Windfall tax on FX gains will significantly reduce banks’ loan credit, profits – Moody’s

The windfall levy on Nigerian banks’ foreign exchange revaluation gains is credit negative for banks, according to new report by Moody’s.

The global rating agency said on Tuesday that the tax will significantly reduce the profits available to banks for problem-loan provisioning and transfers to retained earnings, which form part of regulatory capital, both credit negative for the sector.

“The windfall tax will have a particularly negative effect on banks whose capital adequacy is close to regulatory thresholds. The tax follows record profits declared by banks in 2023, largely because of foreign-currency revaluation gains related to the naira’s massive devaluation of 37 percent in June 2023,” the report said.

It said the tax is in line with the Central Bank of Nigeria (CBN)’s September 2023 policy prohibiting banks from using foreign-currency-related profits for operational expenses and dividends.

“Eight of the nine Nigerian banks we rate reported in excess of N3.5 trillion in aggregate pretax profits in 2023 versus N1.1 trillion in 2022, and we estimate that over a third of the profits were from foreign-currency revaluation and trading gains.

“It is unclear, however, what proportion of the revaluation gains will be taxed, given the differences between trading and revaluation gains. Additionally, the 2023 revaluation gains include unrealised gains, which may affect how the tax is applied, particularly as the government has not been clear how the 50 percent windfall tax will be achieved,” the report added.

President Bola Tinubu had earlier written to the Senate seeking to amend the 2023 Finance Act to introduce the payment of a one-time windfall tax on the foreign exchange revaluation profits of banks in the 2023 financial year.

But the Senate amended the bill on Tuesday by increasing it to 70 percent, stressing that the windfall was not a result of any effort of the banks or value addition, but as a result of government policy which must be redistributed.

Before the levy was increased, Moody had noted that the severity of the negative effect of the tax on banks’ foreign-currency-related profits was also not yet known because details were not yet available.

“Given banks have already been subject to the standard 30 percent corporate income tax rate for 2023, in a less aggressive scenario a surplus tax of 20 percent on the FX gains would equate to the total 50 percent windfall tax,” it said.

The international firm added that it is possible the government may pursue an additional 50 percent windfall tax on banks’ foreign-currency revaluation gains, which we estimate would equate to as much as six percent of the aggregate equity (shareholders’ funds) of banks rated by us.

“For the government, we estimate the windfall tax may yield revenue of as much as 0.3 percent of 2024 GDP. Although this is not negligible given the government’s small tax intake of around nine percent of GDP in 2023, it remains marginal and only a temporary revenue measure.”

The proposal now amended has generated conversation around the timing and legality of the proposal with major tax and advisory bodies wading into the amendment.

KPMG Nigeria has criticised the 50 percent windfall tax on the banks’ foreign exchange revaluation gains recorded in 2023, suggesting it could lead to legal disputes. The firm highlighted that Nigeria’s tax policy does not support retroactive taxes.

PwC Nigeria expressed concerns that the unpredictability of the windfall tax, applied to already reported profits for 2023, could discourage investments