Partner and Head, Deal Advisory and Tax Services, KPMG Nigeria, Mr. Ajibola Olomola, in this interview on Arise Television, provides insights on the Finance Bill 2019. Peter Uzoho presents the exerpts:
What’s is the Finance Bill all about and how is it differ from the current tax legislation?
The Finance Bill 2019 is epochal. It is significant that Nigeria is beginning to join the league of nations that moderate their economy by use of fiscal instruments such as the Bill of this nature which makes changes to try to align the micro-economy with the macro-economic direction of the federal government in terms of their monetary policies and all other elements of fiscal planning. In terms of the directionality of the Bill, what is does is to begin to show signals of the direction towards which Nigeria would go in seeking to raise fiscal revenues with which it intends to finance the budget.
And the very first significant thing that this Bill does is to lessen and almost mitigate the tax burden on a very vital sector of the Nigerian economy – the small and the medium enterprise sector of the economy. It intends to mitigate the challenges they currently face in complying with the tax legislation, reduce the tax burden on that very important sector of the economy and by so doing attract many of them for the first time into the tax net. So, what this Bill does in a nutshell is to begin to reposition the fiscal environment in Nigeria towards attracting investment, encouraging Nigerians to invest in Nigeria, grow the capital, grow the labour market, grow our economy and in a sense, begin to change the narrative of the economy.
If you look at the bill what are the specifics in terms of the features, especially when you compare the changes?
The most important change that most Nigerians have picked upon is the increase in the Value Added Tax (VAT) rate from five per cent to 7.5 per cent, which has been approved by both the Senate and also the House of Representatives, after public hearing. That is the most material change that most people have picked up.
However, in recognition of the fact that very large section of the economy are vulnerable and sensitive to tax rate change, what the Finance Bill has then done is an attempt by the government to moderate the effect of the rate increase, shift it to the higher producing elements of the economy and exempt small and medium scale enterprises who are businesses with a turnover of N25 million and below from paying VAT. In addition, the government has proposed to expand the list of items that are exempted from VAT to include items that most Nigerians will utilise in terms of basic food items and the like. And a very extensive list of tax exempt items has been provided by the Bill in a sense to ensure that the most vulnerable sectors of the country will not be negatively impacted by virtue of the VAT rate increase.
Many agree that the problem that we have is a compliance problem, how does this Bill address that?
The way the Bill has attempted to help to motivate and increase our tax to GDP ratio and also the compliance issue that the Federal Inland Revenue Service (FIRS) has commented upon in the past is to lower the tax burden for companies and therefore incentivise them to come into the tax net. I will give you and illustration: If a business or a small business is currently staged as a partnership, the tax they will pay is not affected, it is still an effective 20 per cent of their profit that they will pay tax on, under the Personal Income Tax Act.
But the Bill is proposing a change to the Company Income Tax Act, such that if that same business was registered as a company, they would face zero taxation up to revenue of N25 million and below. And above N25 million, up to N100 million, there will be reduced tax rate below 30 per cent. That then is the clear motivation for businesses that are currently not registered as companies to come into the formal net and register with the Corporate Affairs Commission (CAC) in order to seek the protection that the Finance Bill provides. This means that more businesses will come in from the old; it means more companies will come into the tax net and once they are in, then the ability of the tax authority to monitor compliance becomes a little bit more enhanced.
Small businesses currently produce 74 per cent of labour in Nigeria and with this new Bill they can employ more people, they can grow their business, expand and invariably eventually grow their business above the minimum tax exempt rate of N25 million or even N100 million for the 20 per cent tax reduction. And then, what you find is that they become corporate tax citizens. It is the government believe that if Nigerian companies were incentivised they would come willingly into the tax net and use self-assessment to discharge their tax burden. So, what this Bill represents is an investment by government in the idea that Nigerians are willing to do the right thing if they are properly incentivised.
We understand that bank customers would not be able to operate their account without tax identification number, how is that going to work?
Already, the bank opening forms for businesses that seek to open account in Nigeria, require them to provide information as to their corporate status, the identity of their directors, the bank account numbers, BVN, number of their directors, the tax identification numbers. What the Bill has done is merely to formalise what is already included by banks under the auspices of the Central Bank of Nigeria Know-Your-Customer directive to make it formal and codified in the tax law that banks should not open accounts for businesses that do not have tax identification number. It is hoped that by closing this loophole, it must be better possible for regulatory authorities to match the operationalisation of bank accounts with contributions to the economy by way of tax retribution.
What are the incentives and challenges you foresee with this Bill?
I will start with the incentives and then I will move on to discuss some of the challenges that we have noticed. In terms of the incentives, there are very many provisions of the current tax regime that operate in a manner that incentivises investment by companies. I will give you an illustration: There is a provision in the tax code that punishes companies that retain profit. So if you make profit in a year of operation and you did not distribute those profits as dividend and retain that profit in your business for the purpose of reinvestment, in the year where you eventually distribute those profits you will likely pay a tax on those profits.
Even though you have previously paid tax on profit in the year when the profit was initially realised. That is effectively a double taxation on profits, which then disincentives companies and put pressure on companies not to re-invest their profit in themselves, and grow their manufacturing capacity, but in a sense always to declare dividends in order to avoid double tax. Section 19 is now being modified to exempt from its application, businesses that are at risk of suffering a double tax. With these changes, Section 19 will do what it was originally intended to do, which is to capture businesses that are aggressively failing to report tax revenue, whiles still distributing profit to their shareholders.
That is a significant incentive and so many companies in telecommunication are now able to choose to retain profit that have been made in any year in the good years of their business to expand their capital base, increase their labour and productivity and in the hope of generating larger profit in the future. This is a very good incentive that has been introduced by the Finance Bill. A few other incentives abound, but I will like to move on to a few of the challenges that we have also noticed. Of course the loudest noise has come from the changes that have been made to the tax regime for petroleum companies in Nigeria. And in fact, for petroleum companies it’s been one change after the other.
Only a few weeks ago the President also signed modifications to the Deep Offshore Act which regulates Production Sharing Contract in Nigeria by amending the royalty rate and requiring some of those companies to pay royalty, where previously they would have zero royalties to pay. Well, a few weeks later, we now have a change in the Finance Bill that proposes to remove the ring fencing that previously was available to profits that have been taxed under the Petroleum Profit Tax Act and require that those profits when distributed to shareholders, should suffer an additional tax of 10 per cent withholding or 7.5 per cent depending on the country or where the recipient of the dividend is incorporated or resident. So, that is an additional tax that previously did not exist for businesses in the oil industry.
And that is a matter that will be a challenge when such businesses begin to consider where to invest their capital and to compare the return they will obtain if they were to invest in Nigeria with return obtainable when they invest elsewhere. And so ultimately, it falls into what will be considered by such companies in their investment analysis to determine whether investing in Nigeria will continue to make sense in the long term. And it is an area I believe the government itself would also focus on probably when passing the Petroleum Industry Bill to see what other changes can be made to ensure that Nigeria remains a competitive environment for all companies to come and do business.
Let’s talk about best practices. Is this Bill supposed to take Nigeria closer to best practices as far as tax legislation is concerned, what is your own view on that?
For several years now the OECD as well as the United Nations have undertaken research into multinationals practice in the area of erosion of profit base through base erosion and profit shifting framework enunciated by both institutions. And so recommendations have been made to countries to try to align their physical framework with the reality of doing business in a modern world where the world is now a global village.
You don’t have to be physically in a country to do business in that country. Hitherto, our tax laws were framed on the assumption that companies or businesses that are physically located in Nigeria should contribute tax in Nigeria. And so the question has been how we move the physical framework in Nigeria and other countries towards the directionality of which international trade is going. What the Finance Bill has now proposed is that provisions have been included by the Minister in the Bill to capture the effects of digital trade and also the effect of international trade, where Nigeria is the recipient or staging area for such trade without necessarily the physical presence of the company that is undertaking the trade.
And so, the Finance Bill has made a proposal for digital trade where a significant economic presence is determined to have been triggered for such operators to fall into the Nigerian tax net. What the Bill has also done is to reserve to the Minister of Finance, the ability to make a declaration of what will constitute significant economic presence by virtue of which international trade participants would fall into the tax net in Nigeria. What the OECD recommends to be a significant economic presence would be revenue in excess of $750 million.
It very well might be that Nigeria will stage its own definition to be below that threshold because that threshold may be considered rather excessive from a Nigerian perspective. For those of us who follow international affairs, we saw what happened when France tried to align with this best practice in the last few months by imposing a tax on digital trade and they defined significant economic presence to be 500 million euros. And of course, that then led to negotiations with the United States of America on behalf of companies like Amazon, Google and so on. And then an agreement was reached. So, it is hoped that by vesting the minister with the ability to determine what constitute significant economic presence in Nigeria, she can go into the consideration of relevant factors in making that determination which will then be available as a guide to companies that undertake international trade.
The government is targeting tax to GDP ratio of 15 per cent by 2023. That means additional tax revenue of over $5 billion in just four years, is that realistic?
It’s an interesting question really as to whether we can achieve it. But, there is no gainsaying that at the current levels of the budget and fiscal planning in Nigeria, should we even be talking about the budget of N8 trillion or N10 trillion? Is that what we need to move Nigeria forward? I think to answer your question; a lot will depend on how rapidly we can achieve an increasing level of industrialisation of the country. How quickly can we get the productive factors of Nigeria to walk in the right direction? How quickly can we grow our economy? How quickly can we grow our GDP? If we can grow our GDP by means of investments, that this government is seeking to make, for example, the government is also trying to borrow money to finance public expenditure with a view to improving infrastructure and other aspect of the economy. The hope is that by doing so, they can facilitate the ease of doing business in Nigeria, attract investment into Nigeria, provide employment for the teaming majority of our people in Nigeria and by so doing, grow the economy. If we are able to do that then, we can improve on our tax to GDP ratio.
PwC did a recent survey and found out that 57.3 per cent are not happy with the planned VAT hike as they surveyed saw it as an additional cost burden. What is your thought about this?
For most business, we want to see stability in terms of our cost and our cost of operation and so of course businesses do not like to see tax increase and of course we will like to stay where we are. But, ultimately you have to then say to yourself what will be the impact of a VAT rate increase on the economy? And of course without the mitigation that the Finance Bill has tried to provide, perhaps the impact might have been potentially negative.
But when you then frame the proposal to the Finance Bill, with the mitigation that the finance bill provides, firstly to small businesses, secondly to everyone in terms of the class of items that are completely exempted from VAT, it is arguable, and I think you will find that the impact will be lower. There will be some impact, but I think ultimately the impact will be positive. This is because if more items are now exempted from VAT, what you will probably find will be reduction in your cost if you were a small business as opposed to an increase in your cost. Furthermore, if you as a whole were exempted from paying VAT, again another significant reduction in your cost of operation as opposed to an increase in your cost of operation.
So, definitely for large companies and companies that are still in the VAT net, you will see an increase in your VAT cost but for a large section of the economy, you will see a significant reduction in those VAT cost. So, ultimately the question will be what the overall impact on the economy might be. And I think until we get to point where we achieve complete VAT recoverability, until then, we continue to probably have nuanced effect.
But I will say my reading of the Finance Bill is that this is not the destination that the president is signaling, I think what they are signaling with this Bill is a direction. So, an increase to 7.5 per cent is an initial direction to where our VAT should go. I think you will probably find that over the next two years we will see further changes to VAT perhaps hopefully, to put us in a place where we can achieve VAT recoverability.