FINANCE - 28 SEP 2017

Living Tax Free in Nigeria

Living Tax Free in Nigeria
Aliko Dangote has benefitted from Nigeria's treatment of nascent sectors as 'pioneer'

Imagine a corporate organisation paying just ₦16 billion in taxes on ₦1.1 trillion in profits over five years – an effective tax rate below 2%. 

This was the story of Dangote Cement between 2012 and 2016 when it enjoyed multiple tax exemptions due to its pioneer status in the Nigerian cement industry.

A tax holiday is an incentive program through which a government offers a tax reduction or elimination to businesses for a defined period.

A common type of tax holiday in Nigeria is the pioneer status (PSI), a form of tax holiday granted by the government to companies interested in investing in specific sectors of the economy, with the understanding that profits from their operations would be ploughed back to the business to create jobs and accelerate the development of that sector.

As contained in the Industrial Development Act, pioneer status can be granted to an industry for either of three reasons. The first is that the industry is not being carried on in Nigeria on a scale suitable to the economic requirements of Nigeria or at all. Alternatively, pioneer status is granted if there are favourable prospects of further development in Nigeria for that industry or if it is in the public interest to encourage the development or establishment of that industry. 

The Act stipulates that pioneer status lasts for no longer than five years, after which is it can be extended. During this time, the company pays little or no tax on profits from activities in that pioneer industry. Period.

 

History of Tax Holidays in Nigeria

Tax incentives in Nigeria date back to colonial administration when different forms of reliefs, allowances, and tax holidays were granted to British companies and individuals to establish trade links with the country.

Specifically, tax incentives for industrial development was introduced in 1958 and included pioneer companies relief, Companies Income Tax relief, Import duties relief and the Approved user scheme. Over time, the government began using tax holidays for industries it sought to attract investment. For instance, the NLNG was granted pioneer status when it began operations in 1989 to promote exploration and export of natural gas, while players in the cement industry have enjoyed tax holidays for over a decade as the government aimed to attain self-sufficiency in local

Recently, as part of the Economic Recovery and Growth Plan (ERGP), the Federal Government (FG) approved 27 new industries eligible for pioneer tax status for an initial three years. Prior to this announcement, the policy was last reviewed in 2006 when it was granted to 24 companies in industries ranging from cement and telecommunications to breweries and steel manufacturing. At the time, a total of 71 industries had pioneer status. 

Looking at the last decade, the effect of these tax exemptions have been markedly mixed. While Nigeria's cement capacity is nearly double current demand, industries such as fertiliser or steel manufacturing are yet to gather steam. 

 

Tax Incentives in Nigeria as a Mixed Bag

The government grants tax holiday to companies for several reasons. A tax holiday reduces the tax burden on companies in nascent industries. Infant industries are characterised by a high cost of production, unproven business models and much more, which accentuate financial risk. By enjoying a tax holiday, the burden of a tax bill is eliminated.

Furthermore, tax holidays often attract foreign direct investment (FDI). Given Nigeria's high-risk business environment, tax exemptions are a direct way of enticing foreign investment into growing industries in need of capital. 

As investment flows in and industries grow, the desired effect is longterm economic growth and national competitiveness. For example, when a company enjoys tax exemptions, its exports are more competitive, and it is able to expand into foreign markets – something Dangote Cement has used to its advantage. 

On the other hand, tax holidays constitute government interference in a free market. Moreover, tax incentives, by intention, attempt to direct capital from one industry to another. However, this requires the government understanding which industries will be more competitive or profitable in the long run. Understandably, this can be very difficult.  

In Nigeria, tax holiday misuse has been rampant. One firm allegedly claimed an extra ₦64 billion tax benefit in 2016, even though the PSI under which it claimed the benefit was under suspension. This ‘assumption of tax holiday’ was rightly flagged by its auditors. 

The possible inefficiency and abuse of tax incentives are relevant as they do not necessarily translate to FDI, better competitiveness or industry development. In Nigeria, the mining, solid minerals, glass industries have all enjoyed pioneer status, yet no noteworthy investment has been made in any of these industries. The story is equally mixed across the globe. 

To top it off, tax holidays reduce government revenues and can translate to billions of naira in forfeited taxes over the lifetime of the PSI.

If rightly applied, tax holidays can be an accelerator for FDIs and economic growth and development. Given Nigeria’s current economic situation, the revision of the PSI is welcome and timely. If it encourages investments into new industries and reduces cost in other industries, this should translate into growth, increased production, jobs and ultimately, forex generation via exportation.

However, it is pertinent that any tax policy, even if designed with good intentions, must be considered as fair. Furthermore, tax regulatory institutions must be adequately strengthened to regulate big businesses whose capabilities stretch government’s ability.

As with all things, time will tell if the new policy will be a success or just another well-thought but poorly implemented policy.

 

Follow this writer on Twitter @Numero_1ne. Subscribe to read more articles here.

Olanrewaju Rufai

Olanrewaju Rufai

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