Nigeria: Finance Act 2020 – Public Character & Impact On The Taxation Of NGOs

The Non-Governmental Organizations (NGOs) are an important part of the Nigerian society as they are quite impactful in many areas of our daily lives. NGOs are usually not profit-making organizations and there have been some ambiguity in the legislations governing the taxation of NGOs, especially with regard to the definition of the term "public character".

This article discusses the issues surrounding the legislative framework of taxation of NGOs and the changes introduced by Finance Act 2020.

Non-Governmental Organizations

An NGO is an association of persons registered under Section 590 of the Companies and Allied Matters Act (CAMA) 2020 as incorporated trustees or under Section 26 of CAMA as a company limited by guarantee.

An incorporated trustee is to be registered under S.590 of CAMA for the advancement of any religious, educational, literary, scientific, social development, cultural, sporting or charitable purpose. Meanwhile, under S.26 of CAMA, an NGO can be registered as a company limited by guarantee for promoting commerce, art, science, religion, sports, culture, education, research, charity or other similar objects. An NGO incorporated by guarantee is not allowed to carry on business for the purpose of making profits for distribution to members. While the above two forms of incorporation are common for an NGO, nothing precludes an NGO from being incorporated as a company limited by shares. However, this is rarely the case in practice.

Taxation of NGOs pre-Finance Act, 2020

NGOs are required to file annual income tax returns in line with Section 55 of Companies Income Tax Act (CITA) and comply with Value Added Tax (VAT) obligations on the supply or purchase of taxable goods and services. However, Section 23 (1) of CITA and Paragraph 13 of the Third Schedule to the Personal Income Tax (PIT) Act, provide that the profits/income of any institution being a statutory or registered friendly society, company engaged in ecclesiastical, charitable or educational activities of a public character, are exempt from tax, in so far as such profits/income are not derived from a trade or business carried on by such society. However, CITA failed to define neither the meaning of "activities of a public character" nor "public character". Hence, applicability of income tax to NGOs or otherwise, has been a controversial issue over the years.

In an attempt to clarify the above issue, the Federal Inland Revenue Service (FIRS) issued a Circular on 27 August 2010 on the guidelines on the tax exemption status of NGOs. The FIRS in trying to clarify the issue stated that where an NGO engages in any trade or business, the profit derived therefrom will be subjected to income tax as provided by CITA. The Circular further provided that where the NGO invests its assets in any institution, the income derived from such investment shall be subjected to tax and Capital Gains Tax (CGT) shall arise where assets are disposed by the NGOs at a gain.

The FIRS' Circular raised controversies as NGOs argued that in so far as the activities or trade are activities of a public nature and the profit is not distributed among its members, such profit is not taxable. Due to the silence of CITA on the meaning of "activities of a public character", NGOs adopted the position that provided the activities of an NGO were ecclesiastical, charitable or educational activities, aimed at benefitting Nigerians generally and its profits are not available for distribution to the company's promoters; such activities would qualify for tax exemption from any profit so generated. The NGOs were also of the opinion that the gains from the disposal of any asset used for the above purposes should be exempt from CGT as provided by Section 26 of the CGT Act.

Definition of Public Character

Prior to the FA 2020, CITA did not include a definition for the term "public character". However, Paragraph 9 of the Requirements for Funds, Bodies or Institutions Regulations, 2011, which was pursuant to FIRS' Establishment Act, defined the term as "a body or institution whose activities are meant to benefit Nigerians in general and particularly the public and its profits are not available for distribution to its promoters".

In the case of American International School Lagos (AIS) v. FIRS in 2015, the key issue for determination was whether AIS qualified as an educational institution of public character. It should also be noted that AIS is registered as a company limited by guarantee and by extension, proscribed from distributing profits to its members or promoters. The Tax Appeal Tribunal (TAT) held that AIS, being an educational institution of public character, was not liable to income tax. In reaching its decision, the TAT relied on the fact that the profits of AIS are derived solely from educational activities, AIS does not distribute its profits to its guarantors and that no segment of the public was excluded from enjoying the services rendered by AIS.

However, in the case of Best Children International School (BCIS) v. FIRS, the Federal High Court (FHC) ruled that BCIS was liable to income tax, on the basis that BCIS is a company limited by shares and the profits of the school do not qualify for exemption under Section 23(1) (c) of CITA. The decision of the FHC was upheld by the Court of Appeal (CoA), in December 2018. The CoA in its decision, held that only companies limited by guarantee, which are prohibited from distributing profits, are entitled to tax exemption under CITA. This gave rise to more uncertainties.

Taxation of NGOs post-Finance Act 2020

In an attempt to lay these controversies to rest, the Finance Act, 2020 defines the term "public character" to mean "organization or institution that is registered in accordance with relevant law in Nigeria; and does not distribute or share its profits in any manner to members or promoters."

Given this definition, it would appear that the key consideration for determining tax exemption status is whether or not an organization is proscribed from distributing profits to its members or promoters. This would appear to align with the decision reached in the case of BCIS v. FIRS. Nevertheless, the Finance Act's definition of public character by reference to the nature of a company and not the activities of the company does little or nothing in the way of resolving the long-standing dispute between NGOs and the FIRS regarding how the tax exemption should be applied. Therefore, the ongoing debate around what represents activities of a public character will linger till the foreseeable future.

Furthermore, the provision that only an organization that does not distribute or share its profits in any manner to members or promoters will qualify as an institution of public character implies that only a company limited by guarantee can validly qualify as an institution of public character in line with the provisions of the CAMA. It remains uncertain whether the Finance Act by its provision has excluded companies limited by shares from the definition of public character or such companies eligible for the tax exemption, to the extent that they do not distribute or share profits to members or promoters. It may seem that the Finance Act in trying to resolve a controversy has created room for even more conflicts and future lawsuits from NGOs that are not incorporated as a company limited by guarantee.

The FIRS, on 31 March 2021, released a Circular on the guidelines on the tax treatment of NGOs and suggests that the income of an NGO is to be wholly used for the objectives of the organization or institution and shall be for the interest of the public. The Circular further states that the distribution of assets, whether in cash or in kind (e.g. gifting a vehicle or any asset for the personal use of the promoters or members) shall be construed as distribution of profit. This additional definition issued by the FIRS is clearly a stretch of the provisions of the Finance Act. Meanwhile, it has long been established by case laws that the FIRS cannot by a mere circular, seek to amend the provisions of the law. An attempt by the FIRS to implement this interpretation will probably be the subject of numerous litigation by aggrieved NGOs.

Jurisdictional Analysis

Kenya has an almost identical taxation regime for NGOs as Nigeria with an even more complicated legal framework, which provides for possible registration under five different categories and multiple laws, which are implemented by different government ministries, agencies and departments. Registered NGOs in Kenya are not subject to corporate income tax except when they undertake an activity that generates an income, in which case such income will be liable to income tax. However, the NGOs are subject to other taxes including PIT, withholding tax (WHT) and VAT.

In Tanzania, an NGO can apply to be recognized as charitable organizations once it is a resident entity of public character, established for relief of poverty or distress of the public, advancement of education, or provision of general public health, education, water or road construction or maintenance. An entity of public character is to have its membership open to the general public or an identifiable group of persons, to operate without the motive of making profit and not to distribute profits generated from its charitable businesses. Surprisingly, obtaining the charitable status does not exempt an NGO from income tax. Rather, the NGO will be granted an additional tax deduction of 25% of its income. Therefore, if an NGO uses at least 75% of its income in their charity activities, then no income tax will be payable. Notwithstanding, the NGO will have the obligation to file returns, as well as pay payroll taxes, WHT, stamp duty and other taxes.

England and Wales arguably have the most detailed and positive system of taxing NGOs commonly referred to as not-for-profit organizations (NFPOs). The law provides for five primary forms of NFPOs namely; Companies limited by guarantee (including Community Interest Companies "CICs"), Unincorporated Associations, Trusts, Registered societies and Charitable incorporated organizations. An NFPO that takes any of the above forms qualifies as a charitable organization except CIC. Charitable organizations are exempt from income tax, corporate tax and CGT. This is subject to the condition that the charity's income is applied for charitable purposes. Tax reliefs are lost (and can be lost retroactively) if a charity makes non-qualifying expenditure, that is, expenditure otherwise than in pursuit of its charitable purposes.

In addition to the above, charities are eligible for a mandatory 80% reduction in business rates (a local tax, payable by commercial businesses to the respective local authority) on premises used for charitable purposes and a further reduction of up to 20% at the discretion of the relevant local authority. In some circumstances an exemption from stamp duty land tax (otherwise payable on the purchase of land or property) is available. Gifts to charities on death are also exempt from inheritance tax and where a testator leaves 10% or more of his estate to charity, a reduced tax rate of 36% as against 40% is applied to the estate. Individuals are allowed to make tax-free donations to these charities.

While charities are generally subject to VAT, certain transactions are exempt from VAT, including most grants, VAT on goods for the disabled and charity for fundraising events.

Conclusion

Overall, further legislation may be required to clarify what the activities of a public character entail. In the interim however, it is important for NGOs to coordinate their business and tax processes in a manner that will not unduly expose them to future tax liabilities.

Nigerian legislators might also consider borrowing a leaf from the well detailed and highly favorable laws governing NFPOs in England and Wales. Afterall, NGOs generally support the disadvantaged and vulnerable in the society and should thus, be given as much support and incentive as possible.