Section 29 of the Fiscal Responsibility Act, 2007 requires any proposed tax expenditure to be accompanied by an evaluation of its budgetary and financial implications in the year it becomes effective and the subsequent 3 years. It also requires the need for the tax expenditure to be supported by countervailing measures for the same period. Unfortunately, the Nigerian Government has never complied with this provision.
However, for the first time, the government stated, in the 2021 budget, the tax expenditures incurred in respect to some taxes such as companies’ income tax, VAT and custom duties. It should be noted that stating just the tax expenditure is not enough, we need information such as the naira cost of the job created by the various tax incentives to enable us to assess the effectiveness and the efficiency of the tax incentives.
International organizations have often called on developing countries to review and reform their tax incentives program because they believe that some of the incentives granted are redundant. This means that investors would likely have made the investment without the incentives. There is also the issue of other considerations that investors assess before making investment. Such considerations will include political and economic stability, availability of skilled labour, local markets and the transparency of the legal framework.
Nigeria’s incentives package is largely in alignment with international best practices, especially in areas such as inclusion of sunset provisions, transparency, and clarity in eligibility criteria. However, there are issues that the government needs to address to make it more effective and efficient. This is the thrust of this article.
Issues with the tax incentives program
High tax expenditure – Grant of tax incentives may reduce opportunities for the much-needed revenue for public infrastructure such as roads, bridges, mass transit, airports, power supply and hospitals. The simple reason is that anytime tax incentives are provided, there is loss of revenue to the government, at least in the short term. However, where the incentive granted is cost-based, like the road infrastructure development and refurbishment tax credit, the benefits may far outweigh the tax expenditure. According to the Honourable Minister of Finance, the tax expenditures for companies’ income tax, VAT and customs duties are N1.2 trillion, N3.1trillion and N347 Billion, respectively. This seems high relative to other comparable countries.
Profit-based incentives – Though Nigeria applies both the cost-based and profit-based incentives, there is a preponderance of profit-based incentives. While a cost-based incentive reduces the cost of investment, a profit-based incentive reduces the applicable rate of tax. Profit-based incentives will include tax holidays, preferential tax rates and income exemptions. Research has shown that profit-based incentives are more effective in attracting investment and are being used broadly by developed nations. These countries rely more on investment tax credits and favourable treatment of R&D credits. Consequently, many less-developing countries are moving away from cost-based to profit-based incentive schemes.
Proliferation of tax incentives – Undoubtedly, Nigeria has many incentives that have been driven by the need to compete favourably with other African countries in order to attract investment. Such competition has led to the so-called race to the bottom that has benefited mostly the investors in these countries. The relevant question that still needs to be answered is whether all these incentives have yielded the desired benefits to the country.
Lack of quality data – The major dilemma that faces every government is always how to strike a balance between creating an attractive tax regime for investment and generating enough revenues for public spending. A related issue is also how to determine whether to continue, reform or stop an incentive scheme. To be able to take informed decisions on these matters, quality data must be available.
Unfortunately, this has been the bane of most developing countries, Nigeria inclusive. There is no adequate data and or analytical tools and skills required to facilitate the analysis. Interestingly, Nigeria Investment Promotion Commission (NIPC) recently removed cement as a pioneer product based on an impact assessment analysis conducted. It would be desirable if such analysis is made publicly available.
Ineffective Tax Monitoring System – The ability of taxpayers to avoid payment of taxes will blunt the impact of tax incentives. Where a taxpayer can easily dodge the payment of tax, it will not see any additional benefit to take advantage of any tax incentive package that may been put in place. This is especially true of Nigeria where the tax-to-GDP ratio is less than 10%, which is abysmally low relative to other comparable countries in Africa.
Way-forward
Given the above issues, there is certainly scope for reforming the Nigerian tax incentives regime to make it more effective and efficient. The following measures will be necessary in this regard:
– Shifting from profit-based to cost-based scheme.
– Ensuring adequate reporting and continuous monitoring of the incentives by the Federal Inland Revenue Service (FIRS) to stem any potential abuse of the incentives
– Ensuring that all tax incentives that are currently documented in agreements (Production Sharing contracts, Memorandum of Understanding, Modified Carry Agreements, Policy Documents) and other laws are clearly prescribed and consolidated in the tax law to avoid ambiguity as to who is responsible for monitoring them.
– Reviewing all existing incentive schemes to ensure that they are temporary rather than permanent. In other words, sunset provision should be built into the enabling law.
– Frequent review of tax incentives to determine whether they should be continued, reformed or repealed.
– Effective coordination with other African countries will help to discourage unhealthy tax competition, which does not benefit anyone. One example of such coordination efforts is that of the Common External Tariff, which provides a common framework for the imposition of tariffs against products coming from outside ECOWAS.
– Implementation of performance metrics for evaluating the effectiveness and efficiency of incentives schemes is very critical. A metric such as dollar cost per job created will help in this regard. It will also help to benchmark tax expenditures with other countries.
– Imposition of an annual ceiling on tax expenditure relative to the GDP will also be desirable. However, it is important that whatever ceiling is prescribed is adhered to as much as possible unlike the case with the budget deficit to GDP ratio, which has consistently exceeded the stipulated 3% threshold in the past couple of years. However, there are on-going plans to modify this threshold in the 2020 Finance Bill.
In conclusion, there is no doubt that tax incentives are important for attracting investment. However, tax incentives generally rank lower in investment climate surveys in developing countries. The Government, therefore, needs to create the enabling environment for investors to thrive in Nigeria. Otherwise, the tax incentives will remain largely redundant. Attention must be paid to factors such as the design, governance, and frequent review of the incentives package to make them effective and efficient.
Government can explore other non-tax alternatives for achieving the same objective of attracting investments. Most importantly, the National Assembly must start to demand compliance with the Fiscal Responsibility Act by requesting the relevant tax expenditure schedule for any proposed tax incentive. Civic society organisations, media and other stakeholders should also be interested in this.
Ajayi is a Partner, KPMG in Nigeria
(@walesj1967)
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