It is no longer news that the world is now a global economic village and no country can survive without engaging in transactions with other countries. Hence, it behooves all stakeholders to pay closer attention to tax issues relating to transactions with foreign entities and ensure that grey areas around the law are uncovered and resolved.
This post discusses the legal perspective, duties and tax exposure of trading parties and action points for both taxpayers and tax authority.
Section 54 of Companies and Allied Mattes Act CAMA requires companies to be registered to carry on business in Nigeria. Although the Act does not define what it means to carry on business, Black’s Law dictionary gives it a wide bracket by defining business as everything about which a person can be employed. In essence, CAMA views such transactions carried on by unincorporated foreign entities as illegal.
On the contrary, the Companies Income Tax Act recognizes unincorporated foreign entities (Non-Resident Company – NRC) and sets the guideline on which the relevant income will be taxed. As a rule of thumb, except for exempted transactions, all income made by foreign entities in Nigeria must suffer a form of tax.
Tax Implications and Responsibilities
The income of an NRC is subject to tax only on its Nigerian activities. Where the company has no taxable presence, any Withholding Tax that may have been charged becomes the final tax. The Nigerian party is charged with the duty of charging and remitting reverse VAT. However, where taxable presence is established, the NRC bears its burden and is required to register and file its complete income tax returns, including an audited financial statement in line with S.55 of Companies Income Tax Act CITA. A deemed assessment was allowed instead of full tax returns until 2015.
Taxable Presence – Permanent Establishment
In determining taxable presence, reference is made to whether the entity has a permanent establishment (PE). PE means a fixed place of business through which the business of an enterprise is wholly or partly carried out. The governing rules in determining a PE are spread across:
- CITA S. 9, 13 and 30
- Federal Inland Revenue Service Establishment Act
- Federal Inland Revenue Service FIRS Circulars
- Nigeria Double Tax Treaty
- Influences from Organization for Economic cooperation and development OECD Article 5 (Permanent Establishment) and Article 7 (Business Profit).
While the rules are several and repeated, the key indices have been summarised into 7 headers:
- Fixed Base: If the NRC has a physical facility such as building, office, or oil mine that can be associated with their activity in Nigeria, a PE can be established. This includes hotels that is made available for the use of the NRC. There is an exemption where the facility is strictly to collate information, storage or display of goods and merchandise.
- Dependent Agent: Where the foreign entity has a dependent agent who habitually exercises power to conclude contract on its behalf, the transactions create a PE for the foreign entity. An agent will be deemed to be independent where he is acting in the ordinary course of his business. For instance, if the agent is a registered broker or dealer of such items. In other cases, the agent will be regarded as dependent.
- Employees: Taxable presence can be created where the employees of an NRC are residing in Nigeria to carry out their employment duties.
Sometimes this takes the form of constant visitation to Nigeria or on-going transactions at a Nigerian partners location. Where expatriate staff is working in Nigeria, the expatriate quota can be used to verify the employer and determine the existence of a PE.
- Transfer Mispricing: Families are a blessing, but for the tax authorities, it is a smell of possible foul play. Transactions between connected taxable persons do not in itself constitute a PE. However, in situations where amounts charged for transactions between related parties do not mirror the market prices, the transactions may create a PE for the foreign party. In addition, FIRS is empowered to adjust the price to reflect the comparable price for such transactions.
- Construction projects: Where a single contract involves survey, installation and construction, the profit from the project is taxable. These are referred to as turnkey projects. Where any form of construction contract is carried out for more than three months, PE is deemed on the construction contractor’s activities.
- Conclusion of contracts: A PE can be created where the material terms of the contract are concluded in Nigeria. If a contract is concluded, signed, negotiated, decided, or governed by the Nigerian law, the transaction can be said to be carried out in Nigeria.
- Place of Management: This refers to where the key management and commercial decisions that are necessary for the conduct of the business of an entity are, in substance made. A PE can be established if the place of management is in Nigeria in line with Article 5 of the OECD Model Tax Convention.
Where a foreign company enters into a contract with a Nigerian company for the supply of goods and services, the Nigerian company is required to deduct and remit VAT. This is referred to as the reverse VAT mechanism. Previously, ambiguities and several conditions were surrounding the application of reverse VAT. Before reverse VAT could apply, the NRC needed to have a taxable presence in Nigeria and must have issued a VAT invoice. Where the VAT was not charged by the NRC, the Nigerian party was also liable to the unpaid taxes. The Tax Appeal Tribunal TAT judgment in the Vodacom vs. FIRS clarified the ambiguity and placed the burden on the Nigerian company to charge the reverse VAT in any of these cases.
- FIRS has the right to select the Nigerian party as a tax collection agent in line with S.31 of the FIRS Establishment Act. This may create a liability for the Nigerian party who is more visible to the revenue service. A proactive stance should be taken by Nigerian parties on transactions with foreign entities. Consultations should be made with tax consultants and the tax authorities to understand the implications and potential responsibilities.
- Nigerian companies should ensure that reverse VAT is deducted and remitted on its foreign transactions even when a VAT invoice was not issued by the foreign entity
- Where transactions are between related parties, proper transfer pricing agreements should be put in place to avoid the establishment of a PE. Taxpayers need to be conversant with the existing Double Tax Treaties to enjoy the available reliefs
- A substantial amount of revenue from potential taxes on International transactions are being lost by the government.
- There should be massive education on the tax implication of transactions with foreign entities to educate the taxpayer and promote self-compliance.
- Local rules on international taxation should be updated to align with widely accepted guidelines such as the OECD model tax convention.