The Finance Act, 2020-What it means for Startups in Nigeria

President Muhammadu Buhari, on Monday, January 13, 2020, signed into law a new Finance Act (‘the Act’) that seeks to increase government revenue whilst bolstering the struggling small and medium (SME) business sector in Nigeria (which most start-ups in Nigeria fall into). The legislation submitted alongside the 2020 Appropriation Bill (the ‘2020 Budget’) to a joint session of the National Assembly on October 14, 2019, by the Presidency, proposes fiscal measures in support of the 2020 Budget. The 2020 Budget is projected to be financed partly by tax revenues expected to be generated through the fiscal changes introduced by the Act.

The Finance Act

The Act amends certain key provisions in seven (7) primary tax laws in Nigeria. The key reforms in the Act affecting Start-ups in Nigeria are contained in the Companies and Income Tax Act, the Personal Income Tax Act, Value Added Tax Act, Stamp Duties Act and Customs and Excise Tariff Etc. (Consolidation) Act.

The provisions of the Act relevant to start-ups include increased VAT rate to 7.5%, a 0% CIT rate for small-sized companies, a lowered rate of 20% for medium-sized companies, a new requirement for Tax Identification Number to open and operate a business bank account, and an increased threshold of N10,000 for electronic bank transfers liable to stamp duty charge of N50.

This article attempts a summary of the reforms in the Act which will likely have an impact on Startups in Nigeria.

Companies and Income Tax Act…

Taxation of Non-resident Companies

The Act expands the basis for taxing foreign/Non-Resident Companies (‘NRC’) carrying on business in Nigeria on the condition that these NRCs have a significant economic presence in Nigeria and their profit be attributable to such activity. In essence, companies providing online/digital services or goods and who have a significant economic presence in Nigeria will be subject to Companies Income Tax (CIT). The FG’s aim here is to establish a digital permanent establishment for CIT purposes to ensure the taxation of companies with an economic base in Nigeria.

This deviates from the previous provision of Section 13 of the CIT Act which subjected NRCs to tax in Nigeria only if the NRC had a physical presence or fixed base in Nigeria and the taxable profit was attributable to that fixed base. The implication of the above is that profits derived by non-resident start-ups from online activities from their users or subscribers in Nigeria were outside Nigeria’s tax net. This resulted in tax revenue leakage for the Nigerian government.

With the introduction of SEP, profits derived by non-resident start-ups from digital activities in Nigeria are now within the FG’s tax bracket. Now, NRCs in the e-commerce, filming, Fintech, computing, ridesharing, media, movie streaming, online gaming, advertising, online consultancy and management services, Instagram and Facebook businesses etc., who previously had no fixed base in Nigeria and no Nigerian tax obligations, will be liable to CIT provided they meet the SEP threshold.

However, the Act does not define SEP. The Act vests the Honourable Minister of Finance with the power to issue an order on SEP. This may see digital companies such as Alibaba, Amazon, Asos, Goggle etc., who operate digital services to pay tax on services they provide to Nigeria.

No and/or minimal tax

To assist Start-ups in Nigeria to grow their business, small businesses earning lower than N25million in any tax year will be exempted from the 30% CIT payable by registered companies in Nigeria.

Similarly, medium-sized companies with revenue running between N25 million and N100 million in any tax year will be required to pay a company income tax rate of 20%, while companies with turnover higher than N100 million annually would still pay CIT rate of 30%.

The incentive for early payment of CIT

Companies must now pay their CIT liability on or before the due date of filing in one lump sum, or in instalments agreed with the FIRS with the last instalment paid on or before the filing due date.

As an incentive for the early payment of tax under the self-assessment framework, the Act proposes a 2% and 1% bonus for medium-sized and large firms respectively if CIT is paid 90 days before the due date of filing/payment.

Thus, if CIT is paid early (90 days before the due date for the company to pay tax or 3 months after the end of an accounting year of the company):

a. for a medium-size company-instead of the company paying a 20% tax rate, they get a 2% bonus thereby paying 18% tax rate.

b. for any other company- they pay 29% instead of 30%.

c. Small companies are exempted from tax. So, no bonus is available to them. However, if a small company fails to file tax returns early, they pay a penalty.

Thus, to avoid the penalty, all companies are advised to file before the due date. All medium and small companies are advised to file within 3 months after their account year ends to get the bonus.

Carry-forward of losses

The Act amends Section 31(2)(a)(ii) of the CIT Act to allow companies to carry forward tax losses indefinitely. This is useful as start-ups who incur significant losses in the first few years of business can now carry forward tax losses against future taxable profits. Hopefully, this will improve investor confidence in Nigeria and the start-up sector.

Value Added Tax Act…

Increase of VAT rate

The new Act increases the VAT rate from the current 5% to 7.5%, which is expected to increase the government’s revenue.

Items exempted

Items exempted from VAT are essential items and other basic food items such as bread, cooking oils, cereals, spices, fruits, meat, milk, nuts, pulses etc.

Non-registration for VAT for small businesses

To reduce the burden of the VAT tax increase on small businesses, the Act stipulates that only businesses that have an annual turnover of N25 million and above will be required to register for VAT, charge and collect VAT on its sales.

This implies that SMEs that do not meet this threshold would not need to register for VAT and as a result would not be able to recover input VAT on their purchases.

Penalties

Penalties for failure to register has increased to N25,000 for the first month of default and N20,000 for each subsequent month.

Introduction of Place of Supply rules for VAT

The Act seeks to resolve the issue of ‘origin’ versus ‘destination’ principle by introducing ‘place of supply’ rules in the definition of ‘services’ and ‘exported services’ and by adopting the ‘destination principle’ which aligns with the OECD’s Goods and Services Tax principles.

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.

Thus, under 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.

Non-Resident Companies

NRCs supplying goods and services are also required to include VAT on their invoices. However, a NRC is not required to withhold and remit VAT. That burden rests on Nigerian companies receiving the services.

Thus, Nigerian startups that receive services from NRCs are required to withhold and remit VAT to the FIRS on behalf of the NRC.

Implications of the amendment of the VAT Act…

The objective here seems to be to spare SMEs from the administrative burden of VAT compliance. However, the fact that these exempted companies will not be required to charge VAT does not preclude them from incurring VAT on their purchases from companies with a turnover of about N25 million.

The implication of this is that these SMEs will have to absorb the input VAT on purchases of stock-in-trade or raw materials, machinery and other items of capital expenditure used by the SME. This increases their cost of production. Further, it will increase the strain on manufacturing industries and companies in capital intensive businesses, which currently suffer from the imbalance in the VAT system that prevents them from being able to recover the VAT on certain items of expenditure.

The unintended consequence is that the increase in VAT may result in deeper erosion of business profits. Thus, industry players may resort to charging overly high prices on their products to cushion the effect of the VAT increase on their businesses.

Also, a situation may arise where SMEs who are not required to charge VAT may charge and collect same from customers without remitting the VAT to the FIRS.

More so, the increase in the VAT rate is not being matched with a commensurate increase in the disposable income for most Nigerians. Thus, the effect of the VAT will be felt by Nigerians. However, it is hoped that the expanded scope of exempted items may cushion the effects of the increased VAT rate. This is because items exempted from VAT are basically essential items and basic food items.

Stamp Duties Act…

Stamp duty of N50 will be applied to bank transfers on amounts from N10,000 and above. However, transfers between accounts by the same owner in the same bank will also be exempted.

Hence, it is better to buy items in bulk and pay just N50 than split the items up.

For example, it is better to buy items worth N50,000 in bulk and pay just N50. The total amount paid will be N50,050. The only way to avoid the N50 POS stamp duty charge is to split up the purchase to an amount less than N10,000. Assuming you split it to a multiple of N5,000 for each purchase it will mean 10 different invoices or transactions and no N50 will be charged on the transactions.

Other changes…

TIN

Banks are to request for Tax Identification Number (TIN) before opening bank accounts while existing account holders must provide their TIN to continue operating their accounts.

Customs Act

The scope of goods subject to excise duties based on the Customs Act now expanded to include ‘goods imported and those manufactured in Nigeria…’

Finally, …

Undoubtedly, the government is trying to improve the fiscal policies and regulatory environment in the SME sector to stimulate growth. However, there is also a deliberate effort to ensure that the sector contributes to revenue generation without causing an excessive financial burden.

To this end, the government is trying to formalise the sector through the TIN project in collaboration with the banks.

Also, the increase of the amount chargeable to stamp duties to N10,000 and above would reduce the challenges faced by SMEs and retailers who have recently transferred the N50 as an additional cost to their customers.

The exemption of small businesses from paying tax could encourage more small businesses to come into the tax bracket, and if it works, could begin to reduce the FG’s dependence on oil revenue.