VAT attribution and derivation: A personal appeal to all parties

Introduction

I have read a tonne of views on the proposed Nigeria Tax Administration and other tax reform bills. On one hand, some stakeholders decry the bills as being a contrast to the current administration’s championing for local government autonomy. Some, like the National Economic Council (NEC), last month recommended the withdrawal of the bills, stating that there were too many controversies surrounding it. They called for more inclusion in the stakeholder consultation process. The Northern Governors Forum (NGF) in similar fashion rejected the new derivation-based model for Value Added Tax (VAT) distribution in the Bills. On the other hand, some wholly support the Bills and believe that its benefits are transformational and necessary. Each stakeholder and commentator holds their view in light of information that is available to them. And that is valid and fair.

Read also: Tax reform bills increase states VAT revenue to 55%

But before I go into the lengthy details of my thoughts on this matter, let me share the definitions of the two subjects that are crucial to this conversation: attribution and derivation.

The principle of derivation in revenue sharing ensures that revenues from taxes are distributed to the region or jurisdiction where they were generated from. For example, if a company generates revenue through sales in a particular state, a portion of the taxes or royalties from that economic activity is returned to the state. The principle of attribution, on the other hand, involves allocating tax revenues based on predefined criteria, such as population size, geographical size, need, national interest, or expenditure responsibilities, etc., rather than the location of the tax-generating entity. Thus revenues are collected nationally and are distributed to states according to agreed-upon formulas.

My view

The present controversy is based on the VAT sharing formula proposed in Section 77 of the Nigeria Tax Administration Bill. I have come to appreciate that the myriad of criticisms against this well-intended bill may be as a result of the lack of clarity or understanding of Section 22 (12) of the bill, which provides for the attribution of VAT revenue, requiring companies to file their returns on the basis of derivation by location (place of consumption).

This provision, from my understanding, was included to cure an existing problem with our current VAT administration. As it stands today, in the existing system, VAT returns by companies are not filed on the basis of the place of consumption but reported based on the head office locations of these companies. This means that a whopping 20 percent of VAT returns are distributed back to states where these head offices are located—whether consumption took place there or not; it explains why Lagos, FCT, and Rivers always take the largest chunk of VAT under the current regime.

“As it stands today, in the existing system, VAT returns by companies are not filed on the basis of the place of consumption but reported based on the head office locations of these companies.”

The proposed amendments of the Nigeria Tax Administration Bill offer a different position that emphasises fairness and more equitable distribution of VAT returns. It proposes that VAT will now be reported based on the place of consumption, which will ensure that most of the amounts currently reported for Lagos, FCT, and Rivers states will now be reported by where the consumption takes place.

The new rule will ensure that places where consumption took place get 60 percent of the amounts reported for them. For instance, if consumption happens in Niger State, the state would receive 60 percent of the VAT generated from its jurisdiction, while the balance would be put in a VAT sharing pool, which it (Niger State) would further benefit from.

In my view, this will result in a more favourable outcome for most states when compared to the current regime that favours Lagos, Rivers, and FCT. It will more or less redistribute most of the present allocation received by those 3 states.

My appeal to NEC, NGF, and NEF, as well as other stakeholders, is thus:

We must not make the misjudgment of throwing away the baby with the bathing water.

Let us carefully look at the benefits of these reforms and weigh the impact on our tax and fiscal space versus the proposed amendments’ ‘perceived shortfalls.’

There is no single problem on earth that is without a solution. In this light, we should think out of the box and suggest workable solutions to address or fix these perceived shortfalls, or we will be condemned to having our cap in hand at the doorsteps of the World Bank and IMF Headquarters more frequently than ever.

Read also: NASS must pass tax reform bills to correct VAT anomalies- ex-FIRS chairman

On a personal note, and based on my little experience as a tax accountant, consultant, and administrator, I would suggest to all stakeholders, particularly the National Assembly, to go ahead and consider the bill, pass it to law, and have Mr. President sign the same, but provided the proposed amendments to the VAT law will be implemented in phases, bearing in mind the following:

FIRS is currently undergoing its own reforms; the FIRS Establishment Act has been re-presented to the NASS and is receiving their attention simultaneously. For FIRS to be able to function as envisaged by the proposed changes or amendments to the FIRS Act, it must first fix the roof over its head to ensure that if any storm arises tomorrow, revenue administration officials and our money entrusted in their hands would be safe.

FIRS must also fix the issue of Fiscalisation within the next three to five years from now. The need for Fiscalisation is one of the key amendments proposed in the Nigeria Tax Administration Bill before the NASS.

Fiscalisation is the process of using technology, like cash registers or POS systems, to ensure businesses comply with tax laws by automatically recording and reporting their sales to tax authorities.

It is an expensive project and will not only require political will at the centre, but also at the sub-national level. To achieve it, the FG, FIRS, and FAAC must be ready to jointly fund this project. It is important because it will bring about transparency and accountability as well as address the issue of subjectivity, which is mainly the fear of the members of NEC, particularly the NGF.

I must emphasise that Fiscalisation cannot happen without data. This brings me to my third point.

The FIRS HQ project should be completed and equipped as a world-class edifice while ensuring that the entire floor historically conceived as the “National Revenue Data Centre” becomes a reality.

Item 2 above (i.e., Fiscalisation) will not only address the issue of transparency and accountability; it will curtail the influence and excesses of vested interests, particularly the tax accountants who are accomplices in the whole of this VAT issue.

If the amendment is passed into law, and its implementation is not delayed, say, by 3 to 5 years, the fear of the stakeholders would be justified because tax accountants are likely to be subjective (or used to being subjective) in the course of filing VAT returns (i.e., VAT attribution) in favour of the states of their choice or those of the choices of some of the political class.

As a tax accountant of your company, you know where your customers are located, if not all, especially the major ones. But when asked to file their companies’ monthly VAT returns based on the location of their customers, for instance, sentiments come into play. And even with the proposal in Section 77 of the Tax Administration Bill, the subjectivity is likely to continue.

Read also: Top 10 Nigerian states receiving more VAT than they contributed in August 2024

Though it was an administrative initiative at FIRS in 2020, I recall that we redesigned the VAT Form 002 that required companies to file their VAT returns based on attribution. Only a few companies (less than 10) complied with our directives nationwide (i.e., file VAT returns based on the location of their customers).

Fiscalization will help our revenue administrators in many ways, including boosting their capacity to generate more revenue for the Federation. It has the capacity to address or track transactions or sales of goods from a customer in one state to the other, particularly cashless transactions. It will also create room for the implementation of a system for immediate tax refunds.

Read the complete article on our website…

Muhammad Nami, a tax accountant and consultant, is the immediate past Executive Chairman of the Federal Inland Revenue Service (FIRS) and Joint Tax Board. He was also the President of the Commonwealth Association of Tax Administrators (CATA).