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APPRIASAL OF TAX INCENTIVES IN NIGERIA

BY

AJAGU CHIKEZIE (B.sc,GMNIM)

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INTRODUCTION

1.1 BACKGROUND TO THE STUDY

As part of the effort to provide an enabling environment that is conducive to the growth

and development of industries, inflow of foreign direct investment (FDI), and stimulate

the expansion of domestic production capacity; the Federal Government of Nigeria has

developed packages of incentives for various sectors of the economy. These incentives, is

hoped will help revive the economy, accelerate growth and development and reduce

poverty.

These incentives, generally referred to as tax incentives is defined by the UNCTAD

(2000), as any measurable advantages accorded to specific enterprises or categories of

business by (or at the direction of) a Government, in order to encourage them to behave

in a certain manner, in Steven and Ana (2007) words, tax incentives is any incentives that

reduces the tax burden of enterprises in order to induce them to invest in a particular

project or sector of the economy. Ifuek(2009) describes tax incentive as special

arrangement in tax laws to: stimulate growth in specific areas, attract, retain or increase

investment in a particular sector, assist companies or individuals carrying on identified

activities. They include measures specifically designed either to increase the rate of

return of a particular sector, or to reduce (or redistribute) its cost or risks.

Most countries, irrespective of their stage of development, employ a wide range of

incentive to realize their investment objectives. Developed countries, however more

frequently employ financial incentives such as grants, subsidized loans or loan guarantee.

It is generally recognized that financial incentives are a direct drain on government

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budget, and as such they are not generally offered by developing countries ( Nigeria

inclusive), instead these countries tend to use fiscal incentives that do not require up-front

use of government fund.

The UNCTAD (2000), mentioned some of these fiscal incentives to include: reduced tax

rates on profit, tax holidays, accounting rules that allow accelerated depreciation and loss

carried forward for tax purposes, and reduced tariffs on imported or exported equipment,

component of raw materials, or increased tariffs to protect domestic market from

imported substituting investment projects, because tax incentive are intended to ensure

overall growth of the Nigerian economy and promote even development of all sectors of

the economy, they are rarely provided without conditions attached . In some cases, and

with some types of investment, however, their impact may be more pronounced. For

some foreign investors, such as export oriented investors, tax incentives can be a major

factor in their investment location decision, also if the country has attractive (untapped)

features of economic importance, tax incentive may also be pronounced. In addition,

government may decide to change the range and extent of tax incentive which they offer.

For these reasons, investment experts, particularly from the investment promotion

agencies view incentives as an important policy variable in attracting investment for

economic development.

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LITERATURE REVIEW

2.1 What are Tax Incentives

Tax incentive has over the years taken different directional views. Tax incentives are

considered as a tool that is used to accelerate economic growth and even development.

This can be supported by the definition of Ifueko (2009) who in his view definition

viewed tax incentives as special arrangements in the tax laws to: attract, retain or increase

investment in a particular sector, stimulate growth in specific areas and assist companies

or individuals carrying on identified activities. He further noted that the underlying basis

is to ensure overall growth o the economy and even development of all sectors. It can

therefore be inferred that tax incentives are tax reduction given to encourage or support

specific course of action intended to encourage investment in certain sectors or

geographical areas.

Bruce (2004), defined tax incentive as fiscal measures that are used to attract local or

foreign investment capital to certain economic activities or particular areas in a country.

Zee, Stotshy and Ley (2002) also adopted a similar definition, as a government provided

reduction in tax liability for a defined period of time with exception for repayment so as

to accelerate local or foreign investment. They claim that any tax provision is applicable

to all investment project does constitute tax incentives. This definition excludes general

tax incentives, such as accelerated depreciation that applies to all investments. Such

general tax provision deserves to be called incentives for three reasons. Firstly, they are

designed as such and functions as such. Second, it makes sense for a government to

broadcast that it is offering attractive tax incentives, even if they take the form of general

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rather than selective provisions of the tax code. And third, a number of countries such as

Uganda and Indonesia have shifted from selective to general incentives, all with the

intention of stimulating investment Shah and Toye (2000).

2.2 Incentives under the Act

In line with the current policy of the Nigerian Government, is to ensure: Incentives are

sector based and not granted arbitrarily, Benefit to the Nigeria economy exceeds the costs

of taxes forgone, Incentives are reviewed regularly to confirm if they are serving the

expected purpose, Ifueko (2009) while foreign investors enjoying incentives are expected

to voluntarily plough back to the Nigerian economy. Tax laws provided various

incentives to companies carrying on business in Nigeria, Incentives may be granted on

industry basis or on the tax type and may include: exemption from payment of taxes,

reduction in rate of tax to be paid, grant of allowances and deductions from profits to tax

e.t.c.

Incentive under the Industrial Development Act:

Pioneer status is granted to qualifying companies and/or products and services resulting

in 3-5 year tax holidays. Qualifying industries include: Mining manufacture of cement

glass and glassware, lime from limestone, ceramic product, rubber, leather textile, and

other areas of industry that of economic benefits to the country, it is granted to companies

where the government is satisfied that: an industry is not being carried on in Nigeria on a

scale suitable to the requirement of Nigeria or at all; there is no favorable prospects for

further development in Nigeria; it is expedient in the public interest to encourage the

development or establishment of an industry in Nigeria. This as a result attracts: tax

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exemption for a three year period in the first instance and a maximum of five years in

total, tax free dividends during the pioneer period, carry forward of losses made and

capital allowances incurred to the pioneer period.

Incentive under the Companies Income Tax Act

Loans granted to Nigerian companies may be exempted from tax, where they meet

prescribed criteria, dividends received from Nigerian are exempted from tax; other than

withholding tax deducted at source; profits of shipping and airline companies subjected

to tax in Nigeria is restricted to activity carried out in Nigeria; dividend interest, rent or

Expenses are exempted from tax; Nigeria companies with a minimum of 25% foreign

equity and within their first four years of operation are exempted from payment of tax.

Incentive under the Personal Income Tax Act

Non Nigeria employees of foreign companies in Nigeria may be exempted from tax in

Nigeria where: they spend a cumulative period of less than 183 days in Nigeria during a

12 month period and their income is subjected to tax in their home country.

Incentive under the Capital Gains Tax Act

Foreign countries carrying on business in Nigeria are exempted from capital gains tax on

disposal of assets, except such proceeds are brought into Nigeria.

Incentive under the Petroleum Profit Tax Act

Expenses incurred outside Nigeria which are wholly, exclusively and necessary incurred

for the Nigerian operations are allowed as deductions against the profit of the Nigerian

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company, and interest on inter-company loans obtained under open market terms are

allowed as deductions.

Incentive under the Value Added Tax

Import of several items exempted from value added tax, exported goods and services also

exempted from value added tax.

Incentive under the Tax Free Zones and Export Processing Zones

There are laws creating tax free zones and export zones, which exempt companies

operating in those areas from tax obligations in Nigeria for operations carried out in the

zones. Companies are to required to register before enjoying the benefits and all

incentives must be performed exclusively within the zone- activities outside the zone will

be subject to tax. Ojo (2009), soyode and Kajola (2006), Ifueko (2009).

2.3 Objectives of Tax Incentives

The objective of tax incentive as observed by Philips (2006) includes:

Regional Investment: Countries often employ a mix of incentive to channel investment

for development of a particular are or region. Regional development objectives include

support to rural development, building industrial centers away from major cities and

reducing environmental hazards. Angola, Brazil, Ecuador, Ghana, India and Thailand are

some countries that use such incentive. Nigeria also has a regional incentive system that

gives allowances ranging from 100% to 5% to companies that establish operations in

rural areas where there are no facilities like electricity, tarred roads, telephone and water.

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Sectorial Investment: Countries employ tax incentives in order to provide sectors of

industry or activities considered crucial for development. These are targeted at mining

and industrial parks, export-led activities, the film industry and business with new

technology. Nigeria, for example, provides exemption from income tax for a maximum

of 5 years to pioneer companies involved in industries that are not fully developed in

Nigeria.

Performance Enhancement

Tax incentives can be used to enhance performance in certain sectors of the economy,

this is evident through the coming up of the telecommunication sector, with MNT being

granted pioneer status, helped to enhance performance in the sector. This can also be

applied to other sectors such as the tourism, film and leisure sectors.

Transfer of Technology

An important objective of using incentives to attract investment to developing countries

(Nigeria inclusive) is the transfer of technology. Certain types of incentive are designed

specifically for this purpose. Nigeria for example, have introduced a specific set of

incentive directed towards research and development (R & D) activities. It provides that

where an individual invest in the equity of a research and development company, he is

entitled to allowance which shall be the lower of the actual value invested, or 25% of the

total income.

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2.4 Issues Relating to Tax Incentives

Infant Industry Issues

Tax incentives may be targeted at investment at regions that are disadvantaged due to

their remoteness from major urban centers. UNCTAD (2000), is of the opinion that

operating in a remote area may entail significant higher transportation and

communication cost in accessing materials used for production, and in delivering the

final product to the market. These higher cost place the location at a competitive

disadvantage relative to other possible sites. Furthermore, firms may find it hard to

persuade skilled labour to relocate and work in remote areas that do not offer relative

services and convenience available in the urban areas. Workers may demand for higher

wages in compensation for this, which again implies higher cost to prospective investors.

The first best solution would be for Government to develop adequate infrastructure and

amenities so as to reduce these cost, Government could also compensate the investors for

the cost of developing the area and in training workers in the region.

Institutional Issues

The offer of incentives can be justified on the grounds of positive spillovers, such as the

diffusion of new technology, upgrading of the skills of the workforce or investment in

research and development. In this case the investor may not capture the full value of the

investment to the economy. For example, the investor may train workers or import

managerial skills, where the benefit to the society outweighs the benefit to the investors.

Employee receiving such training may then leave the project and work elsewhere in the

country. Without corrective public measures, such project may operate below their

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optimum levels. Furthermore, incentives involves more than just inflow of capital, it also

entails the internal utilization of intangible assets such as technology, and managerial

expertise that are peculiar to different firms. Thus a major effect of this investment in the

transfer of technology, managerial expertise, and skills from one country or state to

another.

2.5 Classification of Tax Incentives

Different countries use various forms of incentives which are suitable for the purpose it

was meant for and in line with the economic realities. The tax incentives used in Nigeria

as spelt out by the NEPC (2001) are:

Reduced Corporate Income Tax Rate: Government may set a lower corporate tax rate

as an exemption to the general tax regime in order to attract investment in specific

sectors, Nigeria and other counties use this type of incentive. It is targeted at the income

of investors whim met the specific criteria.

Loss Carry forwards: Government that employ a low corporate tax rate often use other

mechanism to lower the effect of tax rate. One of such mechanisms is to allow investors

to carry losses forward for a specific number of years (usually 3 to 5 years). In Nigeria

for example losses are carried forward only in the first year of the post pioneer period,

while for a continuing business, loss are carried forward for a maximum of four years.

Tax Holidays: Tax holidays are a common form of tax incentive used by developing

countries and countries with economies in transition to attract investment in certain

sectors. Under a tax holiday, qualifying newly established firms are exempted rom paying

corporate tax for a specified period (e.g. five years).

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Investment Allowance: Investment allowance are deductions from taxable income based

on some percentages of new investment, it is used by the Nigerian government to

encourage investment in some preferred sectors of the economy. Investment allowance in

Nigeria has the following key features; it is granted once in the life of a qualifying

capital expenditure and in the first year when the qualifying capital expenditure is first

put into sue, it is and additional allowance and hence cannot be considered in the process

of computing the tax written down value, when the profit available in a particular tax year

is not enough to cover the investment allowance, then the investment allowance utilized

cannot be carried forward.

Zero/Reduced Tax on Dividend: Government generally levy taxes on dividend, these

taxes may be reduced or removed altogether to attract investment. In Nigeria the dividend

exempted from taxation includes; dividend received by way of bonus issue, dividend

received by a pioneer company, dividend received from a company subjected to tax under

the provision of the petroleum profit tax act, dividend received from investment in

wholly export oriented business, dividend from small business in the manufacturing

sector in the first five years etc.

Zero/Reduced Tariffs: Government can grant two types of tariff incentives. On the one

hand, they can reduce or eliminate tariffs on imported capital equipment and spare parts

for qualifying investment project. This has the effect of reducing the cost of investment.

On the other hand, they can increase tariffs on the final products of the investor in order

to protect the domestic market from import competition.

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Investment Tax Credit: Investment tax credit may be flat or incremental. A flat

investment tax credit is earned as a fixed percentage on investment expenditure incurred

in a year on qualifying capital. In contrast, an incremental investment tax credit is earned

as a fixed percentage of qualifying expenditure in a year in excess of some bases that is

typically a moving average base.

Export Promotion Zones (EPZ): Nigerian export promotion zone was established by

Decree no 34 of 1991: the decree provides for the establishment of a geographical

enclave within the country, to which normal customers’ tariffs or duties do not apply. In

other words, EPZ is an incentive provision for exporters within nation’s customs

territory, which provides an attractive environment for doing business especially in an

otherwise not to attractive environment, Opara and Opara (2010). The first export

promotion zone in Nigeria is located in Calaba, and the foundation was laid on November

7th 1991, by the ten president of the Federal Republic of Nigeria- General Ibrahim B.

Babangida.

2.6 Associated Cost of Tax Incentives

Bruce (2004), indentified the following cost that is related to tax incentive, and they

include:

Forgone Revenues: the losses of tax revenue from tax incentives come from three

sources; first the forgone revenue that otherwise would have been collected from the

activities undertaken, second the forgone revenue from project that would have been

undertaken even if the investor do not receive any incentives, and third, lost revenue from

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investors and activities (taxpayers abuse) or shift income from related firms to those

firms qualifying for favorable tax treatment.

Resource Allocation: originated when tax incentives creates distortions on investment

choices among sectors or activities instead of correcting market failures.

Enforcement and Compliance Cost: these cost increases with the complexity of the tax

system and the fiscal incentives (in terms of qualifying and reporting requirements).

Additionally, there is a problem of fairness when targeted incentives are used, which

reduces compliance and, therefore, increases enforcement cost.

Lack of Transparency: when the rational of granting tax incentives is based more on

discretionary and subjective qualifications requirement, instead of automatic and

objective requirement, they can originate negative behavior among investors and

facilitate officials’ abuse on the granting process.

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REFERENCES

Bruce .B. (2004), Effectiveness and Economic Impact of Tax Incentives in the SADC Regoins.

Submitted to the SEDC Tax Subcommittee.

United Nations, New York and Geneva (2000), Tax Incentives and Foreign Direct Investment: A

. Global Survey

NEPC (2001), Export Incentives in Nigeria. Federal Government Printing Press, Lagos. Nigeria

Opara .B.C and Opara .N.C (2010), Analysis of Government Policies and Nigerian Firms Export

Marketing Strategies. International Bulletin of Business Administration.

Onah .J (2009), A Model of Export Promotion for Nigeria.

Ojo .S. (2009). Fundamental Principles of Nigerian Tax. 2nd Edition. Sabribra Tax Publications,

Lagos.

Philips .A. (2006), The Significance of Nigerian income Tax Relief Incentives. The Nigerian

Journal of Economics and Public Finance

Shah A. and Toye .J. (2000), Fiscal Incentives for Firms in some Developing Countries: Survey

and Critique. London; Fran Cass.

Steven .C and Ana C.(2007), Tax Incentives For Investment- A Global Perspective: experiences.

In MENA and non MENA Countries

Soyode .L. and Kajola S.(2006),Taxation: Principles and Practice in Nigeria. 1st Edition, Solicin

Press. Ibadan

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William .L and Erick .H (2005), Executive Insights: Global Marketing Management at the

Dawn. Of the New Millennium. Journals of International Marketing

.Ifueko .O.O. (2009), Tax Incentives for Foreign Investors in Nigeria. The Nigerian Investors

Business Forum, Berne Switzerland.