Lagos State Internal Revenue Service (LIRS) has issued a public notice to notify employers of the exercise of its powers to appoint them as its agent in connection with employees’ tax obligation on severance benefits. It specifically request employers to deduct and remit applicable capital gains tax on payments to employees as compensations for loss of employment.  

This directive, as with many aspect of taxation, raises a number of issues. The first issue is to determine the nature of a given severance benefit. Is it such that the tax law exempts completely or allows to be taxed under a specific tax regime? I will focus mainly on differentiating between terminal benefit and termination benefits and keep the discussion on the specific issue of compensation for loss of employment.

There is no specific definition for compensation for loss of employment in either PITA or CGTA. By general English usage, terminal benefit refer to final entitlements (often pre-agreed) paid upon expiration of agreed tenure of service. This presupposes that the benefit is probably known and known ahead of time. It may or may not have been quantified at the start of the employment but both the employer and employee are aware that this form part of the total employment package.

Termination benefit, on the other hand, if more likely to refer to compensation for unexpected redundancies triggered by a closedown, downsizing, business reorganization and similar sudden change of fortune or focus by the business. As the name suggests, it is paid as compensation for unplanned loss of means of livelihood. It will appear that termination benefit is more likely to fit better into the definition of compensation for loss of employment.

Tax treatment of severance benefit is one aspect of Nigeria’s tax laws that has been a subject of controversies or, at least, confusion. Two tax laws are relevant in explaining the issues here – Personal Income Tax Act (PITA) and Capital Gains Tax Act (CGTA). PITA, which is the primary income tax law which is administered by way of Pay-As-You-Earn (PAYE) scheme exempts compensation for loss of employment from tax. That is, no personal income taxes (as contemplated by PITA) is applicable on compensation for loss of employment.

CGTA, on the other hand, considers any “capital sum” received as “compensation for loss of employment” to be a chargeable gain which is taxable to capital gains tax at the rate of 10%. However, unlike PITA, CGTA does not contain any provision for application of withholding taxes or “PAYE”. It also does not provide for third party obligation with respect to advance deduction of taxes due under CGTA but expects individuals liable to CGTA to self-account for any tax that may be due.

Whilst LIRS agrees that compensation for loss of employment are free of personal income tax, it holds the view that CGTA is applicable and thereby seek ways to proactively collect capital gains tax by holding employers responsible. Simply put, withholding tax (WHT) rules which applies under PITA is now being “imported” into CGTA. LIRS purportedly rely on its powers to appoint anyone as collection agents by citing the provisions of PITA and linkages in CGTA.

This directive is fraught with multiple issues. First, severance benefits must first be clearly separated into termination benefit and terminal benefit. The tax treatment of these different benefits differ, even by the admission of LIRS. LIRS initially issued a public notice in 2017 wherein it stated that terminal benefits should be taxed as regular employment income under PITA (and administered as part of PAYE) while termination benefits should be taxed as capital gains (under CGTA).

The second issue is the application of withholding tax on capital gains and employers’ obligation in connection with the tax. Let us assume, without conceding, that LIRS’ position on the meaning and applicable tax laws for terminal benefit and termination benefit is correct, there is a major issue with application of WHT on capital gains. Tax is a matter of law. It can only be applied in manner prescribed by the law. Whereas PITA makes specific provision on how PAYE/WHT is applied on income taxable under PITA, there’s no withholding tax rule on gains taxable under CGTA.

Taken that compensation for loss of employment is considered as capital sum liable to tax under CGTA, tax can only be applied in manner prescribed under CGTA. Capital gains tax are paid by taxpayers on self-assessment basis. Power to appoint collection agents for tax purposes is contained in PITA, not CGTA. The rule for adoption of PITA administrative process covered in section 43 of CGTA (relied upon by LIRS) does not clearly relate to WHT practice.

Employers are therefore likely to resist importation of the provision of withholding tax rule contained in PITA to CGTA. No one likes to pay tax, it is a statutorily imposed civic obligation. It will therefore not be out of order for everyone to seek ways of avoiding obligations that are not so clearly mandated by the law.

While I agree with the provision of CGTA that “capital sum” paid “compensation for loss of employments” are chargeable gains, CGTA does not indicate employer’s obligation as withholding tax agents. Individuals earning capital gains are required to account for their taxes in manner prescribed by CGTA.

The dilemma faced by Nigeria tax authorities and for which an escape route is being sort is the enormity of the administrative burden of chasing millions of individual taxpayers. So they look for a convenient way out. But no one wants a burden unless legally imposed. Governments should rather focus on revamping tax laws in Nigeria to close identified lapses and bring the laws to modern realities. Nigeria tax laws are laden with rules that have lost touch with emerging realities and not so much is being done to aggressively change the status quo. The process of law-making is cumbersome and long-lasting. So short-cuts are found. While some creative ways such as executive orders may help, issuing public notices and circulars that seek to change the law will be faced with resistance.

I must express my admiration for LIRS for its innovative ways of tackling evasion and growing its tax revenue. You may not agree with their position, but LIRS doesn’t claim helplessness. Despite administering the same federal law, it has its position on several contentious issues and proactively pushes its view. However, some of the positions constitute a stretch of the law which raises considerable tension in the tax space. This is where caution is needed.  

It is important to allow taxpayers enjoy benefits of ambiguous rules. This is the norm in tax practice. Government should rather exercise its power to make and amend laws to curb abuses. Attempts at refurbishing a 1967 law via public notices and expecting same to fit into the modern realities of twenty-first century will only generate legal tussles that will multiply disputed tax cases.

The greatest challenge facing the country is paucity of revenue but this is not being addressed with the required vigor. Both the executive and legislature should be working hard on regulatory intervention to address the revenue challenge. The current low tax penetration challenge cannot be resolved unless the law is fixed. Nigeria need new tax laws that will consolidate existing taxes, introduce modern rules, be wide-covering, efficient and effective.