments will be subject to VAT accordingly.
In South Africa, the application of VAT on lease rentals of buildings is different. While rent on commercial properties is liable to VAT, VAT on supply of residential accommodation will depend on whether it qualifies as a supply of “commercial accommodation” or “dwellings.” Typically, supply of commercial accommodation is subject to VAT at the standard rate. However, the letting and hiring of a dwelling is exempt from VAT. Further, where commercial accommodation is supplied together with domestic goods or services (furniture, water, electricity cleaning, maintenance, etc.) for periods longer than 28 days for an all-inclusive charge, VAT is only payable on 60% of such charge.
Conclusion and Recommendations
The TAT Lagos Zone’s decision in the Ess-Ay Holdings case provides a better interpretation of Section 2 of the VAT Act 2004, as amended, than Ellah’s case. However, the existence of the two conflicting TAT judgments implies that we can only have closure on this matter when the Federal High Court has the opportunity of reviewing the judgments on appeal. This would be necessary to resolve legacy disputes on the subject arising under the VAT Act 2004 prior to its amendment by the Finance Act, 2019. Until then, it is predictable that both the taxpayers and the FIRS will continue to challenge each other’s stance on the subject.
Meanwhile, it is desirable for the National Assembly to further amend the VAT Act, 2004 (as amended) under the Finance Act, 2020 to provide clarity on the applicability of VAT or otherwise on rent to settle the matter once and for all as obtainable in other jurisdictions.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Wole Obayomi is Partner & Head of Tax and Ikechukwu Odoh is Manager, Tax, Regulatory & People Services, KPMG Nigeria.