Nigeria’s Excess Dividend Tax Explained

Government taxes on your revenue Source: Nairametrics File

Summary

  1. There may significant reductions in dividend pay outs in the coming future. In a recently concluded case between a leading company in Oil and Gas Sector and FIRS, the Tax Appeal Tribunal judgement infers that profits of Nigerian companies will be subjected to CIT twice.
  2. This is based on a new interpretation of the Excess Dividend Tax (EDT) that companies are liable to pay. EDT basically means companies are liable to pay tax when their dividend payout is higher than the taxable profits declared.
  3. Dividend payout can be higher than taxable profits if the company decides to pay dividend out of past profits (retained earnings)
  4. Though we understand that this judgment is to be appealed, it may be advisable for companies seeking to pay dividends out of their retained earnings to ensure that such dividends do not exceed their taxable profits for the year in which the dividends are paid out. This should be done pending the resolution of this dispute.

The basis of the judgment is the Excess Dividends Tax (EDT) provision in the Companies’ Income Tax Act (CITA). Section 19 of the CITA imposes what is generally known as “excess dividends tax”. It provides that, where a dividend is paid out of profit on which no tax is payable due to no taxable profits; or taxable profits which are less than the amount of dividend paid, the company paying the dividend shall be charged to tax at 30% as if the dividend is the taxable profits of the company for the year of assessment to which the accounts, out of which the dividend declared, relates.

This means that where a company pays out dividends in a year of assessment in which it has no taxable profits or where the taxable profits for that particular assessment year are less than the dividend pay-out; the company will be subjected to tax on the dividends as though the dividends were the taxable profit for the relevant year. It is typical for companies in a particular year, to pay dividends out of retained earnings and/or current year profits.

A company’s retained earnings usually consist of already taxed profits or tax exempt income. This provision seeks to impose double tax on profits and erode incentives granted by the same legislation.

Prior to this ruling, dealing with EDT meant maintaining a system to monitor retained earnings (that have already been taxed or not liable to tax) such that when a company pays out dividends in a particular year, it is very clear which years they relate to. This way, a direct comparison can be done to compare what portion of dividend pay-out relates to what year.

The current ruling however exposes the company to double taxation as dividends pay-outs in a particular year are no longer to be matched against the taxable profits for the relevant years to which they relate. However, they should be matched against current year taxable profits and any excess will be subject to tax at 30%.

Illustration:

In 2009, DKE Limited declared and paid dividend of N60million of which, N40million relates to 2009 while N11million and N9million relate to 2008 and 2007 respectively.

DKE Limited’s taxable profits for 2009, 2008 and 2007 are N50million, N12 million and N8 million respectively. When DKE Limited pays this dividend out in 2009 a comparison is done as follows

YearDividend Pay-out (DP)
from respective years
Taxable Profits (TP)Comments
200940 million50 millionTP is higher than DP, no EDT
200811 million12 millionTP is higher than DP, no EDT
20079 million8 millionTP is lower than DP, risk of exposure to EDT

In line with previous practices and based on this illustration, DKE Limited is only liable to pay EDT for 2007 at 30% of 1 million (9 million minus 8 million).

However, based on this ruling the comparison will be made between the dividend paid out in 2009, which is 60 million and the taxable profit for 2009; and 50 million. The company will therefore be required to pay EDT at 30% of 10 million. Thereby subjecting to tax once again, fully taxed profits of 2009 and retained earnings of 2008.

Though we understand that this judgment is to be appealed, it may be advisable for companies seeking to pay dividends out of their retained earnings to ensure that such dividends do not exceed their taxable profits for the year in which the dividends are paid out. This should be done pending the resolution of this dispute.

This tax provision is draconian and is one of the major pitfalls of the Nigerian tax system as it seeks to subject to additional tax, already taxed profits of a company. As a result of this, foreign investors are unwilling to have companies in Nigeria. Though the whole point of the provision is to bring all income within the tax net, it has an adverse effect on the operations of the company.

This provision also has an adverse effect on Nigerian Holding companies (Holdco) whose major source of income is dividend income. For instance, in line with the recent bank reforms, banks are required to set up HoldCos. HoldCos are normally set up to facilitate better risk management and supervision; ring-fence the risks associated with other riskier organisational activities; ensure better specialisation; and support clearer responsibility. The Holdco structures tends to be more efficient to business operations, however the excess dividend tax provision creates a big problem. This is because the Holdco’s income is majorly dividend income and it would normally occur that its taxable profits will be less than its dividend pay-out.

To deal with like this the tax authorities have issued a ruling to exempt the bank Holdco from EDT. By implication this exemption maybe replicated for other HoldCos. However, this exemption is currently not applicable to other company structures (companies without HoldCos) and thus creates negative tax implications. In order to mitigate the risk of exposure to EDT, Nigerian companies should ensure that dividends pay-out in each year do not exceed the taxable profits for the relevant year.

This article originally appeared on this website in September 2014.

 

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