In July 2024, Nigerians were greeted with the news of a letter, accompanied by an executive bill, submitted by President Bola Ahmed Tinubu to the Nigerian Senate, requesting for an amendment to the Finance Act, 2023 through the Finance Bill 2024.
The proposal aims to introduce a one-time windfall tax on the realized foreign exchange gains by banks during the 2023 Financial Year. The rationale behind such a tax is typically to redirect unexpected earnings towards broader public use, often in times of national economic need.
Given the fiscal pressure on the Nigerian government, the windfall tax aims to tap into these surplus profits to help fill revenue gaps. Recall, that banks posted significant profits on the back of the devaluation of the naira last year, which saw unprecedented FX revaluation gains, estimated to a combined sum of N3 trillion.
While this may seem straightforward, the proposal raises several legal and regulatory questions, especially when analyzed within the context of Nigeria’s financial laws and global precedents.
Let’s talk about windfall tax
A windfall tax is levied on profits that are considered excessive or significantly higher than normal due to external factors, such as commodity price increase, favorable government policies, or market conditions. In the case of the Nigerian banks, it was because of gains from exchange rate revaluation.
This new tax policy has raised some eyebrows across several quarters, although it is worth noting that Nigeria is not the first country to attempt a windfall tax, with countries like the United Kingdom, Argentina, and Spain implementing it in the past, while the US attempted it, even if it was eventually repealed.
Specifically, the UK government raised about £5 billion through a one-off windfall tax on privatized utilities that had benefited from favorable regulatory environments, charging them at 23%. The tax was used to fund employment programs, and despite initial resistance, it was largely accepted because the profits targeted were seen as the result of government policies rather than market conditions.
Recently, the Argentine Tax Authority (AFIP) established a one-time windfall income tax prepayment for companies that gained extraordinary income from the increase in international prices, charging the companies with profits over 1 billion pesos an additional 15% tax.
More recently, Spain imposed a windfall tax on banks and energy companies in 2022, following a surge in profits driven by inflation and energy prices. The tax was justified on the grounds of economic equity and social responsibility, but it faced significant pushback from the private sector, with some firms threatening to pass on the costs to consumers.
Legal implications of windfall tax
The federal government has highlighted the need for an additional tax to help bridge the 2024 budget deficit, justifying the windfall tax as a means to fund capital infrastructure projects in education, healthcare, and other public welfare initiatives.
However, the proposed windfall tax, has sparked significant debate from different quarters on the legality of the tax imposition and the impact on the financials of the banks. The government suggest a plan to impose a 50% tax on profits from foreign exchange (FX) transactions, as opposed to the standard 30% corporate income tax (CIT) rate.
- This discrepancy introduces practical challenges for banks, especially in the way they allocate expenses across various revenue streams. It could result in inconsistencies, as banks may have to apply a different approach compared to how they previously allocated profits to tax-exempt income.
- Moreover, the change would affect banks’ effective tax rates, as deferred tax liabilities on unrealized profits were initially recognized at the 30% CIT rate.
- Additionally, the proposal suggests that the tax would be applied retroactively to profits from the 2023 financial year, which banks have already reported and settled by June 2024.
- A critical question is whether the windfall tax on banks aligns with the provisions of the Nigerian constitution. Banks could challenge the windfall tax based on the principle of legality, which states that taxes must be clearly defined by law.
- If the windfall tax is viewed as retroactive (taxing past profits), it could face resistance under the principle that no law should have a retroactive effect unless explicitly stated.
Another legal challenge could arise if banks argue that the windfall tax constitutes double taxation. The concern here is that banks are already subject to multiple taxes, including corporate income tax, value-added tax, stamp duties, withholding tax amongst others. A windfall tax could be perceived as an additional layer of taxation on the same earnings, especially if it is applied without significant reform or adjustment to the existing tax structure.
Banks may argue that the criteria for determining a windfall are arbitrary. Without clear guidelines on how excess profits are calculated, banks could challenge the tax as lacking in transparency, making it difficult for them to anticipate or plan for these additional financial obligations. The absence of a uniform method could lead to unequal treatment across the industry, another potential point of contention.
Bottom line
While the windfall tax proposal aims to address Nigeria’s fiscal challenges, its legal and regulatory foundation remains uncertain. For the tax to succeed, the government must ensure transparency, align the tax with existing laws, and engage closely with regulatory bodies such as the FIRS and CBN to ensure a smooth implementation. Though banks may push back against the measure, a well-structured and transparent windfall tax could play a crucial role in closing the country’s budget deficit without stifling the financial sector.