Thread by @SirJarus

Understanding Taxation

(Sunday Knowledge Share by Jarus)

A basic knowledge of taxation by everyone is key to the attainment of issues-based political participation and knowledge-driven society. I am converting to thread this article I wrote 9 years ago to explain taxation

What's a tax?

Tax has been defined as a compulsory levy imposed by government on individuals and businesses to generate funds to finance its activities, among other objectives.

Why tax?

The need for taxation is pretty obvious – not all goods or services can be provided by private persons (natural and corporate). If you use your money to provide road for instance, you cannot stop me from using it. So there is no incentive for you to provide roads.

Therefore, the constituted authority is in better position to provide the road, which will be available to all of us.

But you and I need to contribute to fund the road construction. Hence, imposition of compulsory tax by the government.

You can own your TV, your car, your house and prevent third party from using them, but not your road. There is no incentive for you to provide your road because you can’t solely enjoy the benefit, even if you solely bear the cost.

This kind of good is called public good – good that cannot be consumed to the preclusion of others and which logic calls for provision by government.

You can also think of services which are too critical to be left in the hands of private entities.

Classic examples are defence and law. Defence of a country’s territory or making of law cannot be privately sourced. They have to be fully and solely controlled by government. All of us benefit from a secured and orderly country, but individual benefit cannot be quantified.

Hence the need for all of us to contribute to the funding of these services, which is achieved through taxation. These are the traditional reasons why taxation is necessary.

A Journey Through History

Taxation is actually not a modern phenomenon. It is as old as organized society itself. In Islamic tradition, there is what is called zakat, which is a form of taxation. It is 2.5% of annual taxable wealth.

In Christianity there is tithe at 10%. Traditional African societies have various forms of taxation. There is esusu in Igboland, there are owo ori and isakole in Yorubaland and other forms of traditional tax system. It should be noted that the famous Aba women riot of 1929

was triggered by the inclusion of women in tax net by the colonial government, as against existing traditional practice. So taxation has evolved over time.

We All Hate Tax

Naturally, man doesn’t want to pay tax. That is why enforcing compliance is not an easy task. Yet in advanced societies, the fact that there is no way you can play around it, makes voluntary compliance very high.

But in our own societies, two factors ..

make the compliance situation more severe. One, many folks know they can get away with it. Two, experience with successive thieving governments has disillusioned the citizenry and they see their taxes as going to end up in private coffers, hence disincentivization of compliance.

Types of Taxes

Taxes can be classified into different categories, depending on the criteria. If we want to talk of shiftability of burden, we shall be having direct and indirect taxes. If we're looking at tax base, we shall be having income tax, consumption tax and capital tax

When we look at tax system, we shall have progressive, proportional and regressive tax system.

Direct vs Indirect Taxes

Direct taxes are taxes whose burden can hardly be passed on, while indirect taxes are those whose burden can easily be transferred.

Income taxes are examples of direct taxes, because you can hardly pass on the burden. The PAYE deducted from your monthly pay is an income tax – personal income tax. You can’t pass on the burden.

The companies income tax companies pay is also a direct tax,

although, strictly speaking, it can be passed on. It is only a matter of working back your model and building the tax into your selling price – raising the price and passing on, or at least sharing, the burden to the purchasers of your product, especially if your product has

low elasticity (i.e people can hardly run away from it).

Value Added Tax is an indirect tax in that you can only pass on the tax suffered to the next node in the chain of supply

until it gets to final consumer who, not purchasing for resale or value adding, will not have anyone else to transfer the burden to, and ultimately bears the burden.

Tax base refers to the object being taxed. Is it the income or capital or consumption?

You are liable to income tax if you earn income, except if exempted.

When you consume, you are liable to consumption tax, notably VAT, except if the good or service is exempt. When you sell an asset, which is not what you normally do

(i.e you are ordinarily not in business to sell that kind of asset), and you make a net gain (after removal of purchase price, improvement costs and costs incidental to sale of that asset), you are liable to Capital Gains Tax - except what you sold is exempted.

Progressive tax system relatively takes more from high income earner and less from low income earner. The reverse is regressive system. Where there is a constant rate, it is proportional. Nigeria’s PAYE system is progressive. The rates range from 7-24%, depending on income band

The bulk of the revenue of the government of Nigeria comes from direct taxes. Direct taxes, like I explained earlier are taxes on income.

Income taxes can broadly be divided into personal taxes and corporation (corporate ) taxes.

In Nigeria, the corporation taxes can be divided into two: Companies Income Tax and Petroleum Profits Tax. There is also the Education Tax, which is equally based on income. Let’s briefly discuss each of these income taxes.

PERSONAL INCOME TAX (PIT)

These are taxes on incomes of individuals, sole proprietorships, partnerships and other unincorporated businesses (e.g ABC & Sons Ventures, XYZ Enterprises etc.). It is governed by the Personal Income Tax Act (PITA),

with all the amendments, the latest being the amendment through Finance Act 2022 signed by the President fee weeks ago. Included in the tax net under this Act are those in employment as well as those doing personal businesses inasmuch as the business is not incorporated.

For those in employment, their employers are obligated to deduct the tax at source every month and remit same to the government. This arrangement is called Pay As You Earn (PAYE).

For businesses, they are to file their PIT returns at the end of each year,

deducting their advance tax payments in the form of withholding taxes paid on their transactions during the year, and paying the net tax due to government.

PIT is payable to the state government of the residence of individual or site of that business.

It is immaterial which state is the individual’s place of work located. Place of residence is the determinant. This means that a person working in Zenith Bank Head Office in Victoria Island, Lagos, but lives in Alagomeji in Ogun state, will have his PAYE remitted to Ogun state.

This may defy simple logic that he spends most of his time in Lagos, uses Lagos roads more etc. The law, anyway, is an ass.

Penkelemesi Ventures in Ibadan, as another example, will pay its taxes to Oyo state government.

For men in armed forces and diplomats in foreign mission, the tax goes to the purse of Federal Government irrespective of their location.

CALCULATING PIT

The tax rate for PIT progresses with income. First N300,000 of annual taxable pay is taxed at 7%, next is taxed at 11%,

next N500,000 taxed at 15%, next at 19%, next N1.6m taxed at 21% and income in excess of N3.2m is taxed at 24%. Taxable pay is arrived at after giving some reliefs and allowances like employee’s contribution to pension and National Housing Fund, life assurance premium, and

consolidated relief allowance (20% of gross income plus whichever is higher of N200,000 and 1% of gross income). After these deductions, the rest (taxable pay) is taxed at the rate above. The total tax payable at the end of the computation should not be

less than 1% of gross income, else the former is discarded for the latter, which is called minimum tax. The computation is the same whether it is for individuals or unincorporated businesses, only that a business, if it has been paying taxes in the form of WHT before,

will have it deducted from its total tax payable. This is why WHT is generally regarded as advance payment of income tax.

COMPANIES INCOME TAX (CIT)

This is payable by all companies registered in Nigeria under the Companies and Allied Matters Act (CAMA).

This means that any company that is Limited Liability Company (LTD) or Public Limited Liability Company (Plc) is subject to tax under Companies Income Tax Act (CITA). The only exception used to be companies that engage in petroleum operations, that is,

companies operating in the upstream sub-sector of Nigeria’s oil and gas sector - on their crude oil sales. However, this exemption has been removed by the Petroleum Industry Act (PIA) signed last year.

Companies with annual turnover of less than N25m are however exempted.

The tax rate is 30% of assessable profits, or in the case of companies whose turnover is between N25m-N100m, 20%.

Assessable profits being referred to here is different from the accounting profit reflected in a company’ financial statements.

A number of adjustments go into the computation of taxable profit, which is beyond the scope of this thread. It should also be noted that there are some incentives such as pioneer legislation which, if granted on application, exempts some companies

from payment of CIT for the first three years of operation, which is extensible by one or two years.

Foreign companies that want to operate in Nigeria are required to register under CAMA, which makes them liable to Nigerian CIT.

This means MTN, Citibank, SCB, Nestle, Julius Berger, etc. which are not Nigerian businesses, are fully subject to income tax in Nigeria.

However, for a foreign company that is not present in Nigeria, but comes to Nigeria for a transaction (called non-resident companies),

tax is applicable by way of WHT on the income it earns in Nigeria, subject to double taxation treaty, if any, with its home country.

Nigeria has double taxation agreement with some countries, including the UK. US is not there. US in its exceptionalism hardly signs such treaties

PETROLEUM PROFITS TAX

This applies to oil producing companies on profits from their crude oil production.

It applies at a rates of 50% (deep offshore), 65.75% (onshore and shallow waters in first 5 years of production) and 85% (onshore etc after first 5 years of cproduction)

However PPT has been replaced by Hydrocarbon tax (HCT) by the PIA passed last year. HCT is applicable at between 15-30%.

Remember I said earlier that crude oil profits are also now subject to CIT by the PIA. This is in addition to HCT.

EDUCATION TAX (EDT)

Education tax is a product of the agitation for better funding of education in Nigeria by some activist groups, notably Attahiru Jega-led ASUU, in late 80’s to early 90’s. The result was the enactment of the Education Tax Act,

which requires all Nigerian companies to pay 2% of their assessable profits as education tax. This rate has been increased to 2.5% by the Finance Act 2021 signed by the president earlier this month.

Adjusted profit, the base of EDT, is different from assessable profit,

the base of CIT and PPT. The latter is arrived at after some further adjustments to the former, which means adjusted profit is usually higher than assessable profit.

EDT, like CIT and PPT, is payable to Federal government and administered by

the Federal Inland Revenue Service (FIRS). The pool is used to fund education in Nigeria.

There have been a number of new taxes and levies introduced or reactivated by government in recent times (NASENI levy, Police Trust Fund etc) but these are the major taxes.

Hope helpful