Doing the sums: A look at the regulations governing taxation, reporting, economic zones and the stock exchange

CORPORATE ENTITY REGULATIONS: Nigeria, like other nations, has rules and regulations governing the operation of corporate entities in the country. A foreign entity intending to do business in Nigeria is required by the Companies and Allied Matters Act (CAMA) to incorporate a Nigerian company for that purpose. Branch operations/offices of foreign companies are not allowed in Nigeria except in rare circumstances involving government projects, where a specific exemption allowing the establishment of branch offices may be granted. The Corporate Affairs Commission (CAC), established by CAMA, is the agency charged with the responsibility of registering and regulating the operations of corporate entities in Nigeria. The CAC is also responsible for registering business names and incorporated trustees. Nigerian companies are required to file annual returns as well as other information relating to changes in corporate status, directorship, company name, etc. In addition to the above, corporate entities are also required to obtain business entry approvals and permits from the relevant government agencies. A company intending to offer its shares to the public must comply with the regulations issued by the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE). Other regulations supplement CAMA with respect to some specific industries. For instance, banks are regulated by the Central Bank of Nigeria (CBN), which is charged with the responsibility of administering the Banks and Other Financial Institutions Act, while the National Insurance Commission (NAICOM) is the regulatory body for the insurance industry. In general, companies often encounter difficulties navigating through the legal, administrative and regulatory framework, procedures and requirements for business entry and doing business in Nigeria. In a bid to alleviate the difficulties encountered by entities intending to do business in Nigeria, the Nigerian Investment Promotion Commission (NIPC), the federal agency established to promote, coordinate and monitor investments, has set up the OneStop Investment Centre (OSIC).

The OSIC is an investment facilitation mechanism which brings relevant government agencies together in one location, coordinated and streamlined, to provide investors with efficient and transparent services. It offers investors a single place to obtain the relevant documents and approvals that are statutorily needed to set up a business in Nigeria. The primary objective of the centre is to remove obstacles and bureaucratic hurdles usually faced by investors setting up and running a business in Nigeria.

In addition to the above, tax regulations apply to corporate entities in Nigeria. For instance, all companies doing business in Nigeria (resident and nonresident) are required to register with the Federal Inland Revenue Service (FIRS) for income tax and value-added tax (VAT) purposes, and with the appropriate Internal Revenue Service on the state level for the purpose of dealing with employee income tax. There are also requirements to register for pension contributions, the national housing fund and the industrial training fund.

Overall, the regulatory environment in Nigeria can be quite challenging and difficult to navigate. Hence, companies (both new and existing) must pay particular attention to regulatory compliance, and when in doubt consult professionals.

CORPORATE TAXATION IN NIGERIA: There are two major corporate income taxes in Nigeria: the company income tax (CIT) and the petroleum profits tax (PPT). Other taxes in effect include the education tax (ET), capital gains tax (CGT) and the information technology tax (ITT).

Company Income Tax: The CITA Act governs the taxation of companies other than those carrying out petroleum operations. A Nigerian company is liable for tax on its total worldwide income, while a non-resident company is charged tax on the income attributable to its Nigerian operations. The tax is self-assessed on a preceding year basis – i.e. the accounting period preceding the government’s fiscal year. However, special rules apply in regard to the commencement, cessation and change in accounting date of a company.

The CIT is computed at a rate of 30% of tax-adjusted profit. Generally, the underlying principle for deductibility is that expenses must be “wholly”, “reasonably”, “necessarily” and “exclusively” incurred in generating taxable profits.

Incentives include tax holidays offering exemption for a number of years, free trade and export processing zones (also governed by subsidiary legislations), accelerated capital allowances, investment tax allowances and other special concessions for gas utilisation projects. Tax losses can be carried forward indefinitely for all companies except insurance companies, where they are restricted to four years.

A company which has no tax payable may be liable to either a presumptive minimum tax or a tax on dividends paid if the dividends exceed the company’s taxable profits. Minimum tax does not apply to companies engaged in agricultural business or with at least 25% imported equity capital or in its first four calendar years of commencement.

Failure to pay and file tax returns within the time limits specified in the act attracts certain penalties and interest. Based on the recent Tax Administration (Self-Assessment) Regulations 2011, tax can be paid in not more than three instalments ( previously six) on dates to be approved by the FIRS.

Petroleum Profit Tax: PPT is levied on the income of companies engaged in upstream petroleum operations. The principal legislation is the PPT Act, but this is complemented by the Deep Offshore Inland Basin Production Sharing Contract Act for production-sharing contracts (PSCs). The PPT rate varies depending on the contract type and number of years in operation from the date of commercial find. The tax rate is 65.75% in the first five years of operation and 85% afterwards. Special rates apply to PSCs (mostly 50%) and marginal fields. Tax is assessed on the actual year basis.

Monthly tax estimates are filed in arrears of two months, and the actual tax returns are filed within five months after the end of the accounting period.

Other Taxes: ET is payable by all Nigerian companies at 2% of assessable profit (tax-adjusted profit before capital allowances). ITT is payable by GSM service providers, telecommunications companies, cyber companies, internet providers and financial institutions with turnover of N100m ($640,000) and above. The tax rate is 1% of profit before tax. CGT at 10% is applicable on the disposal of chargeable assets. Shares are exempted from CGT.

VALUE-ADDED TAX & EXEMPTIONS: VAT was introduced into the Nigerian tax regime in 1993, but took effect from January 1994. Currently, the standard VAT rate on goods and services is 5%, the lowest among ECOWAS member nations.

The rate is expected to increase to approximately 15% in the near future in order to ensure harmonisation with other countries in the ECOWAS bloc and in line with the proposed National Tax Policy focus on indirect taxation. The scope and coverage of VAT in Nigeria is extremely broad and applies to all imported, supplied or manufactured goods and services consumed in Nigeria, except those specifically listed as exempt or zero-rated.

VAT accounting is handled on an invoice basis and on an accrual basis. VAT payable is the difference between VAT charged on supply of goods and services (output VAT) and VAT incurred on purchases or imports meant for direct resale (input VAT). VAT incurred on fixed assets, general overhead and services are not claimable, but can be expensed or capitalised as the case may be.

A taxable person is required to register for VAT immediately upon commencement of business. A VAT number (now covered by Tax Identification Number, or TIN) is assigned to every registered person and must be stated on all their VAT invoices.

Non-resident companies that are doing business in Nigeria are required to register for and charge VAT on all of their taxable supplies. VAT charged by a nonresident company is withheld and remitted to the tax authorities by the resident customer. In all cases, government agencies as well as companies involved in the oil and gas industry are required to withhold VAT on their incoming invoices.

Only a few items are exempted from VAT in Nigeria. These include exported services, medical and pharmaceuticals products, basic food items, baby products, medical services, as well as plays and performances conducted by educational institutions as part of learning programmes.

Suppliers of exempt goods should not charge VAT on their sales and cannot claim input tax for VAT paid on their purchases. Non-oil exports are zero rated.

Goods and services for use in export processing zones (EPZ) or free port zones are not liable to VAT on the basis that the zones are outside the scope of the Nigerian VAT system.

The due date for payment of VAT is the 21st day of the month following the relevant month of supply. In practice, a registered person must submit a nil return where there is no VAT able transaction in any particular month.

A registered person who disputes a VAT assessment has a right of appeal to the Tax Appeal Tribunal. An appeal against the tribunal's decision may be made to the Court of Appeal within 30 days after the date on which the decision was given, and the appeal must set out the grounds on which the decision is being challenged.

PERSONAL & OTHER TAXES: The legal framework for the taxation of individuals and unincorporated entities in Nigeria is the Personal Income Tax Act (PITA), CAP, LFN 2004 as amended. PITA is administered by the state governments except in respect of persons employed in the Nigerian armed forces and the police other than in a civilian capacity; officers of the Nigerian foreign services; residents of Abuja; and non-residents who derive income from Nigeria. These individuals are liable to pay their personal income taxes to the FIRS.

Individuals are liable to tax in Nigeria on the basis of residency. A person is regarded as tax resident in Nigeria for personal income tax purposes if such person spends 183 days or more in the country within any 12-month period. Expatriates who come into Nigeria on expatriate quota positions are regarded as tax residents from the first day. Resident individuals are taxable on their worldwide income while nonresident individuals are liable for tax only in respect of income derived from Nigeria.

Taxable individuals (other than employees) are required to file tax returns with the relevant tax authority within 90 days of the beginning of each year. Such returns must indicate total income from all sources in the preceding year.

PITA provides for the administration of employee taxes under what is known as the pay-as-you-earn (PAYE) system. Under this method, employees’ taxes are deducted and remitted to the tax authority by their employers. Annual returns by the employer must be made to the authority not later than January 31st in respect to the preceding year, however.

Employee taxes must be remitted within 10 days of the month following the payment of salaries. Taxes assessed by the Nigerian tax authority must either be paid or objected to within one month’s time, effective from the date of notice.

Effective from June 14, 2011, every individual is entitled to a tax relief of N200,000 ($1280) or 1% of gross income, whichever is higher, plus 20% of gross income as non-taxable personal relief. The tax bands and rates have been amended as shown in the table below (see table below).

Taxable benefits in respect of assets other than accommodation provided to an employee by the employer is 5% of the cost of such assets or actual rent paid. In the case of accommodation, the taxable benefit is the annual value as determined for local rates purposes or as otherwise established by the relevant state tax authorities.

Tax-deductible expenses include life assurance premiums and pension and national housing fund contributions. Medical benefits provided by the employer under the National Health Insurance Scheme and gratuities are not taxable.

Other taxes relating to individuals include CGT, development levy and withholding tax especially on franked investment income, such as dividends where the withholding tax is the final tax.

There are also a number of social security contributions in Nigeria such as Industrial Training Fund and Employee Compensation Insurance (1% each of payroll cost by employer), National Housing Fund (2.5% of basic pay by employees) and pension contribution (up to 7.5% of basic pay, housing and transportation allowance by employees and a minimum of 7.5% by the employer such that total contribution is at least 15%).

REPORTING REQUIREMENTS: The principal legal framework for the preparation of financial statements is CAMA. The act empowers the registrar of companies at the CAC to monitor compliance with reporting requirements and impose sanctions on companies for non-compliance.

The act also mandates that a company’s financial statements be prepared in line with the Statements of Accounting Standards (SAS), as issued by the Nigerian Accounting Standards Board (NASB).

TRANSITION: However, Nigeria is currently transitioning to International Financial Reporting Standards (IFRS) in a phased approach from 2012 to 2014. The roadmap, which is in three phases, mandates publicly listed and significant public interest entities to prepare their financial statements based on IFRS by January 1, 2012 (i.e. full IFRS financial statements are required for accounting period to December 31, 2012), while other public interest entities are required to adopt IFRS for statutory purposes by January 1, 2013. The third phase requires small and medium-sized entities (SMEs) to adopt IFRS by January 1, 2014. It is this third and final phase of the transition that is expected to be potentially the most difficult, as the IFRS knowledge and skill gap of external auditors is wider for SMEs than for the larger companies covered in the two earlier phases.

The Financial Reporting Council of Nigeria (FRCN) is the new body established to take over the roles of the old NASB under the new dispensation. The FRCN is empowered to enforce compliance with IFRS through penalties and sanctions imposed on defaulters. The Nigerian Stock Exchange Act, Nigerian Deposit Insurance Corporation Act, Banks and Other Financial Institutions Act, Investments and Securities Act, Securities and Exchange Commission Rules and Regulation, and the Nigerian Insurance Act, amongst others, supplement the FRCN in regulating the financial reporting requirements of different types of companies in Nigeria.

FISCAL ASPECTS OF SPECIAL ECONOMIC ZONES: undefined A special economic zone (SEZ) is a geographical region within a country that has economic laws that are more liberal than a country’s typical economic laws. SEZs cover a broad range of more specific zone types, including Free Trade Zones (FTZs), EPZs, Free Zones and others.

Nigeria currently has a number of SEZs. The Nigeria EPZ Act of 1992 established the Nigeria EPZ Authority (NEPZA), which is the body that oversees the licensing, monitoring and regulation of these zones. There are three types of licences granted:

• Free Zone Developer’s Licence: Granted to either a public or private entity for the establishment, operation and management of a free zone.

• Free Zone Enterprise Licence: Granted to an entity to undertake approved activity within the zone.

Activities include manufacturing, trading and providing services.

• Export Processing Factory/Export Processing Farm Licence: Granted to export-oriented enterprises located within the Customs territory with capacity to export over 75% of production.

There is a wide range of permissible enterprises across different industries, from oil and gas to manufacturing and construction.

Some of the incentives available to approved enterprises include: complete tax holiday from federal, state and local government taxes, rates, Customs duties and levies; repatriation of foreign capital investment in the zones at any time with capital appreciation of the investment; remittance of profits and dividends earned by foreign investors in the zones; duty-free import of raw materials and components for goods destined for re-export; duty-free introduction of capital goods, consumer goods, machinery, equipment and furniture; rent-free land at construction stage; 100% foreign ownership; waiver of import and export licences; and so on.

The act precludes the need to charge VAT or deduct withholding tax (WHT) on transactions except sales/purchases made to/from unapproved enterprises or companies operating in the Customs area. While the tax incentives provided by the act to approved enterprises may seem to imply a blanket tax exemption, in practice it is the income derived from the activities within the SEZ that qualify for these tax exemptions.

For income derived from within the Customs territory of Nigeria, Nigerian taxes will apply. Where applicable, the approved enterprise should file its tax returns to the FIRS through the NEPZA.

The extent of the jurisdiction of FIRS over companies operating in SEZs is unclear. In practice, however, approved enterprises are often the subject of tax audits, especially regarding VAT and WHT.

PROSPECTS FOR REFORM OF THE TAX CODE: Nigeria’s economy is hugely dependent on crude oil revenue. Given the volatility in oil prices and the rising government expenditure in view of the country’s poor infrastructure, governments at all levels are now focusing on taxation as a more reliable source of revenue for sustainable development.

The main taxes in effect in Nigeria are the CIT, Personal Income Tax (PIT), CGT, VAT, ET and the PPT. For many years, these taxes (apart from the PPT) have contributed just a small fraction of the government’s total revenue.

Generally, the taxation system is based on laws that are obsolete and unable to meet today’s economic realities. Tax administration is clogged with bottlenecks making it difficult and expensive for taxpayers to meet their obligations. In 2002 a study group was constituted to appraise the tax system. Amongst its recommendations were: the introduction of a National Tax Policy; issuance of taxpayer identity cards; a focus shift from direct to indirect taxes; and amendment of various tax laws. These recommendations were accepted and in 2004 a working group was inaugurated to implement these reforms. This led to the amendment of the CIT and VAT Acts in 2007, as well as the enactment of the FIRS Establishment Act granting autonomy to FIRS.

The working group produced a draft National Tax Policy in 2008 and a revised version in June of the following year, which included the following proposals: a shift from direct to indirect taxation, with increase in VAT from 5% to 15% by 2011; CIT reduction from 30% to 20% and reduction in PIT top band rate from 25% to 17.5%; computerisation of tax filing processes; rationalisation of tax incentives; and the elimination of multiple taxation by the federal and state governments.

In 2011 the PITA was amended to simplify the provisions of the law and facilitate voluntary compliance. Also, the amendments led to reduction in effective tax rates for many individuals. In addition, a new set of rules, known as Tax Administration (Self-Assessment) Regulation 2011, was issued to provide guidance and streamline the process for self-assessment tax filing. The Nigerian tax authorities are intensifying their efforts to educate the public on matters related to taxation through various stakeholders meetings, seminars and conferences. It is expected that more reforms will be made in the coming years.

DUE DILIGENCE ISSUES: Business combinations, including mergers and acquisitions, require that the investor carries out a due diligence exercise to ensure an informed investment decision. Typically, a due diligence exercise will focus on key deal breakers, potential risks and other factors that may be useful in the negotiation process.

Tax issues are often significant when undertaking a due diligence. In assessing a Nigerian target it is critical to understand the attitude of the target towards tax compliance, since most tax due diligence issues result from the target’s approach to tax. This is important in view of the relatively low level of tax compliance in Nigeria, which is in turn partly due to weak tax enforcement on the part of the authorities. It is also useful to evaluate the effectiveness of the tax function, quality of tax personnel, competency of tax advisers and overall attitude of management to corporate governance in assessing potential tax risk of a target company.

Oftentimes there are challenges around incomplete and poor record keeping by target companies. These companies are sometimes unable to substantiate their claims of tax compliance, especially filing of returns and remittances. This stems in part from the difficulty in obtaining evidence of tax paid both from third parties and the tax authorities.

In assessing the tax exposures of a target, investors should consider industry-specific issues which may affect the target’s tax position. An example of this could be an aggressive industry position on a tax matter or class action on industry-specific tax issues. A purchaser may need to evaluate the risk associated with ambiguous tax rules which potentially create uncertainties in the interpretation and application of tax laws as well as variances between the letter of the law and what happens in practice.

Common areas of risk include transaction taxes such as VAT and WHT where compliance is generally low or sometimes overlooked by taxpayers. In group situations, taxes on intercompany transactions are often taken for granted or wrongly treated. There are also significant non-compliance issues associated with employee taxes (and social security contributions), especially in respect to expatriates.

The motives of a business combination and the risk appetite of the investor will usually drive the focus and approach of the due diligence exercise. For instance, an investor who is unwilling to take on the liabilities of the target would generally prefer an asset deal to a share deal. In some cases, however, an asset deal may not totally shield an acquirer from the tax liabilities of the target. For instance, under the PPT Act, the tax authority is empowered to recover tax liabilities relating to assets transferred from the acquirer if in its view the transaction was consummated for the sake of avoiding tax.

With respect to the acquisition of governmentowned enterprises, the need for a thorough due diligence is even more important as most government corporations are not diligent in matters of tax compliance. A common remedy is to seek an indemnity to cover identified and potential tax liabilities as a pre-condition to the acquisition. INCENTIVES PROVIDED IN THE CAPITAL MARKETS DEVELOPMENT PACKAGE: The major capital market in Nigeria is the NSE. Since its establishment in 1961, the Nigerian bourse has grown from a listing of just 19 equity stocks to include over 200 securities as of the second quarter of 2012, including corporate and government bonds and foreign listings.

The Nigerian capital markets experienced significant growth following their deregulation in 1993 and the subsequent removal of restrictions on foreign participation. Foreigners are now permitted to participate both as investors and capital market operators on the NSE. In addition, there is no limit on the percentage of foreign holdings allowed in a Nigerian company. Despite the significant growth from the 1990s through the past decade, the NSE has suffered from global and local financial crises in this period, resulting in significant losses in the value of listed shares. At just about $45bn in total market capitalisation, the NSE is still relatively underdeveloped and unsophisticated.

IMPROVEMENT: Measures taken by the NSE to improve activities on the exchange include the use of technology, extended trading hours, real-time price movement report, faster settlement and delivery systems for transactions in listed shares, and improved transparency. Additionally, the bureaucracy involved in listing securities on the stock exchange has been minimised and the transaction costs of trading in shares have been reduced to encourage more activities on the secondary market.

The most significant incentive for participation in the Nigeria capital market is the tax exemption from capital gains on the disposal of shares and stocks. There is also a tax exemption on income earned from debt instruments such as government and corporate bonds. In addition, WHT on dividends (which does not exceed 10%) is the final tax in the hands of investors. These measures and incentives have served to improve activities in the market, by increasing efficiency, transparency and investor confidence.

While the Nigerian capital markets have, in all respects, made good progress, there are desired improvements that would help to further develop the market. For instance, the listing of local and foreign companies on the exchange is still low, and this requires incentives on the part of the NSE, SEC and the government. The most important incentive will be to improve the quality of the oversight function of the NSE and ensure greater transparency to prevent share manipulation and other malpractices by issuers, stock brokers and investors in general. It would also help if the conditions for initial listing are streamlined and transaction costs of trading in the secondary market further reduced. A good starting point would be the removal of stamp duty and VAT on securities traded in the country’s capital markets.