Thursday, November 14, 2019 / 11:19 AM / By Yomi Olugbenro* / Header Image Credit: LIRS
Lagos State Internal Revenue Service (LIRS) has issued a public notice, appointing employers as its agent, requesting employers to deduct and remit capital gains tax on payments to employees as compensations for loss of employment. Let's look at this issue of taxing severance benefits.
Whilst LIRS agrees that compensation for loss of employment are free of personal income tax, it seek ways to proactively collect capital gains tax as may be prescribed by Capital Gains Tax Act, by holding employers responsible.
Simply put, withholding tax (WHT) rules which applies under Personal Income Tax Act (PITA) is now being "imported" into Capital Gains Tax Act (CGTA). LIRS purportedly rely on its powers to appoint anyone as its collection agents.
This directive is fraught with multiple issues, including differentiating between termination benefit and terminal benefit, tax treatment of these different benefits, application of withholding tax on capital gains and employers' obligation thereon.
Two tax laws are relevant in explaining the issues here - PITA and CGTA. PITA, which is the primary income tax law which govern employers' PAYE (or WHT) obligation says compensation for loss of employment is not taxable.
CGTA, on the other hand says "capital sum" derived by way of compensation for loss of employment is taxable. That is, CGT of 10% rather than normal PIT. However, CGTA does not contain provision for applying withholding taxes or "PAYE".
The first issue is to determine whether a given severance benefit constitute compensation for loss of office or just normal end of service (terminal) benefits. That is, do terminal benefits and termination benefits mean the same?
There's no specific definition of compensation for loss of employment either PITA or CGTA. By general English usage, terminal benefit refer to final entitlements (often pre-agreed) paid upon expiration of agreed tenure of service.
Termination benefit refer to compensation for unexpected redundancies often triggered by a closedown, downsizing, business reorganization etc. Termination benefits may be seen as compensation for loss of employment.
LIRS issued an initial public notice in 2017 which provides that terminal benefits should be taxed as regular employment income under PITA (part of PAYE) while termination benefits should be taxed as capital gains at 10% (under CGTA).
Let's assume, without conceding, that LIRS's position on the meaning and applicable tax law for terminal benefit and termination benefit is correct. There's a major issue with application of WHT and employer's duty on capital gains.
is a matter of law. It can only be applied in manner prescribed by the law. Whereas PITA makes specific provision on how PAYE/WHT is applied on income taxable under PITA, there's no withholding tax rule on gains taxable under CGTA.
If indeed compensation for loss of employment is considered as capital sum liable to tax under CGTA, tax can only be applied in manner prescribed under CGTA. Capital gains tax are paid by taxpayers on self-assessment basis. Not via WHT rule.
Power to appoint collection agents for tax purposes is contained in PITA, not CGTA. The rule for adoption of PITA administrative process covered in section 43 of CGTA, at best, does not clearly relate to WHT practice. It will be a rule stretched too far.
Employers are likely to resist importation of the provision of withholding tax rule contained in PITA to CGTA. Individuals earning capital gains should be called to account for their taxes in manner prescribed by CGTA.
While I agree with the provision of CGTA that "capital sum" paid as "compensation for loss of employments" constitutes capital gains against which the provison of CGTA should apply, CGTA does not indicate employer's obligation as withholding tax agents for CGT.
The dilemma faced by tax authorities is the enormity of the administrative burden of chasing millions of individual taxpayers in collecting due taxes. So they look for a convenient way out. But no one wants a burden unless legally imposed.
Governments should rather focus on revamping tax laws in Nigeria to close identified lapses and bring our laws to modern realities. Our laws are laden with rules that have lost touch with emerging realities. That's a big issue needing solution.
Attempts at refurbishing a 1967 law via public notices and expecting same to fit into modern realities of twenty-first century will only generate legal tussles that will multiply disputed tax cases. We must pay attention to real issues.
The greatest challenge facing the country is paucity of revenue but we are not addressing it with the vigor required. Both the executive and legislature should be working hard on regulatory intervention to address our challenges.
We cannot resolve our current low tax penetration challenge unless the law is fixed. We need new set of laws that will consolidate existing taxes, introduce modern rules, be wide-covering and administratively covenant.
I must therefore express my admiration for LIRS on how it tries to stay innovative and find ways of tackling evasion. But it's important to allow taxpayers enjoy benefits of ambiguous rules. Government should rather make/amend laws to curb abuses.
About The Author
*Yomi Olugbenro is the West Africa Tax Leader at Deloitte.