Geese, feathers and taxation of employee loan

The recent plunge in crude oil prices had a corrosive effect on public revenue in Nigeria. Most state governments are yet to pull through its debilitating impact till date in spite of price recovery to $50/bbl mark.  The relatively low price regime, and even more forcefully, energy security policies by major oil consuming nations once again serve as a sharp nudge on seriously-minded governments at all levels on the fierce urgency of exploring sustainable sources to shore up revenue base. And on this note, successive governments in Lagos State since 1999 have fared particularly well with the reduction of federally collected revenue in the state’s total revenue mix.

The fiscal fortunes of the various governments have for too long, been tied to the vagaries of the turbulent oil economy.  There is, therefore, a crying need to shed reliance on “oyel” money. Consequently, at no better time is the argument for taxation, as a major source of government revenue, more compelling than now especially against the backdrop of yawning infrastructural gap and huge outlays required for social investment. The case is, even more, overwhelming for a state like Lagos with visible transformation and infrastructure upgrade by successive governments.

Consistent with the state’s revenue diversification drive, the Lagos State Internal Revenue (LIRS), a few weeks ago, issued a raft of clarifications and directives on personal income tax with the objective of blocking potential tax loopholes and raising additional tax revenue for the state. Amongst the notices is the clarification on the taxation of employee loan. The notice imposes an obligation on employers to deduct and remit tax on the economic benefit derived by employees, shareholders, and directorsfrom a concessionary interest on loan granted by an employer or company.

The implication of this directive is that interest on employee loans advanced at a rate lower than the fair market rate is subject to tax, henceforth (or retrospectively since the effective date is yet to be clarified, to the best of my knowledge). The circular further defined fair or imputed minimum market rate as the prevailing CBN’s Monetary Policy Rate (MPR) less 300 basis points which translates to 11% given the prevailing MPR at 14%.

Let me state upfront that the pronouncement by LIRS is well within the scope of the relevant tax laws and in line with global tax rules, though with varying degree of application. The directive is predicated on S 3(b) of the Personal Income Tax Act (PITA) 2014 as amended which states thus; “tax shall be payable for each year of assessment on the aggregate amounts each of which is the income of a taxable person, for the year, from a source inside or outside Nigeria, including … any salary, wage, fee, allowance or other gain or profit from employment including compensation, bonuses, premiums, benefits or other perquisites allowed, given or granted by any person to an employee”. Subsection (d) goes further to include dividend, interest, and discount as part of taxable income.

It is commonplace for employers to advance loans to employees to bridge the gap between current savings and future income. Other beneficiaries may have a more elevated justification. Indeed, there are potential tax loopholes in a loan of this nature but its social utility can hardly be emphasized enough. Employees have little wiggle room for tax planning and therefore less likely to use employee loan as a tax loophole. The scope for major shareholders and directors of a company is much wider. It is based on this utilitarian objective that this paper implores the LIRS to review the pronouncement.

Importantly, this paper takes the view that interest rate below the market rate, though constitutes an economic benefit, does not impact positively on gross income and in fact, could give rise to negative cash flow at the end of the loan repayment period. The reason is not far-fetched – employee loan, more often than not, is utilized to meet short-term cashflow gap and not for investment in earning assets. The argument can be made that below-the –market interest rate is comparable to other benefits in kinds like rent. They are comparable but not exactly the same. The tax consequences of a loan, as advised for implementation, has a far more negative impact on an employee’s net cash flow (ignoring the time value of money) than rent. Rent is perhaps equivalent to the economic benefit derivable from an interest-free loan. Nonetheless, both are taxable benefits from a taxman’s lens – this much I understand.

Therefore, the LIRS may, therefore, consider introducing certain exemptions to the tax rule on employee loans. Some of the suggested exemptions could include loans without significant tax effect with a clearly defined cap, loans to help an employee relocate, where lender can demonstrate that tax avoidance is not the intent of the loan and any employee loan not meant for investment purpose although this may be difficult for the tax authorities to ascertain.

At a time when developed countries are spending more to reduce the cost of debt with interest rates within the lower single digit corridor, a call for more benign fiscal and monetary policy decisions in Nigeria will not be out of place. This is more so given the prevailing high interest rate environment coupled with material erosion of consumers’ purchasing power. According to the Economist, the annual value of foregone tax revenues as a result of deliberate policy choice, in Europe and the United States of America before the financial crisis in 2007was estimated at about $510 billion and $725 billion respectively.

Tax policies should deliberately seek to avoid outcomes that could potentially worsen the fragility of those that are already financially vulnerable. What I have observed is that our tax policies, oftentimes, continue to target the same set of taxable persons. As we harp on the need to improve on our tax to GDP ratio, it will be helpful if such narrative draws reference to the proximate drivers of tax revenue, spotlights sectoral contribution to GDP as well as their correlative contribution to tax revenue. Data from National Bureau of Statistics (NBS) is insightful here.  According to figures from 2016, Agriculture, Trade, and Information & Communication contributed 53% of Nigeria’s GDP. The question then is – how much of the county’s tax revenue was generated from these sectors.

Jean-Baptiste Colbert, who served as French Finance Minister from 1665-1683 under King Louis XIV, was reputed to have said that “the art of taxation consists in so plucking the geese as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”. Monsieur Colbert was right but only to the extent that a good number of the geese are in a healthy state or have not strayed, for whatever reason. Otherwise, only a few will continue to suffer the misfortune of being thoroughly de-feathered with consequences, of course.

Glenn Ubohmhe