SMEs, Power, Environmental Sustainability and Economic Growth

By Martins Arogie and Kelechi Inyama

Background/Introduction

Small and Medium Scale Enterprises (SMEs) are the backbone of any country’s economic development as it is almost impossible to achieve sustained economic growth which would reflect in the overall wellbeing of the populace without the existence of thriving SMEs.

It is therefore important that we formulate policies which take this key economic constituency into consideration when planning for economic growth and development. This fact has not been lost on the current Federal Administration which has over the last 18 months made significant fiscal and regulatory changes to incentivise the SME sector.

Some of these changes include:

− Exemption of income from Company Income Tax (CIT) provided that relevant returns are filed which show that the revenue earned in the preceding financial year was less than N25 million.

− Exemption of SME income from minimum CIT provided that the gross turnover earned in the relevant year of assessment is less than N25 million.

− Reduced CIT rate of 20 per cent for a medium-sized company which earns gross turnover greater than N25 million but less than N100 million, as opposed to the CIT rate of 30 per cent for bigger companies.

− Exemption from the obligation to file, charge and pay Value Added Tax (VAT) in any year where revenue does not exceed N25 million.

− Exemptions from the requirements to undergo a statutory audit and appoint a company secretary if the company’s turnover and net assets do not exceed N120 million and N60 million, respectively.

The above incentives are extremely commendable and are a step in the right direction if Nigeria wants to develop a formidable SME sector. However, it should not be the end. This article therefore, considers what more can be done to assist the sector in its path to sustained long-term growth.

One bane of most SMEs is their lack of formalisation and records. SMEs typically operate as unincorporated and maybe unregistered entities with no record of their existence to the relevant Government authorities and regulators.

A lot of SMEs also do not have dedicated bank accounts separate from that of the owner and thus, it is always difficult to separate the entity from its owner. This, in the opinion of the authors, has impacted their ability to plan for growth as there is very little data with which to assess the businesses in this sector, identify problem areas and strategise on how to deal with it.

A lot of these are therefore left to perception and experience, which though very important, has its limits in today’s world where empirical data is key.

It was therefore a master stroke when the Federal Government of Nigeria , when introducing the CIT exemption granted to SMEs under the Finance Act, 2019 (FA), included a proviso that these companies ought to prepare and file tax returns as a basis to accessing the exemption.

This ordinarily should influence SMEs who wish to enjoy the tax exemption to maintain adequate records that would enable them to file these returns.

The importance of these records go beyond tax compliance though, as the SMEs would also be able to access debt and potential investors if they are able to provide the relevant information which show the financial position of the business. The existence of such records also avails the business owners’ data with which they can make short and long-term plans for business sustainability and growth.

Incentive or Enforcement

This challenge may persist. Only entrepreneurs or companies which pay tax originally would benefit from an exemption.

Companies and entrepreneurs who are not tax-compliant may not appreciate the exemptions and so may not change their behavior. Therefore, the real question is how many SMEs pay taxes? This does not consider those who pay a presumptive tax to the relevant State Internal Revenue Service (SIRS) where they are located as these presumptive taxes are typically not a function of activity or records. Presumptive taxes are a viable source of collection for the SIRS but the jury is out on their long term productive impact on businesses.

Another pertinent question is how many SMEs know their annual turnover or can say with any certainty what their biggest expense line is and what they are doing to mitigate and or manage it? As pointed out earlier, a lot of them do not have business bank accounts and are primarily cash run businesses. They may therefore not be able to determine if the revenue-related exemption would apply to them.

The government can attempt to change this narrative either by conducting more aggressive enforcement or designing a different kind of incentive. The argument against aggressive enforcement has always been its cost.

These SMEs are innumerable and they are scattered all over the country, so it would require a significant amount of resources to actively identify and monitor them to ensure that they are at least complying with the obligation to maintain adequate books of accounts and file returns as and when due, even when there are no liabilities to be settled.

Also, enforcement is never complete without an adequate deterrent which would typically be either jail time or imposition of monetary penalties.

However, these forms of deterrent may only serve to cripple the non-compliant companies who are identified rather than encourage voluntary compliance for all SMEs. In fact, such an aggressive approach may encourage non-compliant SMEs to play the waiting game until they are apprehended by the hands of the law, if ever. Our best bet then may be to design a different form of incentive that encourages voluntary compliance. The question is what is likely to be effective?

The Power and or Environmental Sustainability Issue

Power remains one of the biggest challenges faced by SMEs in Nigeria. An enduring sight of any complex which houses small businesses in the country would be the assortment of small, gasoline generators which render the air with a cacophony of sounds, for hours on end. A report by Dalberg and Access to Energy Institute in June 2019 states that the available capacity from such gasoline generators is 8 times more than the available capacity from Nigeria’s grid with about 11 million SMEs relying on it for their primary source of power on a daily basis.

The report also highlights the impact of the use of these generating sets on the environment vis-a-vis Nigeria’s ability to meet its stated objective of cutting its greenhouse gas (GHG) emissions by 45% by 2030, as a reduction in the use of the generators may contribute up to 22 per cent of the planned reduction.

It may therefore be necessary to consider a two-pronged incentive which will provide lasting benefits; address our desire to encourage more SMEs to formalise their operations whilst taking us closer to meeting our objective of cutting the country’s GHG by 45 per cent by 2030.

Any incentive system designed must be set to address a problem otherwise it may end up being redundant. Power and environmental sustainability as seen above are actual problems which require creative solutions.
The Solar System Solution

One sure way of addressing the epileptic power challenge for SMEs would be to introduce solar systems to these entities. Currently, the average solar system which can produce the same amount of energy obtained from a small gasoline generator costs, according to the Dalberg A2EI report, about 15 to 20 times more than the cost of purchase and installation of a generating set.

However, it is likely that over the medium term, especially with the rising cost of gasoline, the cost of running the generators would outweigh the significant acquisition and installation cost of solar systems.

It is however imperative to note that this long-term cost vs benefit argument is one that you would struggle to make to a small business owner who receives his revenue in trickles on a daily basis and may therefore be unable to accumulate the significant cost of acquiring the solar system.

Such business owner would rather incur the daily gasoline expense that is more aligned with its daily revenue profile than the significant one-off cost which may save more in the medium to long term.

Consequently, it is evident that the entrepreneur would need to be encouraged to go against his normal business philosophy in order to be able to shift from using a gasoline generating set to a solar system.

How do we propose to do this?

Set up an acquisition fund pool

Nigeria is a developing economy and it may not currently be feasible to require high energy demand users to shift completely to renewable energy as a source of power.

The economics of such a shift may impact its viability, especially when you consider that hydro and gas turbines may, given the peculiarity of our environment, be more economically viable sources of high demand power today.

Consequently, if the government is to stand a chance to meet its GHG reduction target over the next 10 years, it may be better served to focus on small scale users who it can incentivise to move to renewables, specifically solar systems.

The FGN can seek to establish a synergy between these high energy demand users and the SMEs through the creation of a SME solar system acquisition fund. This fund would be accessed by SMEs which meet specified criteria, one of which would be the keeping of adequate books of accounts, for the purpose of acquiring the solar systems.

The disbursed amounts may be treated as grants rather than loans for the SMEs while the contributors would be issued with a certificate evidencing their donation.

The certificate would be capitalised by contributors and can be amortised in the year in which it is earned plus a 10 per cent uplift for tax purposes which reduces their tax obligations.

It is possible to design a system which sets minimum contributions annually, however it may be advisable to base such on the relevant contributor’s rate of CO2 emission. The drawback to this though may be its impact on these large businesses, given that there is already significant concern about the level of taxation for companies.

It may therefore be preferable to make this voluntary but assign incentives such as tax deductible uplifts as stated above to encourage contributions to the funds. This way, everyone wins from the initiative.

The pool fund can be managed by an agency such as the Bank of Industry or any other relevant governmental agency.

Provide incentives to solar system providers

A lot of the incentives in this space now are profit-based which rarely gets transferred to final consumers but are more likely to benefit the shareholders. The Government will therefore need to focus on cost-based incentives which seek to reduce the cost of these systems and are more transferable to customers. This hopefully would reduce the cost of acquiring solar systems and ensure greater access to SMEs, directly or through the pool fund.

The Nigerian Economic Sustainability Plan (NESP) and the Nigerian Electrification Project (NEP) are both schemes put in place by the Government to improve access to energy with the provision of reliable power to 5 million individuals and 250, 000 SMEs respectively. These schemes seek to provide significant concessionary funding to players in the industry with a view to driving down cost and affordability of the systems.

The two-pronged solution, financing for providers and buyers, may therefore be sufficient to tilt the scale towards a more sustainable system.

Conclusion

It is important to state here that the introduction of this system does not only benefit SMEs and the environment. The removal of the bulk of the SMEs from the grid releases grid power for the high demand users who already pay a higher tariff with very low collection losses. This therefore increases profitability and cash flow positions of the on-grid players and thus impacts on the long-term sustainability of the grid system.

The issue of formalisation of SMEs in Nigeria is one which has remained critical to their growth and ultimately, their contribution to economic development in the country. It is therefore necessary for us to continue to consider how we can address this issue. Environmental sustainability is also a pertinent concern which is critical not only to Nigeria but the world at large. Consequently, if there is any solution which addresses both issues with one sling of the bow, then it behooves on the Government to take active steps to study that solution and come up with detailed policies and execution plans.

Martins is a Partner and Kelechi a Senior Adviser, focused on the Power Sector in the Tax, Regulatory and People Services Division of KPMG