Last week, the Federal Inland Revenue Services (FIRS) published a notice in various national dailies regarding payment of provisional tax on interim dividends. FIRS directed attention to the provisions of Companies Income Tax Act (CITA), which requires every company that pays interim dividends to pay provisional Company Income Tax (CIT). The relevant provision is Section 43(6) of Companies Income Tax Act (CITA), Cap C21 LFN 2004.
Based on this provision, every company paying interim dividend is expected to pay provisional CIT. The provisional CIT is calculated as 30% of the profits from which the dividends are paid. As the name suggests, provisional CIT represents payment on account, against final CIT liability at time of filing annual returns. This provision, though not new, has been largely unenforced over the past years. Some companies pay interim dividends without necessary paying provisional tax. This is more so as affected companies are likely to be self-assessment filers that submit their annual CIT returns at year-ends.
The public notice is therefore a form of public enlightenment as continued non-compliance will now attract appropriate penalties. It should be noted that provisional CIT is separate from withholding tax (WHT) payable on dividends at 10%. Interestingly, there are different tax issues connected with dividends payment. We’ll focus on the key ones today. This is why today’s “tweetax” episode is titled – Love Dividends, Love Tax.
It is generally understood that dividends represent return on investments to shareholders. Capital appreciation/gain as well as dividends are two benefits that shareholders get on their investments. Based on the stakeholder concept, whenever shareholders get their reward, Government also ask for its fair share. So, what are the tax issues involved whenever dividends are paid?
Whenever dividends are paid, there is requirement for deduction of withholding tax (WHT), typically at 10%. The WHT deducted is paid to the relevant tax authority while the shareholder receives net amount. The relevant tax authority depends on whether the shareholder is a limited liability company or an individual. WHT due from limited liability companies are payable to the Federal Inland Revenue Services (FIRS) while WHT due from individuals are payable to the Tax Authority in their respective State of residence.
Where the shareholder is resident outside Nigeria, in a country having double tax treaty with Nigeria, lower WHT rate applies. Dividends payable to recipient who is resident in a treaty country usually attract reduced WHT rate of 7.5%. It is necessary to always check the provision of each treaty to ensure that appropriate rate is applied as terms may differ. For non-resident recipients, WHT on dividends represent final tax thereon.
So, be it interim or final dividends, WHT is deductible and payable to the relevant tax authority while shareholder receives net. Unless in specific cases where the law provides exemption, WHT is generally payable on dividends. For example, WHT is not deductible from dividends distributed by companies enjoying tax holiday as pioneer companies. There’s also an incentive for gas utilization (downstream ops) which provides tax-free dividends during the tax-free period.
However, if a company chooses not to pay dividends in order to avoid tax, there are provisions that may be applied to get tax due. There is a special anti-avoidance provision for a company under control of maximum of 5 people that chooses not to distribute dividends. If the decision not to distribute dividends is with a view to avoid tax chargeable on the profit, which could have been distributed. In such cases, FIRS may direct that such undistributed profits be treated as distributed and tax applied accordingly. Sometimes, I feel the humongous power at the disposal of tax authority. But such powers are to be used responsibly.
On the part of the paying company, there are additional CIT issue that are triggered by dividends payment. As is now being enforced by FIRS, where interim dividend is paid, provisional income tax of 30% of profit is payable. At year-end, if total dividends paid exceed the company’s normal taxable profit, CIT is payable based on dividends at 30%. By implication if CIT has been paid based on taxable profit, “excess dividends” attracts 30% CIT. This issue of “excess dividends” tax is a thorny issue for companies. In fact, there are interesting decided cases on the subject. There’s been decisions by both the Federal High Court and Tax Appeal Tribunal on the issue. It’s a story for another day.
Just as there are CIT issues from the angle of paying company, appropriate tax treatment is required by receiver. Ordinarily, dividends (just like other similar income like interest, rent, royalties etc) constitute income that should be taxable. But these type of income enjoy exemption from tax in certain instances. Whenever a company receive dividend that has suffered WHT, it is regarded as franked investment income. Dividends received as franked investment income are not to be added as company’s chargeable income. This is an incentive to investor as effective tax on dividends income is kept at 10% against normal CIT of 30%.
Dividends (just like interest, rent, or royalty) from outside Nigeria and brought in through Government approved channels are also tax exempt. Government Approved Channels means Central Bank of Nigeria (CBN), Commercial Banks, or other duly approved authorised foreign exchange dealers. Dividend received from small companies in the manufacturing sector, in the first 5 years of operation, is also exempted from tax. Similar tax exemption applies to dividends received from investments in wholly export-oriented businesses.
A company that receive dividends and redistribute same to its shareholders, may set of WHT suffered against WHT payable. Investment companies and Holding Companies (“HoldCos”) are usually caught in this type of web. Such companies receive dividends from their investee companies and pay dividends to their own shareholders. Why CITA makes provision for offset of WHT suffered on dividends received against WHT due on dividends paid, it’s not so easy with CIT. Section 19 of CITA requires payment of CIT based on dividends where taxable profit is nil or lower.
Imagine a subsidiary that pays CIT based on dividends paid to its parent company because of Section 19 of CITA. Then, the parent company (a HoldCo) also need to transfer the dividends to its ultimate shareholders. By applying the same Section 19 to the HoldCo, CIT becomes payable based on the dividends if higher than taxable profit. This way, the group tax cost becomes unnecessarily too high and harmful to the business. Section 19 of CITA is one provision that needs to be revisited if Nigeria must be an attractive holding company jurisdiction.
There is no group tax filing in Nigeria, each entity files tax returns as a separate entity. To mitigate the impact of this type of tax burden, a special circular was issued during the regulatory-induced Bank HoldCo regime. The details of the circular issued for Bank HoldCo regime is a subject of discussion for another day. But two quick points from the circular are appropriate for today – treatment of WHT on dividends and “waiver” of section 19 of CITA.
On WHT, the HoldCo subsidiaries are allowed to remit gross amount of divides to the HoldCo without having to deduct WHT. It is the ultimate shareholder (the HoldCo) that is required to deduct WHT on dividends to be paid. This arrangement may not necessarily reduce overall WHT payable as HoldCo will otherwise have been permitted to offset WHT suffered on dividends received from WHT due when redistributing. However, this arrangement eliminate the need for subsidiaries to withhold and for HoldCo to set off when redistributing. The logic is that the WHT tax burden is ordinarily to be passed to the ultimate shareholders of the HoldCo. If subsidiaries deduct WHT and remit same to FIRS, HoldCo will be unable to pass same credit note to its shareholders. Subsidiaries are therefore granted “waiver” from deducting WHT with HoldCo assuming responsibility for deduction and remittance.
On Section 19, Bank HoldCo will not be subjected to “excess dividends” tax rule in respect of dividends being redistributed. This means, Bank HoldCo will not be subjected to CIT based on dividends paid whenever such dividends exceed their normal taxable profit. The exemption does not extend to any other income or profits earned by the Bank HoldCo from other sources. So, far only Bank HoldCo enjoy this type of treatment.
What we’ve seen from today’s analysis is how critical tax is in dividends policy. There are more than we could possibly cover in a “tweetax” session. Be sure to seek professional guidance before taking any business decision as this forum is not a replacement for professional advice.
Let’s call it a day and meet up next week. Thank you for sharing your time with me. Please send in your feedback; remember to share, retweet and favourite.
Note: This article was posted in verses via my Twitter handle, @YomiOlugbenro, on Wednesday, 21 October 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 yomiolugbenro.com, facebook.com/YomiOlugbenro and LinkedIn.com/YomiOlugbenro.
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