Nonresident Taxation
In Brief
In July 2014, the Federal Inland Revenue Service (FIRS) sent letters to some tax consultants requesting their non-resident clients operating in Nigeria to file complete tax returns effective from 2014 tax year. In practice, non-resident companies file their tax returns on the deemed profit basis. Following an initial period of uncertainty as to whether the directive could be withdrawn, the FIRS has now confirmed that it will proceed with implementation.
- Background
- Status of the Directive
- Compliance obligations
- Issues still to be addressed
- What should affected taxpayers do?
Background
Historically, non-resident companies doing business in Nigeria prepare and pay their income taxes using the deemed profit basis. When filing returns under the deemed profit regime, the non-resident only needed to submit the deemed profit tax calculations accompanied with a statement of the turnover derived from Nigeria. A schedule of withholding tax suffered on the income is usually provided to support the claim for tax credit.
The FIRS has always accepted and, in fact prescribed the deemed profit basis of assessment. However, following a stakeholder forum in July 2014, the Transfer Pricing (TP) Division of FIRS issued a letter to several tax consultants stating that the deemed profit returns which had been filed by non-residents for the 2014 tax year were inadequate. The letter required consultants to inform their non-resident clients of the need to submit revised tax returns using the actual profit basis to include (among other things), Audited financial statements; Capital allowance computations; and Tax computations based on actual profits.
Even though the requirement to file full returns is based on the law, some legitimate concerns are being raised by stakeholders. These bother around the need for the FIRS to fully consider the impact of the new directive, the need to provide a detailed guidance on grey areas as well as provide sufficient notice to taxpayers prior to implementing the directive. There should also be a public notice and/or direct communication with affected non-resident companies. This is necessary given that the FIRS has historically through its action or inaction endorsed, and in fact encouraged, the deemed profit basis of taxation.
Status of the Directive
At a recent meeting between PwC and the FIRS TP Division, it was confirmed that the FIRS will proceed to enforce the directive. Taxpayers will however be given up till the due date for filing their 2015 tax returns to comply. This is effectively 6 months after the end of 2014 financial year. For instance, a company with a 31st December year end date will have up till 30th June 2015 to file the amended returns for 2014 tax year along with 2015 tax returns.
Compliance obligations
Affected taxpayers are now required to provide audited accounts for their Permanent Establishments (PE) or fixed base in Nigeria. These companies are to provide income tax computations which show the taxable profits after considering taxable revenue, tax deductible expenses and capital allowances.
The accounts of the PE to be submitted to the FIRS must:
- Be prepared in line with International Financial Reporting Standards (IFRS).
- Be audited by a Nigeria based auditor in line with International Standards on Auditing.
- Not necessarily a full set of financial statements. Income statements or receipts and payments together with statements of financial position (balance sheet or statement of affairs) will suffice.
Impliedly, non-residents companies should henceforth pay their income taxes based on actual profits. However, based on indications from the FIRS, tax may still be assessed on the deemed profit basis at the discretion of the FIRS where the taxpayer fails to provide sufficient evidence in support of actual profit tax.
In addition, affected companies must comply with the requirements of the TP regulations i.e. complete and submit TP declaration and disclosure forms; and provide documentation supporting the arm’s length nature of the dealings between the PE and the head office or other members of the group.
Issues still to be addressed
There are a number of issues to be addressed on the determination of actual profits. Some of these arise because a PE is not a distinct legal entity and as such some attribution analysis will be required to isolate some of its financial and other relevant attributes. Some of the issues include:
- The determination and deductibility of head office costs attributable to the PE;
- The attribution of free capital to the PE;
- The attribution of funding costs borne by the head office;
- The determination of the assets which are economically owned by the PE (including those which may not be located in Nigeria) and which should therefore qualify for capital allowances;
- Since PEs have not expressly claimed capital allowances in the past, whether capital allowances should be claimed for 2014 tax year using the historical cost of the assets or a hypothetical tax written down value;
- What will be the tax base of fixed assets which have been used by the head office and subsequently transferred to the Nigerian PE?
- What dealings between the PE and the head office will be accepted as “intercompany transactions” which should attract compensation?
- On what basis will risks be attributed to the PE for the purpose of characterising and compensating the PE for transfer pricing purposes?
Apart from the tax issues which impact the calculation of actual profits, there are also a number of other issues that may arise in the wake of this directive which we have deliberately not stated in this publication.
What should affected taxpayers do?
Non-resident taxpayers are advised to immediately review their tax and legal status in Nigeria and take steps towards full compliance. This will provide them with the opportunity to assess the impact of the directive on their tax position. It will also provide them with the opportunity to identify grey areas; explore the pros and cons of the various positions that can be taken; and if necessary seek the views of the FIRS on the issues ahead of the filing deadline.
The Way Forward
The directive for non-residents to now file their income tax returns based on actual profits and audited financial statements is a significant change with far reaching consequences. It is therefore important for affected taxpayers to review their tax positions in order to identify and quantify the impact of the directive and also be able to take steps to mitigate any negative impact.
On the part of the FIRS, certain issues bothering on the taxation of non-resident companies should be addressed along with this new directive. These include:
- the requirement for a foreign company that earns investment income from Nigeria, such as dividend, to register and obtain a Tax Identification Number (TIN) without which the Nigerian payer will not be able to remit the withholding tax deducted. This clearly has no basis in our extant laws and in fact it is counterproductive for a government seeking to simplify the tax system and improve tax compliance. It is conventional wisdom that the harder we make tax compliance, the more we provide the incentive for non-compliance and outright evasion.
- given the lack of clarity in some cases regarding what constitutes a fixed base, it is conceivable that a non-resident may derive business income from Nigeria without any physical presence. In the event that tax becomes payable, a less burdensome approach to tax filing should be considered.
Beyond the direct impact of this directive, the move is an indication that the FIRS is increasingly paying attention to the provisions of the tax laws. It is advisable for taxpayers to revisit any tax positions which are not supported by the law even if such positions have not yet been challenged by the FIRS.
