Duty calls: A look at the taxation system and rules for foreign investors

CORPORATE ENTITIES: Nigeria has rules and regulations governing the operation of corporate entities. 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 firms are not allowed in Nigeria except in rare circumstances involving government projects, where specific exemption for branch offices may be granted.

The Corporate Affairs Commission (CAC), established by the CAMA, is responsible for 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 and other information relating to changes in corporate status, directorship, company name and so on. In addition to the above, corporate entities are required to obtain business entry approvals and permits from relevant government agencies. A company intending to offer its shares to the public must comply with the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE) regulations.

Other regulations supplement CAMA with respect to some specific industries. For instance, banks are regulated by the Central Bank of Nigeria, which is charged with the responsibility of administering the Banks and Other Financial Institutions Act (BOFIA). The National Insurance Commission is the regulatory body for the insurance industry in Nigeria.

Companies often encounter difficulties navigating the legal, administrative and regulatory framework, procedures and requirements for business entry and doing business in Nigeria. In a bid to alleviate these difficulties the Nigerian Investment Promotion Commission, the federal agency established to promote, coordinate and monitor investments in Nigeria, has a one-stop investment centre (OSIC).

OSIC is an investment facilitation mechanism which brings relevant government agencies together in one location to provide efficient and transparent services to investors. It provides investors with a single place to obtain the documents and approvals that are statutorily needed to set up a business in Nigeria.

In addition to the above, tax regulations apply to corporate entities. For instance, all companies doing business in Nigeria (resident and non-resident) are required to register with the Federal Inland Revenue Service (FIRS) for income tax and VAT purposes, and with States Internal Revenue Services for employees’ income tax purposes. There are also requirements to register for pension contributions, the National Housing Fund and the Industrial Training Fund.

The regulatory environment can be challenging and difficult to navigate. Companies (both new and existing) must pay particular attention to regulatory compliance, and consult professionals when in doubt.

CORPORATE TAXATION: There are two major corporate income taxes in Nigeria; Companies Income Tax and Petroleum Profits Tax. Other taxes include Tertiary Education Tax, Capital Gains Tax (CGT) and Information Technology Tax (ITT).

Companies Income Tax (CIT): The CIT Act governs the taxation of companies other than those carrying out petroleum operations. A Nigerian company is liable for tax on its 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 on commencement, cessation and change in accounting date of a company.

CIT is computed at 30% of tax-adjusted profit. The underlying principle for deductibility is that expenses must be wholly, reasonably, necessarily and exclusively incurred in generating taxable profits. Incentives include tax exemption for a number of years, free trade and export processing zones (EPZs, also governed by subsidiary legislation), accelerated capital allowances, investment tax allowances, employment and infrastructure incentives and concessions for gas utilisation projects. Tax losses can be carried forward indefinitely for all companies except insurance companies, for which they are restricted to four years.

A company which has no tax payable may be liable to a presumptive minimum tax or 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 companies with at least 25% imported equity capital, or those in their first four calendar years of commencement. Failure to pay and file tax returns within the time limits specified in the act attracts penalties and interest. Based on the Tax Administration (Self-Assessment) Regulations 2011, tax can be paid in not more than three instalments ( previously six) on dates approved by the FIRS.

Petroleum Profit Tax (PPT):PPT is levied on the income of companies engaged in upstream petroleum operations. The principal legislation is the PPT Act, which is complemented by the Deep Offshore Inland Basin Production Sharing Contract Act, for production-sharing contracts (PSCs). PPT varies depending on the contract type and years in operation from the date of commercial find. The rate is 65.75% in the first five years of operation and 85% after. 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 tax returns filed within five months of the end of the accounting period.

Others: Tertiary education tax is payable by all Nigerian companies at 2% of assessable profit (tax adjusted profit before capital allowances).

ITT is payable by GSM service providers, telecoms firms, cyber companies, internet providers and financial institutions with turnover of N100m ($630,000) 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 (VAT) & EXEMPTIONS: Currently, the standard VAT rate on goods and services is 5%, the lowest among the Economic Community of West African States (ECOWAS). The rate is expected to rise to around 15% in the near future to ensure harmonisation with other ECOWAS countries and in line with the approved national tax policy focus on indirect taxation. The scope and coverage of VAT is extremely broad and applies to all imported, supplied or manufactured goods and services in Nigeria, except those specifically listed as exempt or zero-rated.

VAT is substantially invoice-based, so tends more towards accrual. 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 overheads and services is not claimable but may be expensed or capitalised.

A taxable person is required to register for VAT immediately on commencement of business. A VAT number (now covered by Tax Identification Number) is assigned to every registered person and must be stated on all their VAT invoices. Non-resident companies doing business in Nigeria are required to register for and charge VAT on all their taxable supplies.

VAT charged by a non-resident company is withheld and remitted to the tax authorities by the resident customer. In all cases, government agencies as well as oil and gas companies 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 pharmaceutical products, basic food items, baby products, medical services, plays and performances conducted by educational institutions as part of learning, and materials and equipment imported for use in downstream gas activities. Goods and services for use in EPZs or Freeport Zones are not liable to VAT on the basis that the zones are outside the scope of Nigerian VAT. 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, setting 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 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.

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

Taxable individuals other than employees are required to file tax returns with the relevant tax authority within 90 days of the start 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 the pay-as-you-earn system. By this method, employees’ taxes are deducted and remitted to the tax authority by their employers. Annual returns by the employer must be made not later than January 31 in respect of the preceding year.

Employee taxes must be remitted within 10 days of the month following payment of salaries. Taxes assessed by the tax authority must be paid or objected to within 30 days from date of notice.

Taxable individuals are entitled to relief of N200,000 ($1260) or 1% of gross income, whichever is higher, plus 20% of gross income as non-taxable personal relief. The tax bands and rates are shown below.

Taxable benefits in respect of assets, other than accommodation, provided by the employer is 5% of the cost of such assets or 100% of actual rent paid. In the case of accommodation, taxable benefit is the annual value as determined for local rates purposes or as otherwise established by the tax authorities.

Tax-deductible expenses include life assurance premiums, pension contributions 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, a development levy and withholding tax (WHT), especially on franked investment income such as dividends where WHT is the final tax.

There are also a number of social security contributions, such as the Industrial Training Fund, Employee Compensation Insurance (1% each of payroll cost by employer), the National Housing Fund (2.5% of basic pay by employees) and pension contributions (7.5% of basic pay, housing and transport allowance by employees and a minimum of 7.5% by the employer such that total contribution is at least 15%). There is currently a bill undergoing legislative process to raise the minimum combined contribution to 20%.

REPORTING REQUIREMENTS: The principal legal framework for the preparation of financial statements in Nigeria is the CAMA LFN 2004, which empowers the registrar of companies at the CAC to monitor compliance with the reporting requirements, and to impose sanctions for non-compliance.

Nigeria is transitioning to International Financial Reporting Standards (IFRS) in a phased approach that began in 2012. Publicly listed and significant public interest entities adopted IFRS in their financial statements for the year ended 2012. Other public interest entities are to adopt the IFRS for their financial year 2013, while small and medium-sized enterprises are required to adopt IFRS by 2014.

The Financial Reporting Council of Nigeria (FRCN) is the government agency under the Federal Ministry of Trade and Investment that is responsible for, among other things, developing and publishing accounting and financial reporting standards to be observed in the preparation of financial statements of public entities, and for related matters.

The FRCN is empowered to enforce compliance with IFRS through penalties and sanctions imposed on defaulters. The NSE Act, the Nigerian Deposit Insurance Corporation Act, BOFIA, the Investments and Securities Act, SEC rules and regulations, the Nigerian Insurance Act and others supplement the FRCN in regulating the financial reporting requirements of different types of companies. FISCAL ASPECTS OF SPECIAL ECONOMIC ZONES (SEZS): An 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, EPZs, free zones and others.

Nigeria currently has a number of SEZs. The Nigeria Export Processing Zones Act of 1992 established the Nigeria Export Processing Zones Authority (NEPZA), which is the body that oversees the licensing, monitoring and regulation of these zones. Three types of licence are granted by NEPZA:

• Free Zone Developers Licence: granted to either a public or private entity for the establishment, operation and management of a free zone.

• Free Zone Enterprise Licence: granted for 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 fiscal 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 WHT on transactions except sales/purchases made from/to 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 activities within the SEZ that qualify for these exemptions. For income derived within the Customs territory, Nigerian taxes will apply. Where applicable, the approved enterprise should file its tax returns to the FIRS through NEPZA.

The extent of the FIRS’s jurisdiction 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 revenues. Given the volatility in oil prices and the rising government expenditure in view of poor infrastructure, governments at all levels are focusing on taxation, a more reliable source of revenue for sustainable development. For many years, the main taxes in Nigeria (apart from PPT) have contributed just a small fraction of total government revenue.

The tax 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. The national tax policy is aimed at simplifying the system and improving compliance. There will be a gradual shift from direct to indirect taxation, introduction of electronic tax filing, rationalisation of tax incentives and elimination of multiple taxation. The tax authorities are intensifying efforts to educate the public on tax matters through stakeholders meetings, seminars and conferences. It is expected that more reforms will be made in the coming years.

DUE DILIGENCE: Business combinations, including mergers and acquisitions, require that the investor carries out a due diligence exercise to ensure 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 due diligence. In assessing a Nigerian target it is critical to understand the attitude of the target towards tax compliance, as most tax due diligence issues result from this. This is important in view of the relatively low level of tax compliance culture in Nigeria, which is partly due to weak tax enforcement by the authorities. It is also useful to evaluate the effectiveness of the tax function, quality of tax personnel, competency of tax advisers and attitude of management to corporate governance in assessing potential tax risk.

Often there are challenges involving incomplete and poor record-keeping by target companies. These companies are sometimes unable to substantiate their claims of tax compliance, especially in terms of filing 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 that may affect the target’s tax position. An example could be an aggressive industry position on a tax matter or class action on industry specific tax issues. With respect to the acquisition of government owned enterprises, the need for 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 principal capital market in Nigeria is the NSE. Since its establishment in 1961 the NSE has grown from having 19 equity stocks listed to featuring more than 200 securities by the second quarter of 2013, with this including corporate and government bonds and foreign listings.

The Nigerian capital market experienced significant growth following its 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 in a Nigerian company.

Despite the significant growth of the 1990s and the past decade, the NSE has suffered from global and local financial crises resulting in significant losses in the value of listed shares. With less than $100bn in total market capitalisation, the NSE is still relatively underdeveloped and largely unsophisticated.

The most significant incentive for participation in the Nigeria capital market is the tax exemption from capital gains on disposal of shares and stocks. There is also income 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 capital market by increasing efficiency, transparency and investor confidence.

While the Nigerian capital market has in all respects made good progress, there are still desired improvements to further develop the market. For instance, the listing of local and foreign companies on the NSE is still low, and this requires incentives on the part of the NSE, the SEC and the federal government.

The most important incentive will be to improve the quality of oversight of the NSE and ensure greater transparency to prevent share manipulation and other malpractice by issuers, stock brokers and investors in general. It would also help if the conditions for initial listing are streamlined and the transaction costs of trading in the secondary market are further reduced. A good starting point could be the removal of stamp duty on securities traded on the capital market.