The tax system in any country is a major link between the private and the public sector in growing and shaping the economy of that nation. Taxation can be used to control the direction of a country’s economic strategy.
For example, in 2011, when the government of China wanted more activities in its capital market, it reduced the taxes and other transaction charges. This led to increase in the volume and value of trades in the capital market, and it opened the doors for more foreign investors since it was relatively cheaper to do business in the China Capital Market.
Governments willing to attract Foreign Direct Investments (FDIs) often consider the use of tax incentives to lure multinational firms, and governments of FDI source countries.
Research has shown that taxes and other incentives are increasingly dictating the direction of cross border investment flow. An efficient, well-regulated financial market; coupled with innovative financial instruments and conducive tax environment, play crucial role in influencing both local and international investors.
The Tax Model
The tax strategy for Nigeria, lunched in 2005, emphasis government’s intention in achieving a tax system that will significantly encourage investment within the Nigerian economy, and assist job creation which will lead to higher economic growth.
Key highlights of the tax strategy include:
- Use of revenues from Nigeria’s oil wealth to provide basic amenities, while reducing tax burden on the other sectors; thereby developing those sectors to diversify the economy.
- Gradual decrease in Companies Income Tax to an acceptable rate.
- Decrease in the top-rate of Personal Income Tax to an acceptable rate.
- Shift towards greater reliance on indirect taxation, by gradually increasing the Value-Added rate that will not affect aggregate consumption. This will help in achieving a stable non-oil revenue flow, high compliance in the tax system, and fulfil commitments to the Economic Community Of West African States (ECOWAS).
- Restriction of Tax Holidays to sectors key to the development of Nigeria’s economy and ensuring that there is full transparency and accountability in the process of granting these holidays.
- Decrease in the cost of tax compliance by simplifying tax laws through regular review, improving taxpayer services, and developing specific tax regimes that effectively deal with Small and Medium Enterprises –such as Presumptive Income Tax and prescription of a turnover threshold for imposition of Value- Added Tax.
- Elimination of multiple taxations through improved collaboration between the Federal Inland Revenue Service and the States Board of Internal Revenue.
Existing Tax Legislation
- Capital Gains Tax Act
- Casino Taxation Act
- Chartered Institute of Taxation of Nigeria Act
- Companies Income Tax
- Deep Offshore and Inland Basin Production Sharing Contracts Act
- Education Tax Act
- Federal Inland Revenue Service (Establishment) Act
- Income Tax (Authorised Communication) Act
- Industrial Development Act
- National Information Technology Development Act
- Nigerian Export Processing Zones Act
- Oil and Gas Export Free Zones Act
- Personal Income Tax Act
- Petroleum Profits Tax Act
- Value Added Tax (VAT) Act
- Stamp Duty Act
- Taxes and Levies (Approved List for Collection) Act
There are distinctions between taxes and other internal revenue items such as charges, fees levies, rates and penalties. These other revenue items are imposed for the use of utilities, infrastructure, platforms, right of way, or simply imposed on certain category of persons, businesses, activities or persons within a particular area.
Investment and Tax Rates
Nigeria has enjoyed immense oil and gas resources which enables her to finance its expenditure without significant recourse to revenue from the other sectors. Comparatively, this can be used as leverage over the other African countries which depend largely on tax revenue to finance expenditure. Nigeria can therefore afford to lower its tax rates to achieve a competitive advantage.
Ghana, Kenya and South Africa rely heavily on income taxes (both corporate and personal). Comparing the rates for Companies Income and Personal Income Tax, Nigeria’s standard rate of 30% is the highest of the four countries, yet this accounts for only 15% of the overall tax revenue.
Interestingly, if Nigeria lowers income tax rates to attract investment into the country, it may become more difficult for the other African countries, particularly the ECOWAS countries to compete for investments.
Already, there are reports in some quarters that government is looking to reduce the rate of Companies Income Tax to about 20% and to decrease the top rate of Personal Income Tax to about 17.5% of taxable income. It is evident that Nigeria can achieve competitive advantage in its tax system through lowering some tax rates. Decreasing income tax rates, will arguably encourage investments, create greater employment opportunities and increase tax compliance. Furthermore, it is important that there are no significant differences in the rates of Companies Income Tax and Personal Income Tax in order to limit opportunities for tax avoidance.
We compared the VAT rates in some ECOWAS countries and found that Nigeria’s current VAT rate of 5% is comparatively low. Government’s plan is to gradually increase the VAT rate in such a way that it will not affect aggregate consumption. At the same time, there will be a reduction in the companies and personal income tax rates and this will reduce the tax burden on companies and individuals. With the expected increase in VAT, it is important to adhere to the principle of vertical equity, as articulated in the National Tax Policy, so that essential goods and services are VAT exempt or zero rated.
VAT –Perspectives of Capital Market Operators
VAT is a cost on investors that should be looked into very critically. Investors are subjected to 5% VAT on commission made by the stockbroker. They also pay 5% VAT on the Central Securities Clearing System (CSCS) charges and on the Nigerian Stock Exchange (NSE) charges. There is something fundamentally wrong with this. While we recognise the fact that all stakeholders are trying to hedge against a decrease in their income by charging the 5% VAT on investors, the fact remains that this action puts a lot more burden on the investors. The 5% VAT should be borne directly by the stakeholders making the money and should not be transferred to the investor.
Stock broking firms, the CSCS and the NSE should persuade the government to reduce VAT from 5% to about 2% or totally waive it on Capital Market transactions. Whatever the case, the burden for VAT should not be borne by the investor who has already been saddled with other charges.
The basis for this argument is as follows: Investors and prospective investors must be encouraged by the government to put their money in the capital market. By this, the cost of buying and selling the securities when investors need their money will not be too exorbitant to bear. Also, there are various investment windows in the market, but rational investors will not invest blindly in any of these windows without considering the cost of their investments.
Withholding Tax On Dividend Payments
The current withholding tax charged on dividend is 10% of the dividend paid to the shareholder. This is high. There has always been a conflict between government’s goal to increase revenue to develop the country, and the goal of encouraging investors and prospective investors to invest in the Capital Market by reducing the costs involved.
Nigerian government seems to be finding it difficult to reduce or remove the rate of withholding tax on dividend payments, as the global economic meltdown and the Euro debt crisis lingers; coupled with the fact that Nigeria operates a mono-product economy. Oil sales account for about 90% of our revenue amid fluctuating oil prices.
Capital Market –New Issues
Recently, the Securities and Exchange Commission (SEC) capped the cost of primary market transactions at 3.25%, from the 4.32% it was prior to the meltdown. This was an incentive to various companies planning to raise capital in the market. While the regulators have been taking steps to restore investors’ confidence in the Nigerian Capital Market, it is important to note that the transaction costs and taxes charged on both primary and secondary market instruments in Nigeria are still high compared with other emerging economies in the world.
Capital Market –Secondary Market
During the bullish run that was seen in the Nigerian Capital Market in the year 2007 up till the 5th of March 2008, investors were not so concerned about transaction charges since the returns from the capital market was mouth-watering. For example, the return on the Capital Market in 2007 was 76%, and investors benefited from capital appreciation. Some investors made 100% on their investments within the spate of six months or less. During this bullish run, investors did not care so much about the various charges as the returns made up for the transaction costs.
However, from April 2008 when the Nigerian Capital Market commenced a southward descend, largely because of the global economic recession and other peculiar Nigerian economic situations, the margins have significantly reduced and investors have become more price sensitive while demanding for lower transaction charges.
The SEC has intervened and reduced the transaction costs on secondary market deals several times. At the height of the economic meltdown in Nigeria, when investors were losing their investments in torrents, SEC was compelled to announce an immediate 50% reduction on its charges on Capital Market transactions. The NSE was also instructed to do the same. Following the SEC instruction, the NSE reduced their charges and the CSCS charges accordingly. The figures below show the old and current secondary market transaction charges as amended by the SEC.
Considering the above transaction charges, the CSCS fees are charged on both sale and purchase sides which further attract a VAT of 5% charged to the investor. Stamp Duties of 0.075% of consideration is also charged on both the sale and buy side of the transaction. These should be looked into by the authorities as the charges can be further reviewed downwards.
The NSE and the CSCS charges can equally be reviewed downward to encourage more investments in the Nigerian Capital Market. This is without prejudice to the fact that the SEC has taken some steps to reduce the transaction costs over time. The reduction in transaction costs and taxes usually give investors the opportunity to invest more in the capital market. It also means that the portion of investment that could have gone as transaction cost will be available to invest.