Arguably, the most basic principles in business are minimising cost and maximising profit. Thus, it is not unnatural that businesses would seek to reduce their expenses to the barest minimum. Conversely, the tax authorities have the responsibility of ensuring that businesses pay their taxes in accordance with the tax laws.
Businesses sometimes incur punitive payments for default or violation of laws in the conduct of their businesses – commonly in the form of fines and penalties, and these punitive payments are sometimes substantial. It is likely that a business which has incurred substantial punitive payments would expect to treat such payments as deductible expenses in ascertaining its taxable profit. However, a pertinent issue is whether such punitive payments are tax-deductible.
Are Punitive Payments Tax-deductible?
The taxman recognises the need to allow room for businesses to thrive. As such, provisions are often made to allow the businesses pay taxes on only actual profits and not all incomes of the businesses. Thus, certain business expenses are deductible before the net income is taxed. These deductions are often referred to as "allowable deductions," while the part of the income to be taxed thereafter is referred to as the "taxable profit" or "chargeable profit."
The expenses that are tax-deductible are spelt out in section 24 of the Companies' Income Tax Act ("CITA"), which is the primary statute on the taxation of companies doing business in Nigeria. The section lists tax-deductible expenses of a business to include expenses incurred during the applicable period wholly, exclusively, necessarily, and reasonably for the purposes of such business. It would therefore appear that the tax authorities do not recognise such punitive payments as tax-deductible expenses and this is notwithstanding a general reluctance of businesses to pay tax on punitive payments like fines and penalties. The rationale for this may be that such expenses are avoidable in the realisation of the company's profits for the relevant year of assessment. Furthermore, punitive payments are by nature incurred only because the company defaulted or violated some law and as such, can hardly be said to have been incurred "necessarily" for the realisation of the profits of the company.
The deductibility of punitive payments in determining taxable profit, came up for determination in Federal Inland Revenue Service (FIRS) V. The Shell Petroleum Development Company of Nigeria Ltd (SPDC). In that case, the Respondent (SPDC) had made tax deductions on amounts incurred for gas flaring in its tax returns. The Appellant (FIRS) contended that the deductions were penalties for gas flaring and therefore were not allowable deductions. Although the Court held that the payments were punitive payments, it decided that that such fees for gas flaring are not expenses wholly, exclusively and necessarily incurred for petroleum operations as envisaged under section 10 of the Petroleum Profits Tax Act. Consequently, SPDC was not entitled to make tax deductions of the sums incurred.
A more recent case is that between MTN Nigeria Plc (MTN) and the FIRS, arising out of a N330 billion fine paid by MTN Nigeria Plc for failing to deactivate more than 5 million unregistered SIM cards as required by the Nigerian Communications Commission. In filing its returns, MTN treated the N330 billion fine as an allowable deduction and therefore did not account for it as part of its taxable profit. However, the FIRS disagreed with MTN on the deductibility of the fines in arriving at the taxable profit, and imposed tax on the fine. Dissatisfied with the FIRS' assessment, MTN has approached the Tax Appeal Tribunal (the "TAT") to determine the treatment of the fine as a tax-deductible expense. The matter is still pending before the TAT as at the time of this article.
It would be interesting to see how the TAT decides the MTN Nigeria appeal before it. At the moment, the decision of the Federal High Court ("the FHC") in Federal Inland Revenue Service v. The Shell Petroleum Development Company of Nigeria Ltd which disallowed the tax-deductibility of punitive payments, may be considered binding on the TAT being an inferior court to the FHC, unless the TAT is able to distinguish the two cases.
Whichever direction the TAT takes in deciding the MTN Nigeria appeal, it would be important for the jurisprudence on deductibility of punitive payments as allowable expenses. Also, given the value of the sum in dispute – N330 billion, there is a good chance that any aggrieved party will appeal the decision until it gets to the Supreme Court.
 Chapter C21, Laws of the Federation of Nigeria 2004.
 Section 24(1) of CITA.
 (2018) 39 TRLN13.
 Chapter P13, Laws of the Federation of Nigeria 2004 which is similar to the test under section 24 of the CITA.
 Supra, note 3.
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