The increased pace of globalisation has not left Nigeria and Nigerian companies out. Consequently, Nigerian companies are increasingly involved in business activities abroad in order to remain competitive in today's business environment. This means that companies in Nigeria earn income and/or incur costs outside Nigeria.
Nigeria is yet to attain the status of an industrialised nation or developed economy where most business resources, technical expertise and advanced technological infrastructure are available locally. It has therefore been common practice for business organisations in Nigeria to seek some of the resources required for their local business operations outside the shores of the country.
Besides the local availability of required resources, Multinational Enterprises (MNEs) adopt various strategies aimed at optimising costs and by tapping into the synergies that exist within. One of such strategies is to centralise some strategic functions to be performed on behalf of all the entities within their group at a particular location. This helps to enhance economies of scale, operational flexibility and competitiveness. Examples of such services include administrative services at a corporate level, procurement, research and development, treasury management, manpower supply, mobility services etc. In most cases, the cost incurred on these services is apportioned among the MNE's affiliated entities across the globe.
The draftsmen of the Companies Income Tax Act (CITA) seems to have pre-empted the current wave of globalisation and included a provision to subject income earned abroad by a Nigerian company to tax in Nigeria (Section 8). It also contains provisions that seek to subject income earned in Nigeria by non-Nigerian companies to tax (sections 8 and 10). What is mind bugging though, is the provision of Section 27(i) of CITA, which provides that "...no deduction shall be allowed for the purpose of ascertaining the profits of any company in respect of any expense of any description incurred outside Nigeria for and on behalf of any company except of a nature and to the extent as the Board may consider allowable"
Over the years, there have been conflicting views on the interpretation of the above provision. While a school of thought believes that the section seeks to preclude the deductibility of expenses incurred outside Nigeria for tax purpose (except the Board thinks otherwise), another school has argued that the section only seeks to prohibit the deduction of expenses incurred outside Nigeria by a company on behalf another company.
Expectedly, Federal Inland Revenue Service (FIRS) has consistently adopted the first mentioned interpretation in their increasing attempt to apply the provision of Section 27(i) to offshore costs incurred by Nigerian companies. In applying this interpretation, FIRS has allowed between 0% and 100% of offshore costs as tax-deductible, depending on the strength of argument put forward by each taxpayer. On this arbitrary application, one key question comes to mind – "was Section 27 intended to give FIRS the right to arbitrary deductibility of expenses even if such expenses have been legitimately incurred?"
Based on the foregoing, it is imperative to analyse the tax consequence of expenses incurred by companies outside Nigeria, as this could influence their cost optimisation policies and efforts to remain competitive.
In Nigeria, the general test for tax deductibility of expenses by companies, other than those involved in petroleum exploration and production, is that any expense incurred in generating the profits of a company must satisfy all the four major conditions stated in the CITA, usually referred to as the WREN test. In essence, the expense must be wholly, reasonably, exclusively and necessarily incurred during that period for the purpose of generating the profits of the business. The details of the conditions are specified below:
- Wholly – the entire expense amount must be incurred in generating the profits of the company.
- Reasonably – the expense must be reasonable in relation to the profit or loss for the period, comparative amounts of the expense in previous years, materiality of the amount of the expense, general business environment, industry practice and relevant regulatory approvals.
- Exclusively – the business alone must have obtained the benefit of incurring that expense. Any part of that expense relating to a benefit derived by some other persons will not be allowed as a deduction from the income of the business.
- Necessarily – the expense should be such that the company's business profit cannot be derived without incurring that expense.
The CITA goes further to give examples of expenses that would typically pass the WREN test such as interest on loan, staff costs, repairs, rent, etc., as well as those that would not e.g. depreciation, capital expenditure, etc. One of the non-tax deductible expenses cited under CITA is the issue of expenses incurred outside Nigeria as provided in Section 27(i).
In practice, FIRS often disregard the WREN test when determining the tax deductibility of expenses incurred outside Nigeria. Rather, it simply makes reference to Section 27(i) and upholds its own interpretation that since such expenses were incurred outside Nigeria, they should be disallowed irrespective of whether they pass the WREN test or not. A case in point is that of Nigerian Breweries Plc (NB) vs FIRS, which was presented before the Tax Appeal Tribunal (TAT), where the revenue authority insisted that the buying commission and handling charges incurred outside Nigeria by the appellant (NB) and payable to an affiliate entity, are not deductible despite the fact that they passed the WREN test as indicated in Section 24 of CITA. The appellant argued that Section 24 is the relevant section to determine the deductibility of the expenses in question while section 27(i) only speaks to expenses incurred outside Nigeria on behalf of another company.
The ruling of the TAT provides further clarity on this subject. TAT ruled in favour of the appellant, stating that the handling charges and buying commission incurred by the company outside Nigeria, and payable to an affiliate entity are tax-deductible. The basis of TAT's decision are provided below:
- Section 27(i) refers to expenses incurred for and on behalf of any company by the taxable company. Thus the provisions of the section will only apply if the taxpayer incurs the expenses for and on behalf of another company. In any case, the ambiguity in the provision will be resolved in favour of the taxpayer.
- The expenses in question have been wholly, reasonably, exclusively and necessarily incurred by the appellant for the production of its profits in line with the provisions of Section 24 of CITA. Removing any expense from this general rule would require a specific provision and clearly, section 27(i) does not satisfy this.
The TAT ruling is a judicial breakthrough and a welcome relief to lots of companies who incur a substantial portion of their expenses outside Nigeria. It should lay to rest the view held by some that Section 27(i) precludes the tax deductibility of expenses incurred outside Nigeria except where the ruling of the TAT is set aside by a superior court upon appeal by FIRS. Nigerian companies are therefore advised to take note of the principles established in this case and ensure relevant supporting documentary evidence is in place to satisfy the WREN test for tax deductibility of expenses incurred by them in generating business profits.
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.