The Finance Act, 2019 (“the Finance Act”- which came into force on 13 January 2020) 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 companies operating in Nigeria, as well as potential investors who are interested in Nigeria. This is because the changes will have an impact on matters such as investment strategies, tax planning and revenue forecasts.
We will, in a two-part series, highlight some of the changes introduced by the Finance Act and potential implications for the corporate sector. In Part One of this series, we will discuss reforms related to digital and remote services taxation, withholding tax (“WHT”) exemptions for long-term foreign loans, thin capitalisation rules, and tax holidays for agricultural companies.
In Part Two, we will highlight changes pertaining to tax-free earnings for Real Estate Investment Companies (“REICs”), elimination of punitive taxation of tax exempt income and retained earnings, possible income tax and VAT exposure for foreign entities, VAT and CGT exemptions on business reorganisation, incentives for small businesses, and WHT on dividends from petroleum profits.
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:
- The company transmits signals, messages and data of any kind to Nigeria in respect of any activity including electronic commerce, online payment platforms and online advertisements, to the extent that the company has a significant economic presence in Nigeria and profit can be attributable to such activity; and
- The trade or business involves rendering technical, professional, management and consultancy services outside Nigeria to a person resident in Nigeria, to the extent that the company has a significant economic presence in Nigeria.
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 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, investors will need to recognise the drop in net interest income from operating 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. From the wording of the amendment, it appears that the 30% limit also applies to interest paid in respect of a loan which is received from an unrelated party and 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 Investors should be mindful of the impact of thin capitalisation rules on the after-tax profits (and consequently on the distributable profits) of their 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. Companies which have raised project financing may be particularly impacted, especially where credit enhancement structures incorporating parent company or third party guarantees are in place. 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 agriculture and agribusiness more attractive to investors.
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. 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.