The Nation Newspaper

Category: Taxation

  • Increased tax collection: presumptive tax to the rescue

    Taxing the informal sector has become a huge challenge for tax authorities-whether at the state or federal level. Yet they must be taxed for government to be able to meet the desired objective of pooling funds together for development of social infrastructure. Presumptive taxation has therefore become one key tool used by tax administrators to get the “hard-to-tax” into the tax net whether in developed or developing countries. It is presumed that the deployment of a presumptive tax regime will widen the tax net in Nigeria.

    A presumptive tax regime is one where the desired tax base is not itself measured but is inferred from some simple indicators-turnover, assets, farm size, value of land, shop value, etc., which are more easily measured in place of complex financial statements. The kernel of presumptive taxation is anchored on section 6 of the Personal Income Tax(Amendment) Act, 2011, which introduced a new subsection (6) to section 36 of the preceding act, as follows; “Notwithstanding any of the provisions of this Act, where for all practical purposes the income of the taxpayer cannot be ascertained or records are not kept in such manner as would enable proper assessment of income, then such manner a taxpayer shall be assessed on such terms and conditions as would be prescribed by the Ministry of Finance in regulations by order of gazette under a presumptive tax regime”.

    A lot of people have argued that when taken from a historical perspective presumptive taxes have always existed and that there has only been a transition from an agricultural based economy to industrialized driven economies. Whereas tax administrators have made sufficient laws to ensure compliance with regard to structured businesses with verifiable statements of accounts, the informal sector remains unreached. What this portends for an economy that requires all the funding it can get to tackle decaying infrastructure is deprivation of needed resources which is quite huge from the informal sector.

    The size of the informal sector in Nigeria is very enormous, knowing from hindsight that the informal sector employs a huge chunk of labour force, while a lot more are self employed without appropriate documented means of accounting for their income. Presumptive taxes provides for a simplified option for tax compliance without going through the rigors of financial documentation. It opens a new vista for those outside the tax net to be integrated into the system as well as limiting tax avoidance.

    Essentially, presumptive taxation offers even more than assumptions of payable income taxes, as it also offers a streamlined method for transiting from the informal to the organized structure whether individually or a business. A movement from the burden of standard assessment system accounting method to assessment as per volume of trade, value of land or even simple turnover of trade substantially encourages unwilling taxpayers to pay their taxes and also enjoy incentives or benefits that the formal sector enjoys.

    From a Nigeria point of view, it is obvious that most taxpayers and even incorporated businesses are still grappling with maintaining accurate reporting standards or even navigating complex tax codes, which has resulted in non compliance and evasion, requiring additional resources and efforts from the tax administrator to enforce compliance. So figuratively speaking, part of the rationale of presumptive taxation will be to reach as many that the proposed regulation will cover to engender a stronger taxpaying culture. Some tax experts have also insisted that Presumptive taxation will engender self assessment since most taxpayers covered by this regulation will have to file their assessment by completing simple forms with little aid. This appears rational but it must be said that Presumptive taxation is targeted at increasing revenue collection using the simplest means possible.

    In jurisdictions were presumptive taxation is practised, standard and estimated assessments, presumptive minimum taxes, value of land, net wealth and asset value are some of the methods employed in estimating income and assessing tax liability. While a lot of stakeholders have argued for and against the various forms of assessment noting that some of such methods do not allow for fairness of assessment, however it must be noted that the various methods have their merits and demerits but each addresses different set of taxpayers and would be proper to apply them accordingly.

    Interestingly, some advanced countries still practice Presumptive taxation e.g. In Czech, lump sum taxation is available for individuals with income from agriculture production, from a trade and/or from other business activity if the business has no employees or co-operating persons, and annual income in the three immediately preceding taxable periods did not exceed CZK5m (US$234,000). The business owner may not participate in an association that is not a legal entity. In France Presumptive taxation was widely used in the agricultural taxation even though it’s application has reduced tremendously in the last decade, it was used to effectively tax that sector and afforded taxpayers the skill to transit to desirable filing/assessment methods. Also in France, farmers with a turnover of 500,000 francs or less are eligible for the presumptive basis of taxation. Locally, the Lagos Internal revenue Service (LIRS) has introduced some form of direct presumptive taxes which has yielded increased revenue for the state. Though much can still be achieved has it is obvious that artisans and petty traders are the primary focus of their policy.

    Presumptive taxation is an attractive method of governments’ continuing effort at making the tax system more productive and efficient while instilling responsibility of citizenship and ownership simultaneously. Also of strategic importance is the capacity of the tax administration to handle the particular presumptive method being applied for improved compliance. Attention must also be paid to how a particular presumptive method will work in different situation. The administrative competence and capacity of the tax administrator will be sufficiently tasked for the implementation of presumptive taxation to effectively fill the void it was been created to serve because if taxpayers can hide the factors on which the presumption is based as easily as they can hide income, then the presumption will not be of much use. Taxing the informal sector can add substantially to revenue collection and as stated recently by the Ag.Chairman of the FIRS “such a large pool of taxpayers cannot be ignored by any tax system, which seeks to make taxation the pivot of national development”, this statement in itself sums up the desirability of a presumptive tax regime.

    • Obaro can be reached at: obaro.frank@gmail.com

     

  • Issues underlying transfer pricing (II)

    AS earlier stated, our transfer pricing regulation is benchmarked against the OECD transfer pricing guidelines. The Transfer Pricing Regulations also provide a “Safe Harbour”, which is an exemption from “documentation requirement” of Regulation 6 limiting it to when price is in accordance with the requirement of Nigerian statutory provisions and/or when price approved by other government regulatory agencies/authorities established by Nigerian law provided that FIRS is satisfied that the price is at arm’s length.

    Though this can be tagged as mere “approval in principle” since the FIRS reserves the right to still scrutinise the transactions and ensure compliance to the “arm length” principle. The regulations also make provision for a dispute resolution panel to serves as an administrative dispute resolution mechanism from issues arising from the provisions of the Regulations.

    In effect the regulations provide an appropriate basis for taxing economic activities of associated enterprises as well as tools for fighting tax evasion. Provisions of the regulations also reduce the risk of economic double taxation. Also included is a level playing field between MNE and independent enterprises.

    The scope of the regulations covers sale and purchases of goods and services, sales, purchase or lease of tangible assets, transfer, purchase, licence or use of intangible assets, provision of services, lending or borrowing of money, manufacturing arrangement and any transaction incidental, connected or pertaining to the above transactions.

    The regulations also adopt popular transfer pricing methods, such as comparable Uncontrolled Price (CUP), cost plus, resale price, transaction net margin method (TNMM) and transactional Profit Split. In all these, method used must be appropriate to the particular transaction bearing in mind the relative strength and weakness of each method, the nature of the transaction, availability of reliable information and degree of comparability.

    The arm’s length principle, which is the global benchmark for establishing transfer prices between related parties is recognised in Regulation 4 of the Transfer Pricing Regulations. It empowers the Service to make adjustments where necessary to make a controlled transaction consistent with the arm’s length principle. The application of the arm’s length principle assists governments to ensure that the taxable profits of multinationals are not artificially or deliberately shifted out of their jurisdiction and that the tax base reported by multinationals in their country reflects the economic activity undertaken therein. It also limits the risks of economic double taxation that may result from a dispute between two countries on the determination of the remuneration for cross-border transactions between associated enterprises.

    Nearly all systems require that prices be tested using an “arm’s length” standard. Using this method, a price is considered appropriate if it is within a range of prices that would be charged by independent parties dealing at arm’s length. This is generally defined as a price that an independent buyer would pay an independent seller for an identical item under identical terms and conditions, where neither is under any obligation to act.

    There are clear practical difficulties in implementing the arm’s length standard. For items other than goods, there are rarely identical items. Terms of sale may vary from transaction to transaction. Market and other conditions may vary geographically or over time. Some systems give a preference to certain transactional methods over other methods for testing prices.

    The application of the arm’s length principle is generally based on a comparison of the conditions in a controlled transaction with the conditions in comparable transactions between independent enterprises, referred to as a “comparability analysis”. The OCED Transfer Pricing Guidelines (‘TPG’), which has been adopted unchanged by some jurisdictions contain guidance on comparability analysis and a description of five transfer pricing methods, which can be used to establish whether the conditions of a transaction between associated enterprises satisfy the arm’s length principle. The OECD and the United Nations Tax Committee have both endorsed the “arm’s length” principle, and it is widely used as the basis for double taxation treaties between governments.

    The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax authorities to adjust those prices where the prices charged are outside an arm’s length range. Rules are generally provided for determining what constitutes such arm’s length prices, and how any analysis should proceed. Prices actually charged are compared to prices or measures of profitability for unrelated transactions and parties. The rules generally require that market level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items with respect to the related party transactions or profitability being tested.

    Most systems allow use of multiple methods, where appropriate and supported by reliable data, to test related party prices. Among the commonly used methods are comparable uncontrolled prices, cost-plus, resale price or mark-up, and the TNMM. Many systems differentiate methods of testing goods from those for services or use of property due to inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax controversy.

    Most tax treaties and many tax systems provide mechanisms for resolving disputes among taxpayers and governments in a manner designed to reduce the potential for double taxation. Many systems also permit advance agreement between taxpayers and one or more governments regarding mechanisms for setting related party prices.

    Many systems impose penalties where the tax authority has adjusted related party prices. Some tax systems provide that taxpayers may avoid such penalties by preparing documentation in advance regarding prices charged between the taxpayer and related parties. Some systems require that such documentation be prepared in advance in all cases.

    Developing economies are keenly aware of the challenges posed by transfer pricing. Their goal is the same as for OECD countries: protecting their tax base while not hampering foreign direct investment and cross-border trade. The arm’s length principle can help them achieve that goal. The key is to tailor the legislative measures and administrative effort to the strategic needs and resources of each country.

    Applying the arm’s length principle can become complex and resource-intensive, though policy makers should bear in mind that most OECD countries started modestly and built their transfer pricing legislation and practices gradually over several years. Indeed, they are still in the process of improving them.

    The USA transfer pricing regulations of 1994 and the risk of severe penalties, even in case of non-deliberate deviations from the arm’s length principle have resulted in both the USA and countries revising their transfer pricing methods. Countries with less sophisticated tax systems and administrations run the risk of absorbing the effect of stronger enforcement of transfer pricing in developed countries, and, in effect, paying at least some of the MNEs tax costs in those countries. In order to avoid this, any countries have introduced new transfer pricing rules since that time.

    Tax authorities in developing countries that wish to implement transfer pricing legislation may focus on the most common types of transactions and sectors in their economy first, for instance the exploitation of natural resources, manufacturing, or service activities. Enforcement objectives should be realistic, given the available capacity, and compliance requirements made reasonable for taxpayers in light of the size of the cross border trade. So-called “safe harbours” are sometimes used to simplify compliance by small taxpayers, or to deal with small and less complex transactions carried out by multinational enterprises.

    Given the global and sometimes controversial nature of transfer pricing, it is important to develop internationally shared principles to help each country fight abusive transfers of profit abroad, while at the same time limiting the risk of double taxation of those profits. This is what the arm’s length principle is for. As more developing countries apply it, new lessons will be learned. This is a key step on the road to building a stronger and fairer world economy.