Whether in starting out in business or in seeking to expand, business owners often look for different sources of secondary capital. Capital can be raised using financial instruments such as bonds, shares, loans, etc. These sources of capital can be classified as either Debt or Equity.
In accessing any of the sources of capital mentioned, the business owner (“or Nigerian company”) must secure an investor to invest in its business operations. Consequently, the Nigerian company must choose the most efficient source of capital.
The most common financial instrument under this group is a loan. When an investor grants a loan, the ultimate goal is to derive favourable return on investment (ROI). The ROI in terms of a loan is interest; this is calculated at varying rates and over a period of time (subject to the terms of agreement between the lender/ investor and debtor/ business owner).
It is advisable for the Nigerian company to review its business operations and endeavour to make profit projections for at least 5 years. This should be done as a choice evaluation process. From its projections, the company will be able to decide if sourcing capital through debt is appropriate. It is important that interest payments (finance costs) do not erode the company’s profits, as the whole point of seeking investment is to grow the business and maximise profits. The option for debt financing is usually taken where the business owner(s) intend to retain full ownership of the company.
Tax and Debt:
If a Nigerian company decides to source capital using debt, another important consideration is the taxation of the interest payable. Investors are keen on tax provisions as unfavourable provisions may reduce ROI. Sometimes, this is a deal breaker for most financial transactions. However, the situation can be salvaged if there are conditions that limit or totally eliminate the exposure of the ROI to tax.
Withholding Tax (WHT) is applicable on the interest payable to the lender/investor at a rate of 10% on the amount payable or 7.5% if there is a Double Taxation Agreement (DTA) between Nigeria and the home country of the investor. To maximise return on investment and encourage international investors in Nigeria, the tax laws provide tax exemptions on interests payable. These exemption provisions reduce or totally eliminate the WHT deductible on the interest payment.
Please see table below:
Repayment period + Moratorium
Tax exemption allowed
Above 7 years
Not less than 2 years
5 – 7 years
Not less than 18 months
2 – 4 years
Not less than 12 months
Below 2 years
This table is specific to foreign loans. The incentive is explained below:
If a Nigerian company receives a loan for a period less than two years, it will be liable to withhold tax at 10% or 7.5% if there is a Double Taxation Agreement between Nigeria and the Investor’s home country. However, if the loan received has a repayment period of two to four years plus a Grace Period of not less than 12 months, the interest subject to tax will be 60% of the full amount payable.
For Instance, ZXY Ltd has received a loan of N10,000 from CBA Limited in the United States. The loan is payable in 3 years at an annual interest rate of 10%. Based on these loan terms, a total interest of N3,000 (10%*10,000*3yrs) is payable. Where the loan is given for a period of less than two years, CBA limited would receive N2,700 (N3,000-(10%*N3,000) as interest at the end of the loan tenure. However, if the loan is structured to have a two year repayment period plus Grace Period of a year, the interest received by CBA Limited will amount to N2,820 (N3,000-(10%*(0.6*N3,000)). This difference is N120, this may look negligible however lets imagine these payments are in millions.
Using the illustration above, CBA Limited has gained an additional N120 million as a result of this incentive. This exemption applies all the way to a 100% exclusion of the interest payable from WHT, based on the terms of the loan agreement. Where a company intends to use debt to source for capital, these provisions may make the investment attractive to the investors (foreign). In addition, interest payments are allowable expenses for the Nigerian company.
A business owner may also source capital by reducing its ownership stake in the company. This is done by offering up some of its shares for sales to interested persons or to the public (a listed company). These persons are referred to as investors or shareholders. The company pays these investors dividends as return on their investment.
Tax and Equity
As with interest payments, WHT is deductible from dividend payments. It is deducted at a rate of 10% on the dividend payable. If there is an existing double taxation agreement (DTA) between Nigeria and the home country of the foreign investor, WHT is deductible at a reduced rate of 7.5%. In addition, depending on the provisions in the DTA, the foreign investor may be entitled to utilise the tax withheld as foreign tax credit against its taxes in its home country. Furthermore, where the company is non-resident, the tax withheld will be the final tax payable by the foreign investor.
The Nigerian tax laws also exempt from Minimum Tax, a Nigerian company that has up to 25% imported equity.
This is merely informative and the intention is not promote any of the methods of financing. Depending on its short and long term goals, the onus is on the Nigerian company to decide its preferred mode of financing. However, when doing so, it should bear in mind these tax provisions as they would assist the company in making the most beneficial choice.
A Nigerian company may also finance its using a fusion of both debt and equity. This decision would be based on proper analysis of the company’s needs. However, in doing so, the Nigerian company needs to take note of impending Thin Capitalisation Rules that propose a debt: equity ratio of 3:1 that is, for every N300 debt financing the company should have N100 equity financing.
The Author Asabi Vincent is a tax consultant and a Senior Content Partner with Nairametrics
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