Tag: Tax

Taxes are the enforced proportional contributions from persons and property, levied by the state by virtue of its sovereignty for the support of government and for all public need. From the above definition it is seen that taxes are contributions to a common pool by the people for the use of the people. Government all over the world need taxes in order to sustain its relevance and to provide for the needs of its citizenry.

A tax system is expected to be fair and non-discriminatory. For a tax system to meet these requirements, it must have the following attributes.

1. Neutral – A Neutral tax must be unbiased across economic activities, and not overly penalize work in favour of leisure, nor tax income used for saving and investment more heavily than income used for consumption.
2. Visibility – A very large segment of the population must be keenly aware that government costs money, government spending should be held to levels at which its benefits match its costs. This is a critical factor in most developing countries (including Nigeria) where the citizenry believe that tax revenues are not being expeditiously administered.
3. Fairness – This is often stated as making the rich pay higher share of their income in taxes than the poor. There should be some amount of income exempt from tax to shelter the poorest citizens.
4. Simplicity – A tax system should be easy for the government to administer and enforce, and be easy and inexpensive for taxpayers to comply with. There should be clear definition of income and elimination of multiple layers of tax would create a system that is much simpler and easier to administer, enforce and comply with. These are critical issues in Nigeria tax systems that require urgent attention. Our tax laws are old and complex, given room for varied interpretations and applications.
5. Convenience – A good tax system should be convenient in terms of time and mode of payment to the taxpayer.
6. Administrative Efficiency – The process of levying and collecting taxes must be administratively efficient, transparent and economical without any distortion.
7. Productive – A tax system should be such that brings in sufficient revenue to the Government. Since tax payment involves the outflow of money or money’s worth from the treasury of taxpayers, some Taxpayers have adopted many strategies to evade tax, tax evasion is defined as “the wilful attempt to defeat or circumvent the tax law in order to legally reduce one’s tax liability”. Tax evasion is punishable by both civil and criminal penalties.

Tax avoidance on the order hand, is defined as “the act of taking advantage of legally available tax-planning opportunities in order to minimize one’s tax liability. While tax evasion is criminal tax avoidance is legal. This was aptly supported by the celebrated case of Ayrshir Pullman Motor Services & D.U. Ritche V.CIR (1929). The fact of the case and the judgement is as follows:-

The taxpayer changed the structure of its business from sole proprietorship to partnership with 5 of his children to minimise tax. He appealed to the Court of Session against an assessment which failed to recognise the change. Allowing the appeal, Lord Clyde held:

No man in this country is under the smallest obligation, moral or other, to so arrange his legal relations to his business or property as to enable Revenue to put the largest possible shovel into his stores. The Inland Revenue is not slow…. and quite rightly to take every advantage which is open to it under the taxing statutes for the purpose of depleting the taxpayer’s pocket. And the taxpayer in like manner is entitled to be astute to prevent, so far as he honestly can, the depletion of his means by the Revenue.

TAX COMPLIANCE TOOLS

In order to encourage compliance taxpayers to continue to comply, and bring non compliance taxpayers into the tax net, to increase tax base and revenue, governments all over the world have put in place some compliance strategies backed by appropriate legislations.

Section 26(1) of the Federal Inland Revenue Service Establishment Act (FIRSEA) 26(1) gives the Service to call for returns, books, documents and information.

FIRSEA 27 – Gives additional power to the Service to call for further returns and payment of tax due.

FIRSEA 28 – Requires every bank upon demand by the Service to provide quarterly returns specifying:-

(a)     In the  cases of an individual, all transaction involving the sum of N5,000,000.00 and above

(b)     In the case of a body corporate, all transactions involving the sum of N10,000,000.00 and above, the names and address of all customers of the bank connected with the transactions and deliver the returns to the Service.

(c)     Section 28 (3) – Provides sanction to any bank that contravenes above provisions.

FIRSEA 29 – Gives power to access lands, buildings, books and documents

FIRSEA 32 – Gives power of addition for non-payment of tax and enforcement of payment.

FIRSEA 33 – Tax Investigation; this section empowers the Service to employ special purpose Tax officers to assist any relevant law enforcement agency in the investigation of any offence under this Act.

FIRSEA 47 – Gives the Service powers to prosecute any of the offences under this Act subject to the powers of the Attorney – General of the Federation.

THE ROLE OF TAX AUDIT

In addition to all the tax provisions mentioned above, FIRSEA S:26(4) and S.60(4) CITA went further to state:-

“Nothing in any other provision of this Act shall be constructed as precluding the Service from verifying by tax audit or investigation into any matter relating to any return or entry in any book, document, accounts including those stored, on a computer, in digital, magnetic, optical or electronic media as may, from time to time, be specified in any guideline by the Service”.

All the above provisions, among others, are compliance tools meant to ensure that a taxpayer does not pay less or more than what he is required to pay by law. This objective is achieved through tax audit exercises.

The purposes of tax audit are to:-

v To educate taxpayers

v Maintain self assessment system

v Collect taxes as imposed by the laws through the encouragement of voluntary compliance

v Maintain public confidence in the integrity of tax system.

v Provide deterrent effects on other taxpayers not yet audited, as they may quickly file their returns in order to avoid sanctions.

This article clarifies the FIRS’ position on what constitutes ‘trade’ or business for tax purposes. In accordance with the Companies Income Tax Act (CITA), and the Personal Income Tax Act (PITA), any trade is subject to tax under CITA and PITA, even if that trade is carried out by friendly societies, co-operative societies, charitable and ecclesiastical organizations, or trade unions.

CITA states that “any trade or business for whatever period of time such trade or business may have been carried on” shall be subject to Companies Income Tax (Sec 9(1)(a)). The profits of certain institutions are exempt from tax under CITA, but only in so far as such profits are not derived from ‘trade or business’ (Sec. 19(1) (a, b, c, e)). This means that the profits of any organization that are derived from ‘trade’ shall be subject to Companies Income Tax. This raises the question, what exactly constitutes ‘trade’?

A definition of the word ‘trade’ cannot be found in Nigerian tax legislation although an attempt was made in PITA. The interpretation Section of the Fifth Schedule of PITA defines “trade or business” to mean “trade or business or that part of a trade or business the profits of which are assessable under this Act”.

However, the issue has been addressed in several legal cases, the rulings of which provide some legal certainty regarding how the courts interpret the word (see Section 2). In line with these rulings, ‘trade’ can be regarded as “the business of buying and selling or bartering goods or services”. Furthermore, the one-off nature of an activity in no way invalidates that activity as constituting trade. This interpretation matches the approach in other jurisdictions, namely the UK and USA (see Section 3).

Case Law in Nigeria

Although no explicit definition of ‘trade’ exists in the law, the issue has been addressed in several legal cases, the rulings of which provide some legal certainty regarding how the courts interpret the word. The most important case is that of Arbico Ltd v. FBIR, {1996} 2 All NLR 303. The plaintiff in the dispute, Arbico, had acquired a plot of land, erected a building, and sold the property at a profit. The company was subsequently assessed for tax on the proceeds of the sale of property The Company objected to the assessment on the basis that the transaction was a one-off and therefore did not constitute ‘trade’. The case was ultimately settled in the Supreme Court. In the ruling the Court laid down two important axioms:

• Firstly, that the word ‘trade’ should be interpreted in its widest sense, in accordance with its common everyday meaning;
• Secondly, that an isolated one-off transaction can still constitute a “trade”.

In line with the ruling of the Supreme Court, the following definition seems to capture the common meaning of the word ‘trade’. Trade is “the business of buying and selling or barter in goods or services”(taken from Black’s Law Dictionary, Eighth Ed. (2004)).

Treatment in Other Tax Jurisdictions

In considering what constitutes ‘trade’ for tax purposes it is useful to consider how the issue is addressed in other jurisdictions.

In the UK, as in Nigeria, there is no statutory definition of the word ‘trade’. Her Majesty’s Revenue and Customs (HMRC) relies on case law to formulate a working definition. HMRC states that “Usually, trading involves the provision of goods or services to customers on a commercial basis”. As in Nigerian case law, “Simply because a venture is a one-off or occasional does not mean that it will not be treated as trading for tax purposes”. It is interesting to note that although the HMRC definition employs the notion of ‘commercial basis’, HMRC explicitly states that whether or not the profits of an activity are ultimately used for charitable purposes is not relevant for the determination of whether or not that activity constitutes a trade.

In the USA, the Internal Revenue Service (IRS) employs a similar approach to HMRC. IRS regards ‘trade’ as including “any activity carried on for the production of income from selling goods or performing services”. It is interesting to note how IRS treats the trading activities of an organisation that also carries out tax exempt activities. IRS states that “an activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities that may, or may not, be related to the exempt purposes of the organizations. In other words, a single organisation can undertake both exempt activities and trading activities. This implies that an organisation cannot argue that none of its activities constitute ‘trade’ just because it undertakes some exempt activities.

Badges of Trade

In 1955 in England, the Royal Commission on the Taxation of Profits and Income in reaction to whether a statutory definition of trade was necessary, said that “each case must be decided to its own circumstance (1955 Cmnd.9474 para.116) and suggested badges of trade” which they considered to be the major relevant considerations that will facilitate in determining whether any profit is a taxable trading profit or not. Badges of trade refer to certain indicators that may be used in determining the factual question as whether an activity is trade or not. Case law has expanded it to 9. The badges of trade are:

• Profit seeking motive. An intention to make a profit supports trading, but by itself is not conclusive.
• The number of transaction. Systematic and repeated transactions will support ‘trade’. An isolated transaction may also constitute a trade.
• Existence of similar trading transactions or interests. Transactions that are similar to those of an existing trade may themselves be trading.
• Changes to the asset. Was the asset repaired, modified or improved to make it more easily saleable or saleable at a greater profit?
• The way the sale was carried out. Was the asset sold in a way that was typical of trading organizations? Alternatively, did it have to be sold to raise cash for an emergency?
• The source of finance. Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset?
• Interval of time between purchase and sale. Assets that are the subject of trade will normally, but not always, be sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading. However, an asset, which is to be held indefinitely, is much less likely to be a subject of trade.
• Method of acquisition. An asset that is acquired by inheritance, or as gift, is less likely to be the subject of trade.

These ‘badges’ will not be present in every case and of those that are, some may point one way and some the other. The presence or absence of a particular badge is unlikely, by itself, to provide a conclusive answer to the question of whether or not there is a trade. The weight to be attached to each badge will depend on the precise circumstances.

 FIRS Position

A definition of the word ‘trade’ cannot be found in Nigerian tax law. However, the issue has been addressed in several legal cases, the rulings of which provide some legal certainty regarding how the courts interpret the word. In line with these rulings, ‘trade’ can be regarded as “the business of buying and selling or bartering goods or services”. Where one or more of the criteria on the badges of trade apply, FIRS will treat such transaction as trade. Furthermore, the one-off nature of an activity in no way invalidates that activity as constituting a trade. This interpretation matches the approach in other jurisdictions, namely the UK and USA. The following decided cases are relevant in this regard:

1. In the case of Marlin Vs Lowry (1955)3 All ER 48; 11 TC 297), a person without previous knowledge of linen trade bought a surplus stock of aeroplane linen from government which he sold to the public in small lots. He engaged employees for the re-packaging and embarked on sales” promotion through extensive adverts and campaigns. It was held that he was trading.
2. In Murray Vs I.R. Comrs (1951, 32 TC 238), where a timber merchant who bought standing timbers in two plantations and could not cut them due to labour cost, sold the rights to cut the timbers to meet his indebtedness. He was assessed to tax on the profit from the transaction. He contended that the sale was a capital transaction since it was not in the normal course of his business but it was held that the transaction was part of his normal trading as a timber merchant.

iii. In Burge Vs Pyne (1969, All ER 467), a club proprietor providing facilities for bar, dancing, cabaret, fruit machines and gambling, appealed against the inclusion of his winnings in his assessment. The appeal was dismissed on the ground that the winnings formed part of his regular income from the trade of running the club.

From the foregoing and in accordance with the provisions of CITA, any friendly society, cooperative societies, charitable and ecclesiastical organizations or trade unions that carry out trade as defined and described above would be liable to tax on income derived from such trade.