The type of company is the foundation of whether an educational institution would be tax exempt or not... It is however possible that a company that has been set up as a not-for-profit organisation would still be taxable if it is not of a public character or ventures into other trade or business.
The income tax status of religious, educational institutions or charitable organisations ('not-for-profit' organisations) is a controversial topic. Section 23 (1) of the Companies Income Tax Act (CITA) stipulates the conditions for their profits to be exempt from tax. The law can be subject to different interpretations and therefore has been a point of tax disputes in the past.
Key points to qualify for the tax exemption
Section 23 (1) provides: There shall be exempt from the tax—
a. the profits of any company being a statutory or registered friendly society, in so far as such profits are not derived from a trade or business carried on by such society;
b. the profits of any company being a co-operative society registered under any enactment or law relating to co-operative societies, not being profits from any trade or business carried on by that company other than co-operative activities solely carried out with its members or from any share or other interest possessed by that company in a trade or business in Nigeria carried on by some other persons or authority;
c. the profits of any company engaged in ecclesiastical, charitable or educational activities of a public character in so far as such profits are not derived from a trade or business carried on by such company.
Based on the above, for the profits of an educational institution (or indeed charity or religious organisation) to be tax exempt;
Condition 1 - the educational activities must be of a public character.
Condition 2 - the profits must not be derived from a trade or business carried on by the organisation.
The conditions must be jointly met to exempt the income. The first condition is a bit vague. In the TAT judgment of AIS vs FIRS for example, the FIRS argued that the relatively significant school fees of the school means that it sets a bar that automatically disqualifies some members of the public. However, the TAT's judgment mentioned that charging fees is not out of place. It can be inferred that the TAT's view is that the level of fees should not define 'public character' as long as the school is generally open to any member of the public who may apply depending on affordability. It should also be noted that AIS is a company limited by guarantee and the profit from school fees were held to be non-taxable. On the surface, this may look like it contradicts the spirit of the law. However, on closer examination, it is sensible for the TAT not to consider level of fees as the determinant of what constitutes public character. The TAT would have been required to set a threshold, which is an impossible exercise to achieve. For example, what cap of fees would be considered as within the range of 'public character'? Would it be N50,000, N500,000 or N5 million?
The second condition is more straight forward. The clarity is that these institutions can make a profit, but the profit will be exempt from tax only if it is not derived from a trade or business carried on by the institution. The most obvious conclusion that can be reached is that when these institutions carry on a profit-oriented activity that is outside their core, such activities would be subject to tax e.g. a school that rents out its halls for events such as weddings.
There is however a not so obvious point from the second condition. What the recent judgment has reaffirmed is that it would be wrong to assume that once the profits are from educational (religious or charitable activities), the exemption would be applicable. You cannot fault the judgment because CITA did not use the word 'another' in the place of 'a' in this phrase "...in so far as such profits are not derived from a trade or business carried on by such company". Therefore, from a technical standpoint, even educational activities could be taxable if they are considered to be from trading or business activities.
Now, let us look at the recent Court of Appeal judgment and see the conclusions that could be drawn.
Review of the Court of Appeal's decision on Best Children International Schools Ltd v The Federal Inland Revenue Service (BCIS v FIRS) – the implications.
BCIS is a company limited by shares. BCIS argued that it only provides educational services and does not carry on any other trade or business. BCIS had sought an order of the Federal High Court to prevent the FIRS from imposing and enforcing companies' income tax assessment on it. The FIRS argued that a company can only be exempt under section 23(1) (c) CITA if the profits are not derived from trade or business. BCIS lost at the Federal High Court and appealed to the Court of Appeal.
The crux of the appeal was whether the Federal High Court was right in holding that a company limited by shares cannot claim the tax exemption in section 23 (1) (c) CITA.
Relying on section 26 of the Companies and Allied Matters Act (CAMA), the Court of Appeal held that a company that is limited by shares is formed for profit making purposes and therefore, liable to pay taxes. Section 26 (1) of CAMA provides:
"Where a company is to be formed for promoting commerce, art, science, religion, sports, culture, education, research, charity or other similar objects, and the income and property of the company are to be applied solely towards the promotion of its objects and no portion thereof is to be paid or transferred directly or indirectly to the members of the company except as permitted by this Act, the company shall not be registered as a company limited by shares (emphasis mine), but may be registered as a company limited by guarantee".
Based on the conclusions of the court, a company limited by shares will be deemed to have derived its income or profit from trade or business irrespective of whether it has been set up as a school.
It has been argued by some observers that the conclusions of the Court of Appeal could have been influenced by Section 23 (1) (a) and (b) of CITA which specifies that the taxpayers granted exemption under those subsections must be registered as a friendly or cooperative society. However, this assumption may not be completely accurate as the judgment did not reflect or consider those subsections in reaching a conclusion. As highlighted earlier, the law does not specify that the profits that would be taxed must be from other activities.
Based on the decision in BCIS v FIRS, the following conclusions can be drawn:
a. The fundamental and distinctive characteristics or qualities of a company should be determined by how the company was formed.
b. Every business set up is intended to yield income and it is this income that is taxed.
c. Every registered company in business ought to pay taxes except exempted
d. For a company to be exempted under Section 23 (1) (c), it must prove two things:
- it is engaged in ecclesiastical, charitable or education activities of a public character
- the profits the company makes from its activities are not from a trade or business.
e. A company limited by shares is for profit making and must pay taxes. The fact that the company is a school or educational institution is not enough.
The type of company is the foundation of whether an educational institution would be tax exempt or not. Although this condition was not expressly included in the law, the precedents from AIS vs FIRS and BCIS vs FIRS have reaffirmed this conclusion. It is however possible that a company that has been set up as a not-for-profit organisation would still be taxable if it is not of a public character or ventures into other trade or business.
Unfortunately, neither the Court of Appeal nor the Tax Appeal Tribunal has defined what constitutes 'public character'. It means that this would continue to be an issue that would be up for debate. It may also be a misdirection if people continue to focus on the definition of public character during tax disputes. The mere fact that it is a difficult concept to define makes it a weak basis to hinge any legal arguments for exemption.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.