The Federal Inland Revenue Service (FIRS or "the Service") recently published the Non-Interest Finance (Taxation) Regulations 2022 ("the Regulations"), which provide a framework for the taxation of financial institutions offering non-interest financial products and services in Nigeria. The Regulations, with a commencement date of 1 April 2022, were issued pursuant to the FIRS' power under Section 61 of the Federal Inland Revenue Service Establishment Act (FIRSEA).

On 9 June 2022, the Central Bank of Nigeria (CBN) had issued the revised Guidelines for the operation of non-financial instruments to provide a uniform set of rules for authorised institutions to access non-interest financial instruments (NFIs) contained in its Circulars: "Guidelines for the Operation of Non-Interest Financial Instruments by the Central Bank of Nigeria" of December 2012 and "Introduction of Two New Instruments - "Funding for Liquidity Facility and Intra-Day Facility for Non-Interest Banks" of August 2017, respectively.

Therefore, the Regulations provide tax and regulatory framework for the operation of NFIs offered by the CBN for authorised institutions operating under the principles of Islamic Commercial Jurisprudence to ensure equal treatment of both conventional and non-interest financial services and transactions in Nigeria.

The Regulations are divided into seven (7) parts and address twelve (12) different NFIs provided by authorised institutions and their tax implications.

We have summarised below the relevant instruments listed under the various product categories and their tax treatments as provided in the Regulations:

1. Sale-based products

The Regulations describe three types of sale-based products, namely:

i. Murabaha (Cost plus mark-up)

Here, a financial institution, at the request of a customer, purchases an asset from a vendor and resells to the customer at a markup, also known as Murabaha.

Paragraph 3 of the Regulations requires the financial institution to treat the initial purchase price as a loan to the customer. Further, the resale price, excluding the markup, will be treated as a loan repayment and will not be subject to value added tax (VAT), stamp duties and capital gains tax (CGT). However, the markup element will be treated as interest payable on the loan and subject to withholding tax (WHT). Similarly, the purchase of the asset from the vendor will be subject to both VAT and WHT respectively.

ii. Istisna or Parallel Istisna

Paragraph 4 of the Regulations addresses the Istisna instrument where a financial institution undertakes to finance a customer's project for the construction or manufacture of goods or assets and engages the services of a third party for the construction or manufacture of the goods or assets, and thereafter transfers the goods or assets to the customer upon completion.

The Regulations provide that the financing arrangement with the customer will be treated as a loan, which will not be subject to VAT and WHT. However, the transaction between the financial institution and the third party will be subject to VAT and WHT, respectively.

Further, the repayment of the principal amounts (or Istisna contract sum) by the customer will be treated in the same manner as a loan repayment. Therefore, only the markup portion, similar to an interest, will be liable to WHT. The customer will treat the capital portion and markup as qualifying capital expenditure (QCE) for income tax purposes, in line with the provisions of the Second Schedule to the Companies Income Tax (CIT) Act (as amended).

iii. Salam or Parallel Salam

Salam refers to the purchase of a commodity for deferred delivery in exchange for immediate payment. Thus, in a Salam contract, the price is paid in full in advance while the delivery of the commodity is deferred to an agreed date in the future. Subsequently, the financial institution contracts with a third party to purchase the commodities.

2. Equity-based products

i. Musharakah

A Musharakah is a joint venture arrangement where the financial institution and customer enter into a partnership, for a limited duration, to finance the acquisition of an asset or a project, and both share in the profits in a predetermined ratio. However, losses are borne based on capital contribution. The customer may choose, subsequently, to acquire the share of the financial institution in the partnership.

Based on Paragraph 6 of the Regulations, the capital contribution by the financial institution will be deemed as a loan, while its share of profit will be treated as the interest on the loan and subject to the same tax treatment as interest on a conventional loan, i.e., WHT. Payments made by the customer to acquire the shares of the financial institution will be considered a loan repayment and would not be liable to tax. However, the agreement to transfer the interests of the financial institution to the customer will be subject to stamp duties accordingly.

Further, only the customer will be allowed to treat the cost of acquiring the asset or project as a QCE for income tax purposes and claim capital allowances thereon, in line with the Second Schedule to the CIT Act (as amended). The financial institution may claim its share of loss from the partnership as an allowable deduction for CIT purposes if it can prove, to the satisfaction of the FIRS, that the loss relates to expenses wholly, reasonably, exclusively and necessarily incurred in generating the taxable income under the agreement.

ii. Diminishing Musharakah

In a diminishing Musharakah, the financial institutions share is progressively reduced, and reallocated to the customer, who finally becomes the sole owner of the asset. The customer will have an exclusive right to possess and use the asset and pay the financial institution periodic rent and a consideration to acquire its share in the asset. The customer can treat the asset as QCE for CIT purposes and claim capital allowances on the cost of the asset.

Paragraph 7 of the Regulations provides that the amount contributed by the financial institution will be treated as a loan provided to the customer and shall not be subject to any tax. However, the periodic rent paid by the customer will be treated as interest and subject to WHT.

Further, the consideration paid to acquire the interest of the financial institution in the asset will be treated as repayment of the principal and therefore, will not be liable to both VAT and WHT. The instrument executed between the customer and the financial institution to transfer the latter's share of interest in the asset will, however, be subject to stamp duties accordingly.

iii. Mudarabah as deposit

In this instance, the financial institution acts as a fund manager for capital provided by the customer. Both parties share in the profits derived from the use of the capital for investment in approved activities in a predetermined ratio.

Paragraph 8 of the Regulations provides that the customer's share of the profit will be deemed, in substance, a return on investment, and taxed in the same manner as conventional return on investment.

3. Lease-based products

i. Ijarah wa iqtina (Finance lease)

Here, the financial institution will acquire an asset from a third party and lease same to the customer, who has the option to purchase the asset at the expiration of the lease period. Ownership and major maintenance of the asset remain with the financial institution while the customer retains only the beneficial interest in the asset for the duration of the lease. The customer will pay the financial institution an agreed periodic rental fee for the use of the asset.

Paragraph 9 of the Regulations provides that the Ijarah wa iqtina contract will be treated in the same manner as a finance lease. Therefore, the customer will capitalise the lease repayment as QCE for CIT purposes and claim capital allowances accordingly. The lease payments will be subject to VAT and WHT. Further, any agreement executed between the parties for the transfer of the asset at the end of the lease period will be liable to stamp duties.

ii. Ijarah (Operating lease)

The major difference in Ijarah is that there is no intention to transfer ownership of the asset to the customer at the end of the lease period. Therefore, Paragraph 10 of the Regulations provides that in Ijarah, the financial institution will recognise the asset as QCE and claim capital allowances accordingly. The periodic lease payments to the financial institution for the use of the asset will be subject to VAT and WHT accordingly. The customer will be entitled to claim the lease payments as allowable expenses for income tax purposes provided that the asset is used for the purpose of generating the income that is subject to tax.

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