Taxation of Companies in the Digital Economy: On Nigeria’s Refusal to Endorse the OECD/G20 IF Digital Tax Deal”

Author: Kolapo Femi-Oyekola

Background:

In October 2021, Nigeria declined to sign the multilateral agreement reached by over 135 members of the Organisation for Economic Cooperation and Development OECD/G20 Inclusive Framework (“OECD/G20 IF” or the “Agreement”), which introduced a global minimum tax rate for non-resident companies. The Agreement recognises the allocation of taxing rights on the income arising in each jurisdiction where they operate i.e. the market jurisdiction, instead of limiting this right to the traditional principal place of business or permanent establishment.

With more businesses digitized and numerous cross-border transactions conducted daily, the digital economy is increasingly becoming the economy itself. Companies are now able to provide services to persons across territorial borders through ingenuine technology-based business models, and charge for these services. The key challenge to taxing these businesses has been whether to tax these businesses based on where value is created, or where value is consumed. Traditionally, the position on this has been to tax the business with the physical presence or permanent establishment in the consumers’ jurisdiction. However, the shortcoming of this approach is that it leaves non-resident companies out of the tax net as company profits derived in the consumers’ countries may not be taxed in that country where the money was parted with. The Finance Act, 2020, took a great leap in this regard by expanding the criteria for taxation of companies in the digital economy. The Act expanded the tax net from just “having a physical presence in Nigeria” to having a “Significant Economic Presence (SEP) in Nigeria”.

The Finance Act 2021 now builds on the SEP Principle as it provides that companies liable to tax under the SEP principle may now be assessed on “a fair and reasonable percentage” of their turnover, where there is no assessable profit, or the assessable profit is less than what is to be expected from that type of trade or business, or the assessable profit cannot be ascertained. By this, the Federal Inland Revenue Service (“FIRS”) is empowered to assess Companies Income Tax on the turnover of a foreign digital company involved in transmitting, emitting, or receiving signals, sounds, messages, images or data of any kind by cable, radio, electromagnetic systems or any other electronic or wireless apparatus to Nigeria in respect of any commerce, trade or activity, including electronic commerce, application store, high frequency trading, electronic data storage, online adverts, participative network platform or online payments, to the extent that the company has significant economic presence in Nigeria, assess and charge that company for that year of assessment on such fair and reasonable percentage of that part of the turnover attributable to that presence.

On the “VATability” of the goods and services of these companies, the Act provides that non-resident suppliers of these goods or services to Nigeria, or any other person as may be appointed by the FIRS to collect tax under the Value Added Tax Act are now obligated to collect the tax and remit same to the FIRS. In this light, the Act empowers the FIRS to appoint non-resident business-to-consumer (B2C) service providers as VAT collection agents. Non-residents making taxable supplies to recipients in Nigeria are to bear the primary obligation to charge, collect and remit VAT to FIRS. So, the VAT withholding obligation of Nigerian recipients is now limited to where the non-resident or its appointed agent fails to collect the VAT. This amendment draws parallels with Court of Appeal’s decision in Vodacom Business Nigeria Limited (VBNL) v FIRS (2019) LCN/13556(CA).

As mentioned, before the Finance Act 2021, the traditional position had been to tax the business with the physical presence or permanent establishment in the consumers’ jurisdiction. However, the shortcoming of this approach is that it leaves non-resident companies out of the tax net as company profits derived in the consumers’ countries may not be taxed in that country where the money was parted with. To solve this, the Organisation for Economic Cooperation and Development (“the OECD”) Inclusive Framework on preventing Base Erosion and Profit Shifting (BEPS), in 2020, released its Action 1 on preventing BEPS. And in October 2021, as scheduled, following a series of consultations with key stakeholders, businesses, academia, and governments, a multilateral agreement was reached by 135+ members of the OECD/G20 Inclusive Framework (“OECD/G20 IF” or the “Agreement”). The OECD/G20 IF introduces a global minimum tax rate for Multinational Enterprises (“MNEs”), and through its two-pillar approach, allows for the allocation of taxing rights to market jurisdictions, and not restricting the tax jurisdiction to the traditional principal place of business or permanent establishment. As Pillar 1 speaks to the re-allocation of taxing rights to the market jurisdiction, it recognizes that MNEs with (i) a global turnover of over €20 billion; (ii) 10% profitability; and (iii) at least 1 million euros in turnover from Nigeria within a year; will be subject to tax on a portion of their profits derived from market jurisdictions, which in this case, is Nigeria. This addresses the most uncommon problem to digital taxation: Should the tax be imposed where the service is sold or where the users are located. Vide this pillar, imposing of Digital Services Tax (“DST”), is prohibited and member states which had earlier imposed DST are directed to repeal such DST Laws. It is pertinent to note here, that taxation under the SEP is Nigeria’s DST, which enables it to tax its MNEs under the Companies Income Tax Act. Pillar 2, on the other hand, addresses Global Anti-Base Erosion Tax Rules as it introduces a 15% global minimum tax rate (“GMT”) to MNEs with a revenue above €750 million. Notably, Pillar 2 introduces a treaty-based rule, the Subject to Tax Rules (“STTR”), which seeks to bar treaty benefits available in existing tax treaties where payments are not subject to a minimum tax rate available, and allows source jurisdictions to impose withholding tax at a minimum of 7.5% to 9% on interest, royalty and certain other payments between related entities where such payments are not subjected to a minimum tax rate.

However, two member states of the OECD/G20 IF: Nigeria and Kenya, refused being signatories to the Agreement. What is of great concern is the reason for Nigeria’s decision to decline signing this Agreement. The Executive Chairman of the FIRS, in a statement, stated that the operational MNEs in Nigeria, do not meet the requirements for taxation under Pillar 1. Signing the Agreement would mean that Nigeria would be unable to tax its MNEs under its DST, which is the SEP, as introduced by the amendments of the Finance Act. To tax an NRC, the NRC must have generated a gross turnover of more than ₦25 million ($60,000). Compared to the requirements by Pillar 1, it goes without saying that taxing MNEs under Nigeria’s DST admits more companies into the tax net, and would mean higher revenue. Additionally, the €20 billion global annual turnover and 10% profitability requirement of Pillar 1 is not restricted to one accounting year, but for four consecutive years. Attaining such high profits in Nigeria is not tenable.

Another reason for Nigeria’s refusal to sign the Agreement is the “subjectability” of resultant tax disputes to international arbitral panels, as stated in Pillar 1. This may also be a costly process for the country, as the monies expended on international dispute resolution processes may be higher than the tax amount, which in fact, resulted in the dispute. In the notice issued by the FIRS clarifying its reason for the decision, the FIRS mentioned possible ways through which these challenges can be addressed, such as a periodic review of Nigeria’s tax laws, and the establishment of a designated “Non-Resident Persons Tax Office”.

The enactment of the Finance Act and the consequent introduction of the SEP Principle was targeted at resolving the low tax-to-gross domestic products ratio as internal tax revenues proved insufficient for the promotion of economic development. As such, amendments were made to the Companies Income Tax Act in 2019 to require the remittance of income and value- added taxes from companies earning over 25 million naira. Alongside the taxation of digital earnings of MNEs, these innovations would subsequently result in the generation of the highest tax revenue in the history of Nigeria in 2022. It thus appears that Nigeria has found an effective solution to its tax generation insufficiencies prompting its reluctance in signing the Agreement.

With Nigeria’s unilateral approach to digital taxation in such a statement move, its decision to maintain its DST requires effective tax administration through obtaining accurate data and records. Also, the country should be prepared to meet incidences of non-compliance of its DST by member states of the OECD/G20 IF which may affect the expected tax earnings from members of those states and additionally result in retaliatory trade sanctions from countries where MNEs headquarters are located. The imposition of lower tax rates by the Agreement is aimed at preventing profit-shifting from countries with high tax rates to tax-friendlier jurisdictions. Nigeria may face a drop in tax revenues if MNEs decide to focus their business in countries that are implementing the Agreement. This would prove counter-intuitive for the generation of revenue via tax remittance from MNEs. A possible solution to this dilemma is the implementation of a national strategy for the enhancement of tax incentives as suggested by the representatives of Nigeria at the joint workshop organised by the OECD and the FIRS in April 2023. Whether the decision is a good one, remains to be seen, but the initial signs remain positive for the country.

About the Author:

Kolapo Femi-Oyekola is a Nigeria-qualified lawyer. He is a member of the International Bar Association’s Arb40 Committee, the Chartered Institute of Taxation of Nigeria, and the Business Recovery and Insolvency Practitioners Association of Nigeria.