Taxation of Digital Economy in Nigeria, Need for Certainty

By Tayo Ogungbenro

Digital economy no longer needs introduction. We will therefore not be spending time trying to define neither the term, scope nor coverage. But its pervasiveness and disruption of established business norm is no more demonstrated by the recent valuation of Paystack, a fintech company in Nigeria, with less than ten-year track record.

Stripes, a US-based major investor in the payment technology industry recently paid a whooping US$200m (approximately N76 billion at current official exchange rate) to acquire the company. The value of a relatively unknown company set up by young graduates was more than the combined net asset value of at least three non-first tier banks in Nigeria, each of which has been in existence for more than three decades.

Digital economy is literally displacing the brick and mortal forms of business all over the world. Uber is shutting down yellow cab taxi drivers in Lagos. The traditional media houses are competing for space within the social media channel.

The telecommunication companies (telcos) have been granted a form of banking licence by the Central Bank of Nigeria. The major reason why the telcos have not displaced the banks is due to the limitation in the scope of what the telcos are permitted to do. Nevertheless, the fact that the telcos outlets in cash dispensing far exceeds the ATM machines and available in remotest part of Nigeria is a wake up call that banking in Nigeria will no longer be the same.

The Nigeria tax system however lacks a coherent system of taxation for the players in the digital economy. It is still rooted in the past seeking for the traditional ways of tracking income derived, earned, received or brought into Nigeria.
The common factor about each of the basis for identifying a taxable income for companies in Nigeria is ability to identify a particular place or trajectory of where an income is earned within the geographical space of Nigeria. This is where digital economy escapes from tax net of the country.

The situation in Nigeria is extremely critical. The tax laws, sadly, do not guarantee certainty in tax payable by the companies. The problem ranges from identification of the particular legal entity that should account for the tax, to the determination of the taxable income, tax-deductible expense, documents and information required to be filed for tax purpose, among others.

Concept of Significant Economic Presence

Earlier this year, the Minister for Finance, Budget and National Planning, Zainab Shamsuna Ahmed, tried to address the problem by issuing Regulations (Companies Income Tax (Significant Economic Presence) Order 2020) that will define the basis that will make some of the non-resident companies operating within the digital economy space to be deemed to be deriving income from Nigeria.
The regulations moved away from the traditional permanent establishment or fixed base concept to economic substance. It sets various digital criteria by which such companies would be deemed to have Significant Economic Presence (SEP) and therefore liable to tax on income derived in Nigeria from such activities.
Specifically, the Order provides that a foreign company shall have a SEP in Nigeria in any accounting year, where it a. derives N25.0million (approximately $65,000) annual gross turnover or its equivalent in other currencies from any or combination of the following digital activities:

i. Streaming or downloading services of digital contents, including but not limited to movies, videos, music, applications, games and e-books to any person in Nigeria; or
ii. Transmission of data collected about Nigerian users which has been generated from such users’ activities on a digital interface including website or mobile applications; or
iii. Provision of goods or services other than those under sub-paragraph 5 of the Order, directly or indirectly through a digital platform to Nigeria; or
iv. Provision of intermediation services through a digital platform, website or other online applications that link suppliers and customers in Nigeria.

However, this is where certainty in respect of taxation of the players in this economy ends under the current tax legislation and regulations as explained further below.

Uncertainty in taxation still holds sway

The affected Non-Resident Companies (NRCs) will be liable to tax in respect of profit derived from the SEP activities in Nigeria as clearly noted in each of the criteria above. The major issue is how to determine the revenue that will be deemed to be derived in Nigeria. Even if we assume that this is determinable, the other issue is the determination of tax-deductible expense.

CITA requires tax-deductible expense to be those wholly, reasonably, exclusively and necessarily incurred for the purpose of generating the taxable income. It is however difficult, if not impracticable, for the NRCs to determine with reasonable degree of certainty, the portion of their expense incurred across international boundaries that will perfectly meet these conditions. Thus, if it is difficult to determine both the taxable income and tax-deductible expense, the resulting taxable profit will always be a subject of controversy with the tax authority.

In the remaining part of this article, we have analyzed some of the challenges of determining each of these variables – taxable income and tax-deductible expense. In order to avoid unnecessary controversy where one may be tempted to focus on the messenger rather than the message, we will avoid mentioning any of the affected players in the digital economy space whilst illustrating the issue with real life situation.

Our first example relates to an NRC digital player develops and sells an Enterprise Resource Planning (ERP) software to multinational enterprises (MNEs) operating across multiple jurisdictions. Usually, the agreement will be concluded and signed with one legal entity within the group and the software deployed to all operating companies in different jurisdictions. In practice, the operating companies will usually pay their respective share of the expenditure to the contracting company within the group for onward remittance to the ERP software developer.

Currently, there are few Nigeria headquartered MNEs in this situation. Whilst the operating subsidiaries in Nigeria use the ERP, all the operating companies outside Nigeria also use it for their respective businesses in the host country. Thus, the benefits of the expenditure extend beyond the shores of the country. However, to the extent that the payment is made from Nigeria, such transaction will be assumed by the Nigeria tax authority and other regulators to be derived in the country.

In another instance, an NRC digital player has facility for advertisement. The process is simply to place advert on their platform and make the information available to targeted and potential customers spread all over the world. When an MNE does this with a digital player, the company is able to reap the benefit of increased patronage across multiple jurisdictions especially where it has operating companies that can provide the service. Similar to above, the Nigeria’s tax authority will deem the expenditure as an income derived by digital service provider from the country and therefore subject it to tax therein.

The problem posed by tax-deductible expense is no less complex. The first major one is identification of the expenditure itself based on the expectation of Nigeria’s tax administration. Most of the players in the digital economy incur significant expenditure on research and development and usually accumulated in a legal entity that will most likely be different from the one that provides the service. Similarly, they also incur significantly on not only protecting their channels from various forms of attacks, but also their intellectual property. The first major challenge is therefore the ability to collate these expenses and then allocate among the beneficiary-related parties. The issue of appropriate allocation key cannot be overemphasized. There is currently no consensus about the perfect allocation key, rather, the multilateral institutions such as the Organization for Economic Cooperation and Development (OECD) and the United Nations have only been able to offer guidelines and recommendations on options considered appropriate depending on the circumstance.

Irrespective of any allocation key that is used, Nigeria also poses its own varying challenges. For instance, if we hold all other factors constant, a 100 per cent appreciation in the exchange rate of naira to the United States Dollar implies that the proportion of the same expenditure that will be allocated to Nigeria in two different years will be doubled and vice versa.
Thus, movement in foreign exchange rates that should have nothing to do with underlying business transactions or the profitability of an economic activity of a company within a jurisdiction will significantly influence the tax payable. This is definitely not how appropriate tax regime should work. It will make it very difficult for the players in the digital economy to plan with reasonable degree of certainty.

Conclusion

This article is in four series. This first part lays the background in respect of the great uncertainty arising from tax regime available for the players in the digital economy in Nigeria. The second part will focus on what has been done in some other economies to address the problem. Some of the countries considered include France, India, South Africa and Turkey.
The third article reviews the existing problem faced by the tax authority determining the taxable profit of non-resident companies in Nigeria. The Transfer Pricing Division of the Federal Inland Revenue Service in Nigeria has been making frantic efforts in the last few months to address this issue in an equitable and fair manner.
The problem is therefore real and present with us under the current tax regime. The final piece suggests options that are available for consideration by Nigeria government. The options include those that are currently available within Nigeria’s tax code, which is similar to what has been done in some other jurisdictions.

I will be addressing each of the above aspect of the assignment with seasoned professionals in the field who have had real life experience handling or dealing with the issue. They have either advised the leading digital players in the field in respect of the issue or discuss extensively with the tax authority in this regard.

Ogungbenro is a partner in the Tax, Regulatory & People Services Division of KPMG Advisory Services in Nigeria. His area of specialisation includes taxation of players in the digital economy. He is also acknowledging the contributions of Akinwale Alao, Elizabeth Olaghere and Victor Adegite to this article. The opinion expressed in this article however remains that of the author(s).