Steven D. Levitt defines an incentive as "a bullet, a key: an often tiny object with astonishing power to change a situation".
There is a constant tussle between encouraging individuals and corporate bodies to react in certain ways such as investing in specific sectors of the economy through tax incentives and the corresponding loss of tax revenue. Some have argued that tax incentives have no impact on economic development, as it only benefits the rich whilst others believe it can influence economic growth if strategically applied.
The details of tax incentives can be complex, and therefore, it could become difficult to differentiate between an economically required adjustment to the tax system and a wasteful giveaway. The focus of government should not be on incentives alone, but also addressing disincentives such as subsidies, political instability, and inadequate infrastructure.
There have been various changes to the tax incentive schemes available in Nigeria, in recent times. The Finance Acts (F.A.) have introduced some of these changes by the amendment of various primary tax legislations. In this article, we have highlighted some of these changes across the various sectors of the Nigerian economy.
Gas Utilization Incentives
Nigeria's proven natural gas reserves according to the Department of Petroleum Resources (DPR) have risen to 209.5 trillion cubic feet (TCF) as of January 1, 2022, a major increase of 2.97TCF in proven natural gas reserves and 1.42 percentage increase from the 206.53TCF recorded in 2020. With this increase comes increased opportunities for Nigeria's gas sectors and of course revenue to the Government in the form of taxation. It is therefore apt that incentives available to companies in the gas sector are clarified to ensure that players in the sector understand the benefits available while also maximizing benefits for the Government.
Section 39(1)(a) of the Companies Income Act (CITA) grants companies engaged in the trade or business of gas utilization in downstream operations an initial tax-free period of 3 years which may, subject to satisfactory performance, be renewed for an additional period of two years. The gas utilization business involves the marketing and distribution of natural gas for commercial purposes, and it includes power plants, fertilizer plants, gas transmission, and distribution pipelines.
The Industrial Development (Income Tax Relief) Act (IDITRA) also contains similar provisions which grant companies engaged in pioneer industries a 3-year tax holiday which may be extended for another 2 years. Gas utilization typically qualifies as a pioneer industry. T
he amendments introduced by F.A. 2019 and F.A. 2020, addresses any perceived confusion on the possibility of claiming both incentives on the same qualifying capital expenditure. These Acts states that eligible companies could enjoy pioneer status incentive granted under the IDA and additional tax holiday incentives granted under Section 39 of the CITA, only if the incentive claimed are not on the same qualifying capital expenditure and they fulfill the conditions under the relevant Acts.
The F.A. 2021 has gone a step further to provide some anti-abuse provisions in respect of the gas utilization incentive under Section 39 of CITA. The implication of this amendment is that:
- A company cannot claim the tax holiday more than once.
- A new company formed from reorganization, restructuring, buy-back, or other similar schemes out of a company that has already enjoyed the tax-free incentive is not entitled to such relief.
- A company that has previously claimed an incentive for trade or business of gas utilization under any law in Nigeria, including the PPTA and the IDITRA, will not be eligible for this incentive
The provisions introduced by FA 2021 seeks to limit cases of aggressive tax planning by companies by drawing attention to not just the qualifying capital expenditure but the entire company. This may however be counter-productive as companies who have enjoyed the incentive may not be encouraged to introduce additional lines as any new investment would not be eligible for the incentive. However, others have argued that incentives are not the only determinant of investment decision and that this introduction would not impact any decision to expand production lines. Furthermore, the company may decide to set up a new entity for the purpose of hosting any additional investment though this option would need to consider the compliance and regulatory costs of another entity.
Exemption from Value Added Tax (VAT) Registration and Compliance
The F.A. 2019 introduced revenue thresholds for taxable persons categorizing businesses as Small, Medium, or Large. It exempted taxable persons with annual revenue less than Twenty-Five Million Naira (₦25m) from accounting for VAT to the FIRS. Such taxable persons are also exempt from penalties imposed for non-registration for VAT.
This amendment has provided regulatory and likely financial relief to small companies as they do not have to bear the obligation of acting as agents of the Government as VAT collectors and the focus is now on the medium and large firms. Companies within this threshold are also exempted from registering for VAT, issuing a VAT invoice, collecting, and filing VAT returns with the Federal Inland Revenue Service.
However, Section 32 of the Finance Act 2021 has now amended this provision of the VAT Act to exclude companies engaged in upstream petroleum operations from this exemption. These companies will continue to comply with the provision of the VAT Act regardless of their revenue amount.
Companies in the upstream oil and gas sector typically take a while between when they obtain the right to a producing asset to when they commence actual commercial production of oil, thus earning any revenue. These companies incur significant expenses during this period and may not be obliged to deduct VAT on these transactions with the exemption they would have enjoyed without the introduction of this change by FA 2021. The change therefore addresses an area of potential revenue leakage for the Government especially in a time where Government is looking to improve its revenue position.
Capital Allowances Restrictions
Another change to the current tax benefits available to companies is with respect to capital allowances. The F.A. 2021 has introduced a restriction to the extent of capital allowance claimable by a company. The Act provides that costs attributable to exempt income should now be accounted for in detail to check if it crosses a 20% threshold.
Companies are only allowed to claim the full capital allowances due (subject to the 66⅔ restriction) when the proportion of tax-exempt income to the total income of a company is less than 20%. In situations where the tax-exempt income generated from the use of a QCE is 20% or more, the capital allowance claimable on the QCE for that period shall be prorated to the actual percentage of taxable income generated. This introduces an additional accounting burden for taxpayers as they are now required to properly analyse their income along the lines of taxable and tax-exempt income. In addition, the basis of determining which specific QCE is attributable to the tax exempt income may also be an issue for certain taxpayers. However, companies which enjoy pioneer status incentives as provided under the Industrial Development (Income Tax Relief) Act will continue to treat their assets, for capital allowance purposes, as though they were bought after the pioneer period.
Another amendment introduced by the F.A. 2021 is with respect to small or medium sized companies. The amendment provides that in a year where a company is small or medium-sized based on its revenue, the capital allowance for that year should be computed in line with the provisions of the second schedule to CITA, even though such companies will not be required to pay income tax in such a year of assessment. Therefore, the capital allowance that would have been claimable by the company for that year is deemed to be claimed and any residue are carried forward to the subsequent year.
The aim of this provision is to ensure that small and medium companies do not get an undue advantage by using the capital allowance from non-taxable years to reduce their taxable profits in years that they qualify for tax payments.
It is important to note that the wordings of the provision can easily be interpreted to mean that all brought forward capital allowances and yearly computations are lost by a company in the year in which it is a small or medium company.
Export Profit Exemption
Section 23 of Companies Income Tax Act, exempted profits generated by Nigerian companies in respect of goods exported from Nigeria on the condition the proceeds are used exclusively for the purchase of raw materials, plants, equipment, and spare parts. This was prior to the enactment of the F.A. 2021.
However, the F.A. 2021 has specifically exempted companies in the oil and gas sector from enjoying this incentive. A need for this clarification arose following the enactment of the Petroleum Industry Act 2021 (PIA 2021) which subjected these companies to Hydrocarbon Tax (HT) and/or CIT. Therefore, companies in the oil and gas sector will continue to pay taxes on their total profits either under the HT regime or the CIT regime irrespective of their export status. This amendment ensues that the Government continues to get full taxation revenue from companies in the oil and gas sector.
CGT on Sale of Shares
Another interesting change to the tax incentive space in Nigeria is the amendment of the Capital Gains Tax (CGT) Act, which now imposes 10% CGT on gains from the disposal of shares where the proceeds are ₦100 million or above in any 12 consecutive months. The proceeds from such disposals will only be exempt if; it is wholly reinvested in a Nigerian company within 12 months.
The aim of this question was to be for the Nigerian Government to receive a share of the earnings in the stock market especially from short-term investments by institutional investors. However, this change also brings a lot of questions to the fore. For example, will CGT apply if a re-organisation of a Group requires moving shares of a Nigerian company from a related Nigerian entity to a related non-resident parent company? We wait to see how these issues will play out.
Expiration of Tax Exemption on Bonds and Securities
In 2011, the Federal Government of Nigeria issued an exemption order excluding the interest and proceeds from various Bonds and Federal Government short-term securities withholding tax and income tax respectively. On this basis, several companies invested funds into these securities as a means of earning income which would not be taxed. The order had a 10-year exemption period which expired on 2 January 2022.
Save for Bonds issued by the Federal Government of Nigeria, all the other categories of securities are now exposed to income tax on their proceeds as well as withholding tax on the interest income earned.
It should also be mentioned that there had also been an order for the VAT exemption on these securities which also expired on 2 January 2022. However, based on the recent amendments to the VAT Act, these securities will continue to enjoy an exemption from VAT as they do not fall into the category of goods and services as defined by the VAT Act.
The last three years have been a period of active fiscal supervision and review of the macro environment and changes to tax incentives have been one of the significant amendments over the period.
While some benefit from an amendment, others are deprived of the tax holidays or exemptions due to a new amendment. For now, tax incentives continue to be a tool to encourage investment in Nigeria. However, like with all other schemes, tax incentives only become most effective when combined with other non-tax factors such as political stability, secured terrain, and adequate infrastructure.
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.