Technological changes are constantly shaping business relationships and organizations have continued to refine their business models to keep up with digital innovations. However, tax has not kept pace with the digital revolution and collective attempts are just being made globally to catch up with the fastchanging pace of the digital economy.
According to the Organisation for Economic Cooperation and Development (OECD)’S Action 1 on preventing Base Erosion and Profit Shifting (BEPS, digital economy is characterized by massive use of data, unparallel reliance on intangibles, difficulty in determining the jurisdiction in which value creation occurred, little or no physical presence required for value creation or service delivery, etc.
To address the tax challenges of the digital economy, the OECD, through its BEPS Inclusive Framework, has proposed the following approaches for allocation of taxing rights and nexus rules, for consideration by its members:
User Contribution – which allocates taxing rights by focusing on user base for digital services, data and content generation in a highly digitized business.
Marketing Intangibles – this has a broader application by focusing on aspects of commercial exploitation of a product or service, and includes trademarks, customer list, proprietary market, etc.
Significant Economic Presence – this allocates taxing rights based on evidence of a combination of factors that create purposeful and sustained interaction with the economic life of a jurisdiction through digital means.
However, the approaches are still being debated, and OECD has up till December 2020 to conclude its work on the new architecture for corporate income tax.
Regarding the applicability of VAT to digital/ electronic transactions, Nigerian courts have before now been tasked to fill the gap in extant Nigerian tax legislation by ruling (such as in Vodacom Business Nigeria Limited vs FIRS; Appeal no. CA/L/556/2018) that such transactions are liable to VAT.
Therefore, the legislative intervention by the Finance Act to address the uncertainties around taxation of digital economy in Nigeria is a welcome development that brings clarity to this area of Nigerian tax laws.
Establishment of Digital Permanent Establishment for Companies Income Tax
The Finance Act introduces new provisions under the CITA aimed at, among other things, capturing the digital economy by adopting “significant economic presence” (SEP to affix the affected companies with a fixed base in Nigeria.
Prior to the Finance Act, Section 13 of the CITA subjected a Nonresident Company (NRC to tax in Nigeria only if such company had a fixed base in Nigeria and the taxable profit was the profit attributable to that fixed base.
A fixed base may be created by the physical presence of an NRC’S employees in Nigeria, an arrangement with a dependent agent who executes transactions on behalf of the NRC in Nigeria, the execution of a single contract for surveys, deliveries, installations or construction by the NRC in Nigeria, or existence of an artificial or fictious transaction involving related parties in Nigeria. Hence, the nexus for taxing profits derived by a foreign company in Nigeria is based on physical presence in Nigeria.
Accordingly, the profits derived by nonresident digital businesses from online activities, such as advertising, movie streaming, online gaming stores, e-commerce, etc., from their users/subscribers in Nigeria were outside Nigeria’s tax net. The direct consequence of this was tax revenue leakage for the Nigerian Government.
To address the challenges of taxation of the digital economy, the Finance Act introduces SEP to create a nexus for taxing profits derived by NRCS from digital operation in Nigeria. The amendments provide that the “profits of a company other than a Nigerian company from any trade or business shall be deemed to be derived from Nigeria if it transmits, emits or receives signals, sounds, messages, images or data of any kind from cable, radio, electromagnetic systems or any other electronic or wireless apparatus to Nigeria in respect of any activity, including electronic commerce, application store, high frequency trading, electronic data storage, online adverts, participative network platform, online payments and so on, to the extent that the company has significant economic presence in Nigeria and profit can be attributable to such activity.”
The implication of this amendment is that affected NRCS in e-commerce, filming, computing, ride-hailing, media, etc., who previously had no fixed base in Nigeria under the conventional rules, and no Nigerian tax obligations, will be liable to Nigerian income tax provided they meet the SEP threshold.
Also, such NRCS may be required to register for taxes and file income tax returns in Nigeria in line with Section 55 of CITA.
The Finance Act vests the Honourable Minister of Finance (MOF) with the power to issue an Order on SEP. On this basis, it is expected that the tax regime for the digital economy introduced by the Finance Act will only become effective after the Order has been issued. As this is a matter of global importance, it is expected that the MOF will leverage guidelines provided by the OECD’S
BEPS Action Point 1 in determining what constitutes SEP for the purpose of an NRC deriving digital income from Nigeria. According to the OECD guidelines, SEP principle allocates taxing rights based on evidence of a combination of factors that create purposeful and sustained interaction with the economic life of a jurisdiction via digital means. The factors include revenue generated on a sustained basis, existence of a user base, maintenance of website in a local language, volume of digital content generated from the jurisdiction, etc.
8.2 Introduction of Place of Supply rules for VAT
There had been uncertainties in the application of the provisions of the VATA to cross border services.
For instance, while the extant VATA contains definitions of “exported services” and “imported services”, it does not have provisions relating to the “place of supply”. This has led to civil suits between taxpayers and the tax authority on whether the Nigerian VAT Act is based on the “origin principle” or the “destination principle”. The origin principle holds that goods and services are liable to VAT in the jurisdiction where value is created (i.e., where goods are produced and services are rendered), however, under the destination principle VAT is chargeable in the jurisdiction where goods and services are consumed.
The Finance Act seeks to resolve this issue by introducing “place of supply” rules in the definition of “services” and “exported services” and also adopts the destination principle which aligns with the OECD’S Vat/goods and Services Tax international tax principles. From the effective date of the Finance Act, services received by a person resident in Nigeria will be chargeable to VAT, regardless of the location of the supplier.
The Nigerian recipient of a Vatable service provided by an NRC will also be required to self-account for the VAT where the NRC has not included VAT in its invoice.
The amendments aimed at taxation of the digital economy in Nigeria aligns with global trends and provide more certainty on liability of cross-border transactions to VAT in Nigeria.
The anticipated significant impact of the amendments on the affected businesses makes it necessary for them to review their commercial arrangements for the purpose of compliance or restructuring.
Wole Obayomi Partner