Nigeria passed laws earlier this year that created Nigerian income tax obligations for certain nonresident companies with digitalized business models, and certain service providers that do not have a permanent establishment (PE) in Nigeria. This new tax obligation was conditional on these companies having a significant economic presence (SEP) in Nigeria. What constituted an SEP was however not defined at the time.
Nigeria has now issued the Companies Income Tax (Significant Economic Presence) Order, 2020 (the SEP Order). The SEP Order defines what constitutes an SEP of a nonresident company in Nigeria.
This article will briefly outline the scope of the SEP Order and discuss a few areas of interest including: the compliance obligations of affected companies, challenges with the determination of the profits to be taxed once an SEP is established, and the interaction of the SEP Order with the work of the Organization for Economic Co-operation and Development (OECD) Inclusive Framework on the taxation of the digital economy.
How Will a Nonresident Company Create an SEP in Nigeria?
Broadly speaking, to determine if an SEP has been created, one will need to apply one or more of several tests. These include: a business activity test, a revenue threshold test, and what I will call a “localization test.”
There are two categories of nonresident companies that can create an SEP in Nigeria based on the nature of their business activities (the activity test). The first category is those that run digitalized business models (let us call them digitalized companies—DCs). The second category includes providers of technical, professional, management and consultancy (TPMC) services.
SEP Tests for DCs
The DCs that can create an SEP can be further grouped into two sub-categories.
The first sub-category of DCs must earn revenues above 25 million Nigerian naira ($64,500) before they will create an SEP in Nigeria (the revenue threshold test). These include companies that are in the business of:
- providing digital content (e.g. videos, music, games, applications, books, etc.) to persons in Nigeria;
- transmitting data about Nigerian users; and
- providing goods and services (including intermediation services) through digital platforms.
The Nigerian sourced revenues of several related DCs will be aggregated for the purpose of determining whether the revenue threshold has been crossed.
One should note that a DC that sells data that has been generated by Nigerian users can create an SEP in Nigeria even if the data is sold to another nonresident company.
The second sub-category includes DCs that:
- use a Nigerian domain name;
- register a website in Nigeria; or
- have a purposeful and sustained interaction with persons in Nigeria by customizing their digital platforms to target persons in Nigeria (localization test).
An example of the latter is where the company reflects the prices of its products in naira or provides options for billing and payment in naira. This category of DCs is not subject to the revenue threshold test.
SEP Test for TPMC Service Providers
TPMC service providers will have an SEP in Nigeria if they provide services to a person in Nigeria or to the Nigerian fixed base or agent of a foreign company. Companies in this category are not subject to a revenue threshold test.
What Compliance Obligations will Affected Companies Have?
DCs that have an SEP in Nigeria will be required to register for taxes in Nigeria and pay income tax on their net profits. This means that they will:
- prepare separate accounts for the income sourced from Nigeria;
- determine the profits that are attributable to their Nigerian activities;
- compute and pay income tax in line with the Nigerian tax rules; and
- file annual income tax returns.
It is also likely that they will have to comply with the local transfer pricing regulations.
TPMC service providers may not have to worry as much if current practice is sustained. This is because the law limits their Nigerian tax obligations to the withholding tax (WHT) that has been deducted at source by their Nigerian customers (I note that a strict reading of the law suggests that these companies should also be taxed on a net profit basis; however, this does not appear to be the intention of the legislature). Although TPMC providers have full registration and filing obligations in principle, in practice, when the income tax obligation of a nonresident company is limited to the WHT suffered at source, it is not required to file income tax returns in Nigeria.
What Profits are to be Taxed for DCs?
The law does not tell DCs which have an SEP in Nigeria how to determine the amount of profits that will be taxed in Nigeria.
There are at least two views on this issue. The first is that it is the full profits from the income that is sourced from Nigeria that is to be taxed: the second is that it is only the profits that are attributable to the SEP that should be taxed in Nigeria. To illustrate, assume a DC makes $10 of profit for every $100 of sales it makes to Nigeria. The first interpretation suggests that it is the full $10 that should be taxed in Nigeria. The second interpretation suggests that it is only that portion of the $10 (not the whole of it) that can be attributed to the Nigerian SEP that should be taxed. This interpretation assumes that the Nigerian SEP is a separately identifiable subset of the activities that generate the Nigerian sourced income.
Proponents of the first interpretation will argue that: (i) this is the right interpretation if the law is interpreted strictly; and (ii) the SEP does not serve as a unit to which profits are to be attributed, it only serves as a trigger for the taxation of the full profits that are derived from the Nigerian transactions.
The second interpretation is consistent with the idea that value should only be taxed where it is created. It is also in line with the SEP proposal that was discussed in the OECD’s public consultation document (of February 13, 2019) on Addressing the Tax Challenges of the Digitalization of the Economy. This consultation document contemplates that it is only a portion of the profits from the transaction that should be taxed in the jurisdiction where the SEP is created.
While this second view is consistent with the general way of thinking about the attribution of profits, it is debatable whether such an attribution can be done under the existing profit attribution rules (i.e. the arm’s length principle) that Nigerian law generally prescribes. For example, the proposal in the OECD’s consultation document contemplates the use of a fractional apportionment method whereby profits are to be allocated among the jurisdictions that have a taxing right, using factors such as sales, assets, and employees (and in some cases, number of users). It does not appear that a fractional apportionment method can be applied to SEPs in the Nigerian context without the introduction of new legislation and/or guidance.
In practice, when the Federal Inland Revenue Service (FIRS) is unsure about the taxable profits of nonresidents, it will tax them based on a percentage (typically 6%) of their Nigerian sourced turnover. Although SEPs are not included in the list of the types of nonresidents that can be taxed in this way, the FIRS may still be able to apply this approach based on a legislative provision that allows them to tax companies using a best of judgment assessment.
What Will Happen if the Inclusive Framework Reaches a Consensus?
Nigeria is a member of the OECD’s Inclusive Framework. As such the SEP Order recognizes that the OECD Inclusive Framework may reach an agreement on the “Unified Approach” for the allocation of taxing rights, and allocation of profits, as it pertains to DCs. The SEP Order provides that where Nigeria signs up to any international agreement in this regard, any of the DCs that are covered by that agreement will no longer be subject to the provisions of the SEP Order.
This is instructive because the Unified Approach, as currently envisaged, will only apply to groups with annual revenues above 750 million euros ($840 million). In addition, even where a group meets this revenue threshold, it may still be excluded from the scope of the Unified Approach if its profit margins are below a yet to be determined threshold. The implication is that many nonresident groups that do not qualify to be taxed under the unified approach may continue to be taxed under the local SEP rules.
Planning Points
DCs and TPMC services which have a customer base in Nigeria will need to consider how Nigeria’s SEP Order affects them.
The FIRS may soon clarify its position on the gray areas such as the attribution of profits to Nigerian SEPs. If this does not happen, affected companies should consider having proactive engagement with the FIRS in order to reduce the risk of disputes and possible double taxation.
Seun Adu is a Partner, Tax and Transfer Pricing, with PwC Nigeria.
The author may be contacted at: seun.y.adu@pwc.com
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Source: news.bloombergtax.com
