Thread by @AndersenTax_NG

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Topic: Significant Economic Presence – Impact on Companies in the Consumer Market and Financial Services Sectors

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#consumermarkets #FinancialServices

1.Prior to the enactment of the Finance Act, 2019 (FA), Section 13 of the Companies Income Tax Act (CITA) as amended, provided the basis for the taxation of the profits of non-resident companies (NRC) in Nigeria.

2.The provisions of the section required a non-resident company to have an identifiable physical presence (“fixed base” or “permanent establishment”) in Nigeria, before the NRC can be deemed to be carrying on a business in Nigeria, for the purpose of taxing its profits.

3.Based on the provisions, the profits of a foreign company were only liable to CIT where the company,

4.has a fixed base in Nigeria, is involved in a turnkey project, has a business or trade carried on by a dependent agent on its behalf, or where the transactions between the foreign company and a related party are deemed to be artificial or fictitious.

5.In addition, the courts ruled that a fixed base may also be created by the presence of an employee of the NRC or an equipment of the NRC located in an office in Nigeria.

6.Consequently, the emphasis on physical presence, as a trigger for creating a taxable presence created a situation where the profits of some NRCs whose operations did not require any form of physical presence could not be taxed in Nigeria.

7.The Finance Act however introduced the concept of Significant Economic Presence (SEP) which ensures that even companies with no physical presence in Nigeria can be taxed based on the volume of their economic activities.

8.The SEP primarily creates a taxable presence for NRCs based on their digital/technological footprints in Nigeria.

9.The Minister of Finance is empowered to define what will constitute SEP in Nigeria and in this light, the Companies Income Tax (Significant Economic Presence) Order, 2020 (“the Order”) was passed.

10.This article focuses on the impact of the Order on transactions of foreign companies with Nigerian companies in the consumer markets and financial services sectors in Nigeria.

11.Provisions of the SEP Order The Order states that;

12.a). An NRC who provides digital or related services via satellite will be deemed to have SEP in Nigeria in any accounting year where it –

13.i. derives income of more than ₦25million from – streaming or downloading services, transmission of data, digital provision of goods and services, or provision of intermediation services.

14. (For the purpose of determining if a company meets the threshold, activities of connected parties will be aggregated);

15.ii. uses a Nigerian domain name i.e. (.ng); or

16.iii. customizes its website to target persons in Nigeria (including but not limited to displaying prices in Naira).

17.b). Foreign companies with trade or business relating to technical, professional or consultancy services will be liable to CIT in Nigeria,

18. if such company has SEP in Nigeria. The Order further defines Technical Services as any service of a specialized nature; including advertising services, training or the provision of personnel.

19.c). A foreign company under Section 13(2)(e) of the CITA will be deemed to have SEP in Nigeria in an accounting year if it earns any income or receives payment from a person resident in Nigeria, a fixed base or an agent of a foreign company.

20.However, an NRC will not be considered to have SEP, where it makes payment to its employee under a contract of employment, or for teaching in an educational institution. SEP will also not be applicable where payments are made by foreign fixed base of a Nigerian company.

21.Implication of the Order - Manufacturing sector : In Nigeria, most manufacturing companies rely heavily on foreign technical support to maintain their manufacturing processes.

22. These manufacturers contract the services of foreign companies for the transfer of technology, in order to optimize their manufacturing process.

23.Such transfers are usually performed physically or even remotely using advanced technologies. Also common in this sector, is the need for consulting, management and professional services from non-resident related parties.

24.Based on the Order, NRCs and foreign related parties that provide consulting, management, technical or professional services will have a significant economic presence in Nigeria,

25. if they earn any income or receive any payment from a person resident in Nigeria, or from a fixed base or agent of a non-Nigerian company.

26.Also, it is not uncommon for companies operating in this sector to have arrangements with various foreign software licensors/developers who provide them with various software licences such as accounting packages, payroll processing software etc.

27.These software packages are installed to enable the companies perform their day-to-day operations. In line with the Order, such NRCs will have SEP in Nigeria and will now be liable to income tax

28.Trading /e-commerce : The e-commerce platform is more of a “marketplace” where both international and local vendors display their products.

29.In the marketplace, every stage of the buy/ sell process i.e. from placing of orders to payment for the order is enabled and concluded through digital channels.

30.Therefore, foreign companies using this platform to render services to their Nigerian customers, will now be liable to the relevant Nigerian taxes by virtue of their digital footprints in Nigeria.

31.Similarly, NRCs who specialize in the design, implementation and management of various e-commerce platforms that enable Nigerian businesses display, sell,

32.pay and deliver all forms of goods will also have SEP risk in Nigeria by virtue of the digital platforms deployed in enabling such transactions.

33.The Financial Services Sector : The financial services sector by virtue of the services it performs, substantially relies on technology in providing various banking and related services to customers.

34.Undoubtedly, the leverage on digital technology by the financial sector has been a major catalyst for growth of companies who provide financial technology such as payment solutions and financial intermediation.

35.Most of the technology adopted by the banks and other financial institutions such as investment banks, insurance companies, pension fund custodians, financial technology companies etc.

36.is provided by foreign software vendors, who develop the software that enables them provide such financial services to their customers, without necessarily having any form of physical presence in Nigeria.

37.In practice, the agreements for the provision of software services also include services such as the maintenance of software, renewal of software licenses, installation of software and trainings on the use of the software.

38.Most of these services are usually performed by the software developer in partnership with other foreign and local based partners who assist in the distribution of the software in Nigeria.

39.In most cases, these services are performed remotely, without the foreign company creating any physical presence in Nigeria.

40.Therefore, based on the strict interpretation of the Order, the various software and related services will fall under the definition of SEP

41.and as such, create a taxable presence for the foreign companies providing such services, including the overseas agents/ partners who assist to distribute or deliver such services in Nigeria.

42.Adoption of SEP in Other Jurisdictions : Interestingly, the SEP concept is not alien in modern taxation, as many countries have introduced the SEP concept to tax the profits of foreign companies operating in their country.

43. For instance, India, UK, Italy, and Israel have introduced different forms of digital services tax (DST) to capture activities in the digital economy, based on the SEP.

44.In India, a 6% “equalization levy” applies on all outbound payments to NRCs for digital advertising services. In Italy, digital service tax is applicable to individuals/groups whose worldwide revenue is equal to,

45.or greater than 750million Euros (in prior fiscal year) and where their revenue from qualified digital services arising in Italy or to an Italian user is equal to or exceeds 5.5million Euros.

46. The DST is payable by the Italian resident company and the NRC that provides qualified digital services. Some of the qualifying digital services include; placing advertisements on digital platforms, intermediation services and data transmission services.

47.Most of the countries (including Nigeria) who have adopted the SEP in taxing NRCs’ profits are part of global effort being coordinated by the Organization for Economic Cooperation and Development (OECD) and the G20 in addressing the challenges of the digital economy.

48.Matters Arising : There are practical challenges around the administration and implementation of the SEP in Nigeria and unfortunately, the Order does not address these challenges. Some of them include:

49.a). The method of assessment to be adopted in assessing the NRC to tax under the SEP. Will the self-assessment regime apply as provided under Section 55 of CITA or will a deemed profit basis be adopted?

50. How practical is it for the NRCs to register for tax and file their returns in Nigeria, given that they are not resident in Nigeria? It is a common practice by the FIRS to rely on the deemed profit basis in assessing NRCs to tax,

51.especially where it is difficult to determine the actual level of profits. More clarity is required on the methodology to be adopted to encourage early compliance.

52.b). There appears to be inconsistency in the definition of “connected persons”. The Order, defines connected persons as “persons controlled by or under common control”.

53. Meanwhile, the Finance Act, introduced a broader definition which is “any person controlled by or under common control, ownership or management”

54.or “any person who is not connected but receives an implicit or explicit guarantee or deposit for the provision of corresponding or matching debt, or “any related party as described under the Nigerian Transfer Pricing Regulations, 2018.

55. This inconsistency in definition needs to be resolved, and a common definition adopted, in order to prevent future tax controversy and disputes.

56.c). The Order does not mention how the SEP will apply to NRCs resident in countries that have Double Tax Agreements (DTA) with Nigeria.

57.Although, the Order makes reference to multilateral or consensus agreements in resolving the associated challenges in taxing the digital economy, the existing DTAs between Nigeria and other countries do not address challenges with taxing the digital economy.

58.However, it is worthy of note that Section 45(1) of CITA provides that the provisions of the DTAs will supersede the CITA.

59.d). While the Order specifies a commencement date of 3 February 2020, it does not mention how the transactions on agreements signed prior to the commencement date will be treated, especially for transactions that would require deduction of Withholding Tax (WHT).

60. In this case, will the SEP affect such transactions, even though the agreements that gave rise to them were signed prior to the commencement date?

61.In addition, more clarity is required on the tax treatment of transactions that were concluded between the commencement date and the date the Order was made public.

62.Will the Nigerian entity be required to self-account for the applicable WHT due on these transactions?

63.e). While the Order clarifies that foreign companies who provide technical, professional or consulting services to Nigerian companies will be liable to SEP in Nigeria, based on Section 13(2e) of the CITA,

64.it does not clarify the seeming ambiguity created by Section 13(2e) on whether WHT will be the final tax on the payments for such services.

65.Specifically, Section 13(2e) provides that “if the trade or business comprises the furnishing of technical, management, consultancy or professional services outside of Nigeria to a person resident in Nigeria

66. to the extent that the company has significant economic presence in Nigeria: provided that the withholding tax applicable to income under this

67.paragraph shall be the final tax on the income of a non-resident recipient who does not otherwise fall within the scope of Sub-Section (2)(a) – (e).

68.The above suggests that WHT will not be the final tax of NRCs providing technical, consulting or professional services since these services fall within the scope of Sub Section (2)(a) – (e). It appears this is not intention of the FA and more clarity is required.

69.These issues will require more clarity and codification into the existing laws so as to provide more direction and encourage compliance.

70.Recommendation/Conclusion : In light of the above, it is imperative for companies operating in all sectors of the economy to review their various agreements with foreign digital, software and related services providers.

71.The review should consider the applicability of income taxes on profits derived from Nigeria, and advise the NRCs to register with the relevant tax authority for the purpose of complying with Nigerian taxes.

72.Also, NRCs providing technical, professional, management or consultancy service, including advertising and training services should also be informed of the SEP rule which will now make them liable to income taxes in Nigeria.

73.Where applicable, signed agreements that are yet to be implemented should be reviewed to fully convey the tax obligations of the foreign vendors,

74. in light of the Order. Where Nigerian companies do not proactively communicate these developments to the NRCs and amend the relevant agreements with their foreign vendors,

75.they may be required to account for the applicable taxes on their transactions with the NRCs, in the event of a tax audit by the tax authority.

76.The SEP, in no small measure, will contribute to the government’s drive of increasing tax revenue by expanding its tax net to cover the activities of companies operating in the digital economy.

77. Therefore, it is recommended that companies review all existing and future transactions and agreements with non-resident vendors to include the potential tax obligations based on the SEP and probably identify ways of mitigating any potential tax exposure therein.

78.Thank you everyone who joined in on our #twitter conversation. We hope to see you all next Thursday