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Monday, July 13, 2020 / 12:40PM
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Introduction
The Finance Act, 2019 ("the Finance Act")[1]
has made significant changes to the tax regime in Nigeria. The Act makes changes
to legislation such as the Companies Income Tax Act ("CITA"), Petroleum Profit
Tax Act ("PPTA"), Personal Income Tax Act ("PITA"), Value Added Tax Act
("VATA") and Capital Gains Tax Act "(CGTA"), amongst others.
We anticipate that some of these reforms would be
of interest to private equity ("PE") and venture capital ("VC") investors and fund
managers interested in Nigeria. This is because the changes will have an impact
on matters such as investment strategies, tax planning and revenue forecasts.
We highlight the relevant changes and potential
implications for the PE industry below.
Taxation of Digital
and Remote Services
A key reform introduced by the Finance Act relates
to the taxation of foreign companies that provide digital content/services (or
engage in digital transactions) or technical/management/consultancy/professional
services to persons in Nigeria.
Before the Finance Act, the physical presence of
the foreign company or its agents in Nigeria was the primary consideration
whilst determining whether profits of the company were derived from Nigeria. However,
pursuant to the CITA (as amended by the Finance Act), a digital or virtual
presence may now suffice.
Thus, the profits of a foreign company shall be also deemed to be derived from Nigeria where:
In exercise of statutory powers, the Minister of
Finance issued the Companies Income Tax (Significant Economic Presence) Order,
2020 on 29 May 2020 (the "SEP Order") which became effective on 3 February 2020,
stipulating what would constitute a significant economic presence of a foreign
company.
Thus, where a foreign company that provides
digital content/services is deemed to have a significant economic presence in
Nigeria, its profits will be subject to companies income tax of 30%. Where the
foreign company provides technical, management, professional or consultancy services,
it will suffer 10% withholding tax ("WHT")
when it receives payment for these services from a person resident in Nigeria
or a fixed base or agent of a foreign company in Nigeria.
Planning points: Nigeria is currently a party to bilateral Double Tax Agreements (the "DTAs") with 14 countries. Nigeria's power to tax the profits of a company
resident in any foreign territory covered by a DTA is only exercisable in
respect of profits attributable to a 'permanent establishment' (in essence, a
physical presence) in Nigeria. As such, there may be an opportunity for
multinational enterprises ("MNEs") with access to benefits under Nigeria's DTAs
to optimize their group structures with a view to mitigating the impact of the
SEP provisions. In exploring that opportunity, it should be noted that the extent
to which the DTAs would prevail over the SEP provisions is still uncertain. Also,
the OECD's ongoing work on taxation of the digital economy could potentially extend
the definition of a permanent establishment in the DTAs to include provisions
similar to those of the SEP Order.
Removal of Full
WHT exemption for Long-term Foreign Loans
Prior to the enactment of the Finance Act, interest paid from a
Nigerian company to a foreign lender were fully exempted from WHT if the underlying
loan had a repayment period (inclusive of any moratorium) of more than 7 years.
Partial exemptions were available on a graduated basis for shorter tenor loans
and any WHT chargeable as a result was (and continues to be) the only tax on
such interest.
The amendments introduced by the Finance Act have reduced the WHT
exemptions on interest on such foreign loans to a maximum of 70%.
Planning points: Given the reduction in the tax exemptions in respect of
interest on foreign loans, Fund Managers will need to recognise the drop in net interest income from
portfolio companies which have been funded with long-term debt, and its impact
on things like PIK notes. They will also need to reevaluate strategies for
negotiating debt instruments, such as convertible loan notes.
Thin
Capitalisation Rules
Prior to the introduction of thin capitalisation rules by the Finance
Act, Nigerian companies enjoyed unlimited deductibility of interest expense for
income tax purposes, and interest not deducted could be carried forward
indefinitely. Under the amended CITA, a tax deduction in respect of interest
paid on a loan received from or guaranteed by a 'foreign connected party' must
not exceed 30% of the taxpayer's EBITDA. However, it also appears that the 30%
limit would apply to interest paid in respect of a loan received from an
unrelated party but which is guaranteed by an unrelated party. Interest on debt
provided by local lenders is, however, still deductible without limit. Interest
not deducted due to the above restriction can still be carried forward, but
only for a maximum of 5 years.
Planning points: PE Fund Managers should be mindful of the impact of thin
capitalisation rules on the after-tax profits (and consequently on the
distributable profits) of their portfolio companies, where such companies are
already funded using debt provided by a foreign related party or guaranteed by either
a foreign related party or by an unrelated party. Consideration should be given
to optimizing the debt mix by substituting local debt for foreign debt where
possible, whilst bearing in mind transfer pricing rules that may adjust
interest rates to reflect arm's length conditions.
Tax Holiday for Agricultural
Companies
The provisions in the CITA (as amended by the Finance Act) relating to
tax holidays for companies engaged in agricultural production may make potential
investments in Nigerian agribusiness a more attractive proposition for Fund Managers.
Before now, such companies enjoyed income tax exemption under the
Industrial Development (Income Tax Relief) Act for a period of up to 5 years. However,
in terms of the amended CITA, companies engaged in agricultural production may now
enjoy income tax exemption for up to 8 years, subject to the satisfactory performance
of agricultural production[2].
Tax-free earnings
for Real Estate Investment Companies
The amendments to the CITA (pursuant to the Finance Act) relating to
the taxation of real estate investment companies ("REIC")[3]
is also relevant to investors in the real estate sector.
The amended CITA provides that dividend and rental income received by a
real estate investment company will be exempt from tax, provided that 75% of
the dividend or rental income is distributed within 12 months of the end of the
financial year in which the dividend or rental income was earned. If the
distribution does not take place within this period, the tax exemption will be
lost and such earnings will be assessed to tax.
Elimination of Punitive
Taxation of Tax-exempt Income and Retained Earnings
Before the recent amendment of the CITA, where a Nigerian company paid
dividends that exceeded its profit, the tax payable by the company would be based
on the dividends and not on the lower profit. This meant that a portfolio
company would be liable to income tax if it distributed dividends from tax
exempt income, or, to a further income tax if it distributed dividends from
retained earnings which had previously suffered tax. It also created a
disincentive to use local holding companies, as a distribution of the dividends
received by a holding company to its shareholders would invariably trigger a
further tax liability.
CITA has now been amended so that no further companies' income tax will
apply to dividends which are:
These amendments effectively eliminate the double taxation that occurs
where such dividends are paid from retained earnings that have been taxed. They
also ensure that tax incentives are not eroded when dividends that are paid out
of tax-exempt income are distributed.
Planning points: As a result of
this reform, companies can distribute dividends from tax exempt income without
paying income tax, and distribute dividends from retained earnings without
paying a further income tax. Conversely,
the pressure to distribute all profits in a financial year in order to avoid
double taxation is removed.
Another key
implication of the reforms is that where investors determine that it is
beneficial to set up a holding structure in Nigeria, that can now be done on a
tax neutral basis and without concerns about the possible double taxation of
the profits of subsidiaries and erosion of tax incentives.
Possible income tax
and VAT exposure for foreign entities
Recent decisions of the Nigerian courts and the amendment of the VAT
Act's definition of 'exported services' may have broader tax implications for
Fund Managers who would ordinarily be considered not to be tax-resident in
Nigeria, particularly if they seek to raise funds from Nigerian investors.
Prior to its amendment by the Finance Act, the VAT Act defined an
exported service as a "service
performed by a Nigerian resident or a Nigerian company to a person outside
Nigeria". As exported services were (and still are)
exempt from VAT, one view widely held in practice was that a
Nigerian entity marketing funds to Nigerian residents on behalf of a
non-resident fund manager was not required to include VAT in an invoice for
that service or to include such transactions in its VAT returns for the
relevant period.
However, in Allan Gray Investment Management Nigeria Limited
(Appellant) v Federal Inland Revenue Service (FIRS), the Tax Appeal
Tribunal ("TAT") took the view that a South African investment manager was carrying
on business in Nigeria because its Nigerian subsidiary marketed investment
funds to Nigerian residents on its behalf. That finding was used to support a
decision that services rendered by the local subsidiary were in fact rendered
to a fixed base of the non-resident company and, therefore, could not be
considered to be exported services. The decision in Allan Gray now
appears to have been codified by the Finance Act's redefinition of 'exported
services' as expressly excluding services provided to the
fixed base or permanent establishment of a non-resident person.
One implication of these developments is that Nigerian companies or
individuals that are engaged to market foreign funds to local investors on
behalf of non-resident fund managers will now be required to issue VAT invoices
in respect of such services.
There is also a chance that the tax authorities and courts could begin
to take the view, following the TAT's reasoning in the Allan Gray
decision, that foreign PE funds sourcing investors through local representative
offices should be deemed to have a permanent establishment or fixed base in
Nigeria, and therefore be liable to pay income taxes in Nigeria.
Planning points: It
is necessary for Fund Managers resident outside Nigeria to assess their
operations and existing relationships (with local representatives or agents) to
determine whether the prevailing circumstances are such that their firms may be
deemed to have permanent establishment or fixed base in Nigeria and therefore
become liable to pay taxes such as VAT and companies income tax.
VAT and CGT
Exemptions on Business Reorganisation
Prior to the Finance Act, the transfer of assets in the course of a business
reorganisation was construed as a disposal for the purpose of CGT. Such
transfer of assets was also deemed as a 'supply of goods' to the transferee and
was, therefore, subject to VAT. This was so even if the transferee was a wholly
owned subsidiary of the selling entity.
The Finance Act has introduced amendments to the CGT Act and the VAT Act. The effect of these amendments is that CGT and VAT will no longer be payable upon the sale or transfer of assets during a business reorganisation if:
However, if the transferee subsequently disposes of the assets within
365 days after the date of the transaction, the tax exemptions will be
rescinded.
Planning points: Opting for an asset acquisition rather than a share acquisition would now be tax neutral. It would involve the following 3-step process- (1) the selling entity will incorporate a wholly-owned subsidiary; (2) the selling entity will transfer the assets to the wholly-owned subsidiary after 365 days; and (3) the selling entity will then sell the subsidiary to the acquirer. Where a portfolio company of a private equity fund is the seller, this 3-step process will also be available.
Incentives for
Small Businesses
The Finance Act provides that small businesses (i.e. with a turnover of
N25million or less) are exempt from
CIT, whilst medium-sized companies (i.e. with a turnover greater than N25million but less than N100 million) are to be taxed at a reduced
rate of 20%.
WHT on Dividends
from Petroleum Profits
Before now, dividends paid out of profits that have been subjected to
petroleum profits tax did not suffer WHT. This meant that PE entities with
investment in the petroleum industry could receive dividends thereof free of
WHT. However, such dividends will now suffer WHT of 10%, although, shareholders
that are resident in a country that has a DTA with Nigeria will enjoy a reduced
rate of 7.5%.
Footnotes
[1] The Finance
Act came into force on Monday, 13 January 2020.
2 However, such companies will not be granted similar incentives under
any other law, such as pioneer status under the Industrial Development (Income
Tax Relief) Act.
3 The Finance Act defines a REIC as a company duly approved by the
Securities and Exchange Commission ("SEC") to operate as a real estate investment
scheme in Nigeria.
4This is defined in the CGTA as a group of
companies as prescribed under the relevant accounting standard.
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The contents of this article are intended to provide a general guide to
the subject matter. Specialist advice should be sought about your specific
circumstances.
If you need additional information, please contact taxgroup@aelex.com.
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