Today is episode 9 of our weekly “tweetax” session – #TaxWiseNG. How time flies! What are we discussing today? We will be focusing on one of the tax regimes that I will like to see introduced into the Nigeria tax system – Tax Consolidation. Let me give a brief introduction, drawing from general accounting sphere.
Preparing financial statements is synonymous with business. Financial statements can simply be seen as a formal report of the financial activities of a business or an entity. Accountants are familiar with group accounts or what is commonly called consolidated accounts or consolidated financial statements (CFS). CFS is usually expected in instances where one company owns or control other companies. The company that owns the other is the PARENT and the entity owned is the SUBSIDIARY, together they are a GROUP.
Ordinarily, each entity is expected to prepare its own set of financial statements. Financial statements will usually show an entity’s assets, equity, liabilities, income, expenses and cash flows covering a given period. Financial statements are either on a stand-alone basis or consolidated. In the stand-alone financial statements the results of the subsidiaries are presented individually. In a CFS, the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single entity. For example, the consolidated income statement will report all of the revenues earned and expenses incurred by the group.
Let’s leave out other technicalities of when (and when not) CFS are required and assume simply that group of companies prepare CFS. Our focus today is a tax regime that mirrors the concept of consolidated financial statements. As you know, every company operating in Nigeria is expected to submit annual corporate income tax returns.
Nigeria does not have group tax filing. Each entity is treated separately and this is hugely inefficient for many reasons. In fact, determination of income tax is based on business lines. For example, in the days of composite insurance businesses, separate returns is expected from life and general business. A company that have pioneer certificate for one line of business is expected to submit different tax returns for the non-pioneer business. Companies with significant “other income” sources may be compelled to file separate tax return for “other income” especially if the core business is loss-making.
Beyond the multiplicity of returns and cost associated with the system, the overall position is often unsavory from group perspective. Many countries around the world have adopted tax consolidation or group tax reporting. With tax consolidation, a group of wholly-owned or majority-owned companies and other entities are treated as a single entity for tax purposes. What happen in such cases is that the parent company assume responsible for all or most of the group’s tax obligations – returns filing and tax payments.
Tax consolidation is a veritable tool for driving efficiency and simplifying the process of group tax reporting. With entity-based tax filing, the overall tax cost for a group of companies become rather inexplicable. Imagine a scenario where one entity has huge unutilized tax losses and capital allowances whereas others are in net tax payable position? With group tax reporting, losses in one group company is available to reduce profits for another to arrive a net tax due position.
CITA generally adopts separate entity doctrine and treats a company as a separate taxpayer. This reflects the traditional separate entity doctrine under which a company is regarded as a separate legal entity from its shareholders. The absence of group tax reporting is a major disincentive for operating a group structure in Nigeria. There are instances where a business finds it appropriate to set up Special Purpose Entity (SPE) or Special Purpose Vehicle (SPV). In many cases, the SPEs/SPVs are set up as wholly owned limited liability companies with each entity having tax reporting obligations.
It is important to understand business dynamics and the fact that certain structures are necessary to drive a business agenda. SPVs/SPEs are sometimes created to fulfill specific or temporary objectives with need to isolate the firm from financial risk. Companies may use SPEs to legally isolate a high risk project/asset from the parent and perhaps allow other investors share part of the risk. There are also instances where this is regulatory induced as we’re seeing in the financial sector.
A company may be desirous of diversifying into new areas where the regulation prohibits such to be combined in the existing structure. In a highly regulated industry such as financial sector, it may be difficult for a single company to combine multiple operations. The recent experience with the withdrawal of universal banking license is a good illustration. The Central Bank of Nigeria (CBN) phased out Universal Banking (UB) and introduced specialised banking.
When UB was introduced in 2000, Banks became one-stop shops, offering a range of financial services under one single entity. They could offer commercial and merchant banking, insurance, mortgage, stock broking and BDC under one structure. CBN stopped this due to fears that Banks were putting shareholders’ funds at risk and are not concentrating on their core business. CBN later rolled out a policy that brought all of those services and subsidiaries of Banks into a financial holding company (HoldCo).
The HoldCo became a non-operating entity while the Bank became a subsidiary of that non-operating financial holding company. Banks that were still interested in operating a diversified structure have to set up separate entities with licenses for different lines of business. Separate licenses were issued for each business – commercial, investment, mortgage, micro-finance, non-interest banking, etc. The various entities, including the Bank, became subsidiaries of the HoldCo with the latter being the listed company. As separate entities, each company will file separate tax returns without being able to extend its unused losses or capital allowances to the other. The HoldCo will typically receive dividends from its subsidiaries which it will, in turn, distribute to its shareholders.
A critical pain point with absence of group tax reporting is the dreaded Section 19 rule of CITA or what is often called the “excess dividend tax rule”. The rule requires that companies that pay dividends must compare the dividend payable with their normal taxable profit. If the dividends payable is higher than the taxable profit, income tax at 30% will be paid based on dividends paid. Put differently, the excess of dividends paid over the normal taxable profit will be subjected to additional tax at 30%. Hence the name, excess dividend tax. Thankfully, FIRS, through strong support of the Regulator and entreaties from the industry came up with a special Bank HoldCo tax regime. This was a special case for this sector. There are other industries, sectors, and companies that are suffering from same burden.
There are companies that find justifications to set up different SPEs with a Holding Company owning the subsidiaries. Sometimes, it is the need to avoid having one entity fall under supervision of more than one regulatory body with its attendant overlaps. Whenever a group operate in this manner, they are exposed to the burden of “excess dividends tax” due to lack of group tax reporting.
In is important to stress that tax consolidation regime is becoming increasingly popular with varying degree of application. This range from the relatively restrictive group loss relief regimes to the more comprehensive consolidation regimes. Also, countries which do not permit tax consolidation often have rules which provide some of the benefits. Some countries allow losses of one commonly controlled company to offset the profits of another commonly controlled company. In the UK, for example, there is a system of group tax relief, which permits profits of one company to be reduced by losses of another member of the group.
Tax consolidation has become a measure of sort of fiscal competiveness with the lobbying effort of global businesses around the world. Since a full blown tax consolidation regime can include arduous rules and regulations, let’s start with a home-grown model group tax relief. For example, waiver of excess dividends tax rule for entities whose reports are consolidated and allowing it only at the HoldCo level. All that is required a roll-out of the existing framework for Bank HoldCos, just to make it a policy of general application. This could increase the country’s attractiveness as a holding company destination and complement efforts at driving FDI. It will be a good place to start, while we look forward to full blown implementation of tax consolidation.
Nigeria is gunning for a slot in the top 20 economies of the world, as daunting as it looks, nothing is impossible! By same token, we should equally aspire to get up on ease of paying taxes and doing business indices. We should begin to make bold claims that if the US, Netherlands, France, Spain, New Zealand, Australia, Japan, Italy, South Korea can do it, we can.
On that note, let’s call it a week! Thanks for following the discussion. Please share, like and get your feedback across.
Note: This article was posted in verses via my Twitter handle, @YomiOlugbenro, on Wednesday, 11 November 2015. Every Wednesday at 17:00 WAT (CUT+1), I run a one-hour “tweetax” session with hashtag #TaxWiseNG where topical tax issues are discussed. The tweets are subsequently posted as an article and posted on my website www.yomiolugbenro.com, facebook.com/YomiOlugbenro and LinkedIn.com/YomiOlugbenro.
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