A Introduction after many years, the Federal Government of Nigeria has reintroduced the practice of presenting a Finance Bill along with the annual budget proposal. This practice, which is standard in many tax jurisdictions, was a usual feature under the Military Governments in Nigeria. The Finance Act is a fiscal policy statement, which shows how the Government intends to finance budgeted expenditure and achieve other socio-economic objectives.
The President of the Federal Republic of Nigeria signed the Finance Act into law on 13th of January, 2020. The objectives of the 2020 Finance Act include: to support Micro, Small and Medium-sized Enterprises (MSMES) in line with the Ease of Doing Business Reforms (EDBR). The EDBR aims to remove critical bottlenecks and constraints to doing business in the country and make Nigeria a progressively easier place to do business.
MSMES are the engine growth of most economies of the world including Nigeria. The collaborative National survey carried out by the National Bureau of Statistics (NBS); and Small and Medium Enterprises Development Agency of Nigeria (SMEDAN) in 2017 found that MSMES constitute over 90percent of businesses in Nigeria and employ about 60million people. These businesses contributed about 49.78percent to Nigeria’s GDP in 2017. Based on the National Policy on MSME, businesses that qualify as MSME typically employ less than 200 people with assets base of less than N500million. The overriding differentiator between micro, small and medium scale enterprises is the number of employees. However, under the Finance Act, a company that earns gross turnover of N25 million or less is defined as a small company and a company that earns gross turnover greater than N25 million but less than N100 million is defined medium-sized company.
The collaborative survey referenced above found that high/ multiple taxes was considered as the second most unfavorable policy affecting MSMES in Nigeria. Therefore, one of the initiatives of the Presidential Enabling Business Environment Council is improving the ease of paying taxes, by evaluating the administrative burden of paying taxes on medium-sized companies. The Finance Act and MSMES The Finance Act introduces a few provisions targeted at MSME. These provisions include:
(i) The exemption of small companies from payment of any tax under the Companies Income Tax Act (CITA). This includes the normal corporate income tax (CIT) at 20percent or 30percent of taxable profit or minimum tax, tertiary education tax, and deduction of withholding tax (WHT) by its customers. With regards to the non-deduction of WHT by customers, the Federal Inland Revenue Service (FIRS) may need to issue certificates to these small companies to enable them to present same alongside their bids, contracts and invoices. However, to qualify for this exemption, the small company must register for the tax and submit its annual income tax returns to the FIRS. For small businesses, this exemption should provide additional funds which can be ploughed-back into the business for growth. It should also help to improve cash flow, considering that customers are not required to deduct WHT from their invoices.
In the view of the authors, the objective of this exemption is to attract more small businesses into the tax net. Many of the business that qualify as small companies are informal in nature. According to the NBS/SMEDAN collaborative survey, the informal sector (that is Micro businesses) account for about 99.8percent of businesses in the MSME category. Only 10.6percent of these micro businesses were registered with the Corporate Affairs Commission (CAC) – mostly as business names (that is, non-limited liability companies). Among the small and medium enterprises surveyed, only 21percent were registered as limited liability companies. Also, based on our analysis of the number of registered entities with the CAC, about 75percent are registered business names.
Entities registered as business names are chargeable to tax under the Personal Income Tax Act (PITA). The income tax exemption provided under the CITA is not replicated under the PITA; thus, a significant number of MSMES may be liable to pay income tax. The personal income tax is calculated on the taxable profit using graduated rates, from 7percent to 24percent, and is payable to the State Board of Internal Revenue where the business is resident/registered. This is the main source of internally generated revenue for all/most State Governments in Nigeria. Consequently, over 75percent of registered small businesses in Nigeria may not benefit from this exemption.
(ii) Small companies are no longer obliged to register for Value Added Tax (VAT) and file monthly VAT returns. The implication of non-registration for VAT is that an unregistered company cannot include VAT on its sales invoices. This initiative should result in improvement of sales for small businesses by making the value of their goods or services cheaper because no VAT is added. But, if a small company is not supplying a Vat-exempt good or service, the customer (that is registered for tax), may still be required to self-account for the VAT in line with the provisions of section 14(4) of the VAT Act as amended. Hence, the goods or services may not be cheaper for the customer in the long run.
Furthermore, small businesses are not exempted from payment of VAT on goods and services purchased for business purposes (that is, input VAT). This input VAT cannot be recouped for income tax purposes because small companies are exempted from CIT. So, small businesses engaged in manufacturing or trading of non-vat exempt goods may have to include VAT on their invoices to customers (that is output VAT), so that they can recover the input VAT incurred on raw materials/inventory purchased against the output VAT received from customers. Also, a small business that intends to recover its input VAT against output VAT would need to submit monthly VAT returns to the tax authority showing the net VAT position. However, such companies may need to evaluate the benefits of recouping the input tax against the costs of compliance (filing of returns) and likely exposure to tax audits.
It is important to note that, based on the current administrative practice of the FIRS, tax payers only require a single registration for tax purposes. Therefore, when a small company registers for CIT, it is automatically registered for VAT too.
(iii) Medium-sized limited liability companies would be liable to pay CIT at the rate of 20% of taxable profits. However, these companies are still liable to pay minimum tax at the rate of 0.5percent of gross turnover (net of franked investment income), if the CIT payable is lower than the minimum tax in any year. If the tax liability is paid 90 days before the income tax filing deadline, the company would be entitled to a 2percent tax credit which can be used to offset its tax liability in subsequent year.
Meanwhile, the continued deduction of WHT at 5percent or 10percent may adversely impact the cash flows of this category of companies, especially if the ratio of taxable profit to revenue is less than 17percent in any year. It may therefore be necessary to revisit the WHT rates applicable to this category of companies.
(iv) Other general provisions of the Finance Act that would impact MSMES include –increase in VAT rate on goods and services from 5percent to 7.5percent. This would result in an increase in the cost of goods and services bought and sold by businesses.
– limited liability companies engaged in agricultural production can enjoy a tax holiday for a maximum period of 8 years (an initial period of 5 years with a possible extension for 3 years). Companies engaged in crop production, management of plantations and animal husbandry will benefit significantly from this provision.
– non-payment of excess dividend tax on distribution of dividend to shareholders.
– complete removal of the restriction on loss carry forward.
– all businesses must submit a TIN to open and operate a Bank account
– expansion of the VAT exempt list to include additional basic food items and raw materials for food processing
In the NBS/SMEDAN collaborative survey, the top three unfavorable policies identified by MSMES include; high interest rates, high/ multiple taxes and high cost of power. Therefore, any tax regulation or initiative that can address all or some of the issues identified would have the most impact on MSMES. Some of the initiatives that the Government may consider include:
(i) harmonisation of taxes payable by MSMES especially at the state and local government level should consider. This would help reduce the incidence of double taxation, and a reduction in the overall tax liability.
( ii) extension of the VAT exemption to purchases made by small companies to eliminate irrecoverable VAT incurred. The FIRS may have to issue an exemption certificate to the affected companies so that they can provide this to suppliers and vendors to claim the exemption. The practicality of this certificate would also be an issue, as there may be room for abuse where purchases are made for not for business but for personal purposes and these certificates are then presented.
(iii) bringing more MSMES into the tax net by linking compliance to other government benefits. Also, provision of more incentives in the PITA targeted at unregistered businesses and unincorporated entities would help promote the success of these businesses.
(iv) Also, Banks (especially Microfinance Banks) should review the interest rates charged on loans provided to cottage (home-based) industries and other MSMES engaged in specific types of businesses, because of the income tax exemption granted on such interest income although subject to certain conditions provided in the law. Conclusion
Are the incentives in the Finance Act sufficient to drive the growth of MSMES in Nigeria? Fingers are crossed at this time on this. The impact of the Act would be better assessed at the end of this fiscal year. However, the reintroduction of a Finance Act is a step in the right direction and should provide the platform for Government to address gaps identified in the current Finance Act, in subsequent laws.
In terms of implementation, we recommend that the FIRS should apply the law with due consideration to existing socio-economic exigencies. Also, strict review measures should be adopted to avoid abuse of the incentives by taxpayers; for instance, unauthorised collection and retention of VAT by small companies, or setting-up multiple companies to manage gross-turnover.
Overall, it appears that small companies registered as limited liability companies are better-off tax wise compared to unincorporated entities. However, there are other regulatory issues that need to be considered, for example, unincorporated entities are not statutorily required to prepare audited financial statements annually.
Olufemi and Ijeoma are Associate Director and Senior Associate respectively, in KPMG Advisory Services, Nigeria.