The Nigerian digital economy will be worth $88 billion with capacity to create three million jobs by 2021. But it is largely untaxed. Taxing multinational companies like Google, Apple, Twitter, Amazon, Facebook, Uber, eBay and banking software manufacturers will require new tax laws that capture their mode of operations. These firms deploy the Base Erosion and Profit Shifting (BEPS) rule to shift profits from the spots where economic activity and value creation occur into low or no-tax locations. The BEPS practice and absence of suitable tax laws have constrained the Nigerian tax authorities from taxing the digital economy. The Federal Inland Revenue Service (FIRS) is engaging the National Assembly to amend the tax laws to align with changing technological advancement and halt tax revenue leakages from the digital space, writes COLLINS NWEZE.
Adekunle Peters, a Lagos-based banker, marked his 10-year work anniversary with a commercial bank in May. A month later, he got a big surprise gift from his branch manager- Acer laptop, a reward for good performance on the job.
To protect the laptop from virus attack, Peters went online to download anti-virus software directly from the software company based in United States of America. He used his dollar debit card to pay $40 for the product.
Although the purchase was done from his base in Lagos, Peters dodged the value-added tax (VAT) on the laptop purchase, making the government to lose tax revenue.
Peters is one of the millions of Nigerians that make purchases for goods and services online from companies without physical presence in the country, denying government the much-needed tax revenue. Google, Apple, Amazon, Facebook, Twitter, Uber, eBay, anti-virus firms and banking software providers among others, fall within the digital economy space. They employ thousands of staff to check every loophole that will enable them evade taxes. They also retain the services of the big accounting and global law firms with the sole aim of driving down the effective rate of tax they pay wherever they operate or their goods are sold.
Tax-motivated profit shifting of this kind has risen up the multilateral agenda since the 2007- 2008 global financial crisis, with organisations such as the International Monetary Fund (IMF) pointing to ample evidence that it is taking place. Estimates of the global scale of annual public revenues lost to profit shifting vary. One recent estimate put global losses from corporate tax avoidance at about $500 billion annually, with developing countries, including Nigeria hardest hit.
Traditionally, discussions about who pays tax and where have been based on two models: residence taxation and source taxation. The former holds that people and companies should contribute to the public services provided for them by the country where they reside and that this tax applies to all their income, no matter where it comes from. The latter holds that the country providing the opportunity to generate income or profits should have the right to levy tax.
Both of these models are well understood when they relate to physical goods and services. But in the realm of digital services, as seen Peters’ case, it is more complex. Digital services often result in consumers in one country receiving a product or service without the supplier of that product or service being physically present in the country.
Already, the question of how the increasingly digital economy will be taxed is under discussion by revenue authorities, multinational entities and advisory bodies alike around the world.
The debate is even getting louder in Nigeria, where the Federal Inland Revenue Service (FIRS) is working with the National Assembly to amend the tax laws to ensure that revenue from technological companies are captured.
The FIRS Executive Chairman, Babatunde Fowler, disclosed that the agency will soon begin collection of VAT on online transactions. Speaking at a FIRS stakeholders retreat in Lagos, with theme: Parliamentary Support for Effective Taxation of the Digital Economy, he said the digitization of the economy is considered to be a major stimulant to growth, development and innovation.
He said that online and cross-border transactions requiring little or no physical presence have transformed world trade. The digitalization of the economy has also created a big challenge for taxation as most local laws are not robust enough to address the complexities created by the digital economy.
Fowler said there are plans for banks to act as collecting agents for VAT on online transactions for purchase of goods and services done by multinational tech giants without physical presence in the country. The agency is also working with the National Assembly to get the tax laws amended to that effect.
The FIRS boss said a number of countries have made new regulations addig that Bill on the amendment of of the tax laws will be brought the Senate to enable the country move fast in tapping tax revenue opportunities in the digital economy.
He said the country needed to start from the basics adding that banks should help the government is harnessing tax revenue from the digital economy. “I support the idea of using the banks to extract tax revenue from the digital economy. Let’s review the activities of banks as it relates to the digital economy and check areas that require legislation. The banks need to be engaged to help government collect the taxes from the digital economy,” the said.
He said that FIRS generated N5.3 trillion in 2018, which is 1.4 trillion deficit against the N6.7 trillion it targeted for the year. But despite the shortfall, the 2018 figure showed an increase of N1.3 trillion or 32 per cent over the N4.03 trillion generated in 2017. Data presented by the agency at its 2019 stakeholders retreat in Lagos, showed the generated revenue comprises of N2.5 trillion from oil tax revenue and N2.8 trillion from non-oil tax revenue.
He said: “In the 2019 budget, the target for FIRS is within the region of N8 trillion and with other arms of government support, we believe we can achieve it”.
But achieving this target will also require tapping the huge tax potential in the digital economy, which is fast becoming the most innovative and widest reaching economy in the world.
The Nigeria Investment Promotion Commission said that the Nigerian digital economy is expected to generate $88 billion and create three million new jobs by the end of 2021 but a large part of the transactions there are un-taxed.
Associate Director, Andersen Tax, Ogochukwu Isiadinso, explained that since non-resident companies are taxed in Nigeria based on profits derived from Nigeria, the question as to whether a foreign company is liable to income tax in Nigeria is usually controversial.
Section 13 of Companies Income Tax Act (CITA) implies that a non-resident company must have physically performed activities in Nigeria, directly or indirectly, before such a company can be liable to income tax in Nigeria. For instance, where a software company provides online data to users in Nigeria without being physically present in Nigeria in any form, it may be difficult to conclude that such a company is liable to CIT in Nigeria, although the company could have derived income from the country.
“A major challenge is therefore determining at what point such non-resident would be deemed to have carried on business in Nigeria and therefore liable to income tax in Nigeria. Also, customers that complete transactions on online platforms may not be aware of the exact location of the digital goods and services they are consuming. In some instances, the jurisdiction may be in dispute as the location of the seller can be different from the location of the goods being sold,” she said.
“To ensure digital companies do not escape tax in Nigeria, the FIRS has often required Nigerian companies to withhold tax on all payments made to non-resident persons regardless of the non-establishment of the tax presence specified under Section 13 of CITA. This requirement has encountered resistance from taxpayers given that such non-resident persons may not be liable to tax under Nigerian laws,” she stated.
The Organisation for economic Cooperation and Development (OECD) and G-20 countries have agreed to address Base Erosion and Profit Shifting (BEPS).
The OECD believes that the digital economy is increasingly becoming the economy itself, it would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy for tax purpose”.
For Partner & Head Consumer and Industrial Markets KPMG Nigeria, Tayo Ogungbenro, the digital economy is the combination of several general purpose technologies and the range of economic and social activities carried out by people over the internet and related technologies.
“The digital economy encompasses physical infrastructure like broadband lines, routers, computers, smartphones, – the applications they power (Google, Salesforce), the functionality they provide ( data analytics, cloud computing) among others. It is expected generate up to $88 billion and three million jobs by 2021.
Continuing, he disclosed that the digital economy is expanding due to rising youth population and internet penetration, the growing popularity of social media advertising, e-commerce platforms, ride-hailing services and cryptocurrencies.
For instance, the National Bureau of Statistics Gross Domestic Product (GDP) report shows that the Information, Communication and Technology (ICT) sector remains the main driver for the growth in the non-oil sector.
“The digital economy is growing globally and becoming increasingly complex. Traditional tax laws cannot adequately tax it. There is also no global consensus on how to tax it fairly and effectively. Developed and developing countries have adopted (are adopting) interim measures for taxing the digital economy, pending when a global best practice would be agreed. Nigeria can, therefore, leverage relevant tax initiatives to get its fair share of tax from the digital economy,” Ogungbenro advised.
On proposed measures in taxing digital economy using direct taxes, he said there is need to modify the definition of permanent establishment to address circumstances in which artificial arrangements relating to the sales of goods or services of one company in a multinational group effectively results in the conclusion of contracts.
He said: “ There is need to address treaty shopping arrangements through which companies are set up in a country in order to take advantage of the treaty network of that country rather than for carrying on business activities in that country; address unintended cases of non-taxation that result from tax treaties, in particular where countries eliminate double taxation through the exemption method; prevent the use of structures involving the use of dual resident companies that claim to be resident of a particular treaty country to achieve double non- taxation”.
Ogungbenro also called for setting a fixed ratio that limits an entity’s deduction for interest to a specified percentage (between 10 and 30 per cent) of its Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA).
Gaps in Nigeria’s tax laws
Ogungbenro called for the introduction of an anti-fragmentation rule to ensure that it is not possible to benefit from exceptions in permanent establishment definitions through the fragmentation of business activities among closely related enterprises.
On VAT, he said that the main gap remains that VAT Act states that ‘the tax shall be charged and payable on the supply of all goods and services’. “VAT Act then defined goods and services as supply of goods- means any transaction where the whole property in the goods is transferred while supply of services means any service provided for a consideration”.
He explained that the gap is that most digital items are neither goods nor services for instance, software will not attract VAT. The case between CNOOC E&P Nigeria Ltd v SAPetro Limited & Ors, the Judge ruled that “ if in this country we need to charge VAT on incorporeal property, we need to borrow a leaf from the UK VAT Act, 1994 which defines supply of services as either anything that is not otherwise defined; or anything other than supply of goods.
“Worse still, VAT Act states that “imported service” means service rendered in Nigeria by a non-resident person to a person inside Nigeria. But production points of digital items are stateless – difficult to put in a particular jurisdiction?,” he argued.
Transfer pricing
Again, since 60 per cent of global trade takes place within multinationals, transfer pricing is another area that will be affected by evolving tax rules relating to digital services. Transfer pricing involves the prices charged, or profits earned, by members of large multinationals for goods and services exchanged between the entities that make up the company.
For example, an automotive company based in Europe might manufacture components in various countries, and distribute its vehicles through local subsidiaries globally. These companies might drive sales through their own marketing initiatives or by developing sales channels. Transfer pricing principles govern how all transactions between these companies in the group are accounted for, and how profit is distributed, depending on the value created by each entity.
Senator Yahaya Abdullahi, representing Kebi North Senatorial District, said the issue of taxing the digital economy should be taken seriously by all the stakeholders including the banks and government. He huge tax revenue the sector is capable of generating is an indication that it should be given a priority. He called for the review of the tax laws to ensure all agencies that will help us in harnessing the huge tax revenue in the sector are given the needed support. Doing this, he added, will help a lot in providing infrastructure and development projects that the available tax revenue cannot meet.
“The Senate will look into the tax laws. We need to amend the existing tax laws or get new ones to help boost tax revenue for the country. That responsibility is not juts for the legislators, we need to be guided. We need to change our tax law to accommodate the digital economy,” he said at the FIRS stakeholders retreat in Lagos.
Director, OECD Centre for Tax Policy and Administration, Pascal Saint-Amans, explained that the digital economy is a transformative process, brought about by advances in information and communications technology (ICT) which has made technology cheaper and more powerful, changing business processes and bolstering innovation across all sectors of the economy, including traditional industries.
For him, sectors as diverse as retail, media, manufacturing and agriculture are being impacted in some way by the rapid spread of digitalization. In the broadcasting and media industry, for instance, the expanding role of data through user-generated content and social networking have enabled internet advertising to surpass television as the largest advertising medium.
“In other words, “digitalisation” is pervasive, making it very difficult, if not impossible, to ring-fence the digital world from the rest of the economy, including for tax purposes. This is the first finding regarding the tax challenges of the digital economy agreed by all G20 and OECD countries, under the Base Erosion and Profit Shifting (BEPS) Project. BEPS refers to tax strategies that allow Multinational Enterprises to shift profits away from the locations where the actual economic activity and value creation takes place, into low or no-tax locations,” he said.
While finding that the digital economy cannot be separated out from the rest of the economy, it was equally clear that some specific features of the digital economy may exacerbate the risks of base erosion and profit shifting for tax purposes–namely mobility (such as intangibles, business functions), reliance on data (and other forms of user input), network effects, and the spread of multi-sided business models.
There are now new businesses across all sectors having the capacity to design and build their operating models around technological capabilities, with a view to improve flexibility and efficiency and extend their reach into global markets. These advances, coupled with liberalisation of trade policy and reduction in transportation costs, have significantly expanded the ability of certain business models of the digital economy among others electronic commerce, online advertising and cloud computing–to take advantage of BEPS opportunities.
Global efforts on digital tax payment
Many global economies want to get their own share of taxes from the digital economy. India introduced ‘Equalization Levy’ in 2016 to tax international companies (such as Facebook, Google, among others) which earn advertising revenue from India. About $80 million Equalization Levy was generated from Google, Facebook and Twitter between 2017 and 2018. India amended its existing permanent establishment rules through its Finance Act 2018, which took effect from 1 April 2018.
The new rules apply permanent establishment thresholds to determine whether a non-resident company has a “Significant Economic Presence” in India for income tax purposes India has established frameworks through which it effectively taxes the supply of goods and services in cross-border transactions. For example, it applies destination principle in taxing cross-border services consumed in India.Indian courts have delivered several well-reasoned landmark judgments on the taxation of tech giants.
In 2016, the European Commission ruled that Apple had received unfair tax incentives from the Irish government and was directed to remit about 14 billion Euros in back duty taxes to the Irish government.
Director at Graphene Economics, an African transfer pricing advisory firm, Michael Hewson, said the outcomes of the OECD plan will potentially affect all multinationals operating in the digital economy. It is, therefore, imperative that relevant stakeholders contribute to the discussion. This includes taxpayers and tax authorities.
For example, the value of digital services provided into African countries is generally greater than the value of digital services provided out of African countries. Accordingly, there may be a tendency for countries in Africa to seek to use this G20/OECD project to implement protectionist measures.
He said countries in Africa that are seeking to increase their services economies and encourage local companies to provide services to recipients in other countries should consider how potential proposals may affect these companies.
“Businesses should identify how their digital strategy will be affected by different countries’ regulations (regarding VAT, income tax and transfer pricing) and track and plan for the developments in the territories in which they operate.
More stakeholders speak
PricewaterhouseCoopers (PwC) West Africa Tax Leader, Taiwo Oyedele, said Nigeria needed to go far and fast given the challenges that currently confront the country.
Speaking yesterday at the forum organised by Financial Derivatives Company Limited in Lagos, on the theme: Policy Change: Enabler of Sustainable Growth, he said Nigeria should wake up from her slumber and speedup economic growth that will translate to more revenue for the country.
Oladele disclosed that global companies are always thinking of where to invest that will benefit them while keeping in mind the BEPS rule. He said Nigeria loses companies interested in investing in the country because of unfavorable government polices, including tough regulation which affect level of tax revenue for the country.
He said that many companies do not want to put their headquarters in Nigeria adding that a bank that operating a Holding Company structure in Nigeria will have to pay tax twice.
Also, company that registered with the Corporate Affairs Commission is likely to pay about 40 per cent tax rate, while the one that is not registered will pay around 19 per cent.
The tax leader said these are issues affect business and tax collection in the country and needed to be addressed for sustained economic growth.
Speaking on taxation and need to diversify the country’s revenue base, Executive Chairman, Foundation for Economic Research and Training, Prof Akpan Ekpo, said the Nigerian government’s revenue is dependent on the oil sector .
He said: “I call the oil revenue exogenous revenue because you have no control over the price and you are not even in control of the output. You cannot use that to finance long-term development. You should see it as a windfall and use it as such, as they did in Norway. We have not done that over the years. So we must diversify the economy into other areas so that we can earn foreign exchange from other sources outside the oil sector”.
“Another way of making money is to look at the tax structure. I am not saying we should increase tax rate, but we need to bring more people into the tax net. A lot of Nigerians who are wealthy or rich do not pay tax, you have to bring them into the tax net. Then you have to tax luxury goods heavily. For example, if you go to Abuja and Lagos airports, the number of private jets that you see, they should pay tax. People will not like to hear this, our VAT rate is the lowest in the world. If you tinker with VAT to even 6.5 per cent, that will generate a lot of revenue. So, those are the areas, because right now the government needs liquidity to do a lot of things,” he said.
According to Ekpo, who was immediate past Director-General, West African Institute for Financial and Economic Management (WAIFEM), it is good to tax people.
”But, let me say that it is good to tax because like I said, Nigeria’s tax to Gross Domestic Product (GDP) ratio is one of the lowest. But there is a limit to taxation, you have to have service delivery. I pay tax because I get service. If people are not happy about the service delivery they will not pay tax, except those who are working and they do not have a choice. Again you can generate more tax by looking at people who are employed, if employment increases, people will work and they will pay tax. When you have a high unemployment figure, it means that a lot of the youths are unemployed. That is a serious problem because you are losing tax from that. The next thing will be how will the government create employment? Nigerian cities are the least policed in the world, if you employ a lot of policemen in thousands, you are creating jobs. They will police the citizens, they will earn salaries and they will pay tax. So the government has to think of how to do it,” he said.
Way out by stakeholders
According to Ogungbenro, government can issue new regulation that will address place of supply, registration, collection of tax from non-residents to bridge gaps in respect of VAT collectible goods and services done in the digital economy.
“The measure can also include the application of destination principle in assessing the VAT ability of cross-border transactions. The FIRS should consider issuing regulation that will make beneficiaries account or pay VAT when making payment for electronically- supplied goods and services,” he said.
He said that Nigeria can study South Africa, which appointed banks to assist in this regard. “Today, South African banks will only remit payment for certain services if there is evidence of tax compliance such as management and technical service fees. There is need to engage more experienced and extremely knowledgeable hands possibly on contingency arrangement,” he added.
Such individuals, he said, should have deep knowledge of the operations of digital economy in the context of current fiscal policies and tax laws. They should also leverage on initiatives from foreign countries and adapt to local environment, provide assistance to develop policies and suggest amendments to tax laws/regulations to reflect new business models/ digital economy.
Also, the National Assembly will soon pass a bill that will harmonise the various tax and excise law reforms. The proposed tax law will take into consideration new tax areas, including taxing the digital economy.
Fowler gave this hint in Abuja at the inauguration ceremony of the reconstituted National Tax Policy Implementation Committee (NTPIC).
Despite the challenges in tax collection from the digital economy, the Federal Government has vowed to tackle the challenge of tax evasion, as its recent findings on remittances and illicit financial flows indicate a pattern of systematic evasion by multinational and local operators.
Changing the Nigerian economic psyche remains a tough task since tax mobilisation, by its nature, tends to erode the popularity of any government that pursues it. The FIRS statistics showed that Nigeria has just 20 million active tax payers from an economically active base of 70 million.
For Fowler, “Nobody wants to pay taxes, including tax administrators. But as new laws and technology continue to make tax payment convenient and transparent, payment monitoring will become more efficient and compliance will rise”.
Still, there is need for government to fulfill its tax obligations as such would motivate the people to pay their taxes correctly and promptly for the good of the society.