The minister of finance has approved the reversal of the reduced withholding tax (WHT) rate of 2.5% applicable to construction and related services.
As a result of the low profit margin in the construction industry, resulting in perpetual excess WHT credits, the former minister of finance granted a reduction in WHT rate from 5% to 2.5%. The amendment to the WHT Regulation was issued through an official gazette with an effective date of 1 January 2015. The reduced rate was applicable to all aspects of building, construction and related activities (excluding surveys, designs and deliveries).
This reduced rate has now been reversed by the current minister of finance on the recommendation of the FIRS.
However, the reversal is yet to be formalised through an official gazette which implies that the reduced rate of 2.5% should continue to apply in the meantime.
Considering the difficulty in obtaining tax refunds and the huge cash flow impact on players in the construction industry, the retraction of the reduced rate will leave the perennial excess withholding tax credits problem unresolved.
At a corporate income tax rate of 30%, a minimum net profit margin of 16.7% is required for a business to fully utilise its WHT credits of 5%. In the case of a company that suffers 10% WHT, a net profit margin of 33% is required. Where the level of profitability for tax purposes is less than these thresholds, the affected business will perpetually be in an excess WHT credit position.
What it means
While it is understandable that there is pressure on the FIRS to generate more tax revenue, it is unfair to make any taxpayer suffer more tax than is intended by the law. A guiding principle should always be to ensure that every taxpayer pays the right amount of tax rather than the maximum tax possible.
Overall, we consider this move as undesirable to the financial wellbeing of the affected companies. Although it may result in higher tax collection by the FIRS in the short term, it could be counterproductive in the medium to long term given the associated huge financial burden on the industry.
Affected companies should make a case to the minister of finance for the reduced rate to be retained while evaluating the likely tax and cash flow implications pending the release of the official gazette.
