Reforming Nigeria’s Tax Incentive Program
Introduction
Section 29 of the Fiscal Responsibility Act, 2007 requires any proposed tax expenditure to be accompanied by an evaluation of its budgetary and financial implications in the year it becomes effective and the subsequent 3 years. It also requires the need for the tax expenditure to be supported by countervailing measures for the same period. Unfortunately, the Nigerian Government has never complied with this provision. However, for the first time, the government stated, in the 2021 budget, the tax expenditures incurred in respect to some taxes such as companies income tax, VAT and custom duties. It should be noted that stating just the tax expenditure is not enough, we need information such as the naira cost of the job created by the various tax incentives to enable us to assess the effectiveness and the efficiency of the tax incentives.
International organizations have often called on developing countries to review and reform their tax incentives program because they believe that some of the incentives granted are redundant. This means that investors would likely have made the investment without the incentives. There is also the issue of other considerations that investors assess before making investment. Such considerations will include political and economic stability, availability of skilled labour, local markets and the transparency of the legal framework.
Nigeria’s incentives package is largely in alignment with international best practices, especially in areas such as inclusion of sunset provisions, transparency and clarity in eligibility criteria. However, there are issues that the government needs to address to make it more effective and efficient. This is the thrust of this article.
Issues with the Tax Incentives program
High Tax Expenditure – Grant of tax incentives may reduce opportunities for the much-needed revenue for public infrastructure such as roads, bridges, mass transit, airports, power supply and hospitals. The simple reason is that anytime tax incentives are provided, there is loss of revenue to government, at least in the short term. However, where the incentive granted is cost-based, like the road infrastructure development and refurbishment tax credit, the benefits may far outweigh the tax expenditure. According to the Honourable Minister of Finance, the tax expenditures for companies income tax, VAT and customs duties are N1.2 trillion, N3.1trillion and N347billion, respectively. This seems high relative to other comparable countries.
Profit-based Incentives – Though Nigeria applies both the cost-based and profit-based incentives, there is a preponderance of profit-based incentives. While a cost-based incentive reduces the cost of investment, a profit-based incentive reduces the applicable rate of tax. Profit-based incentives will include tax holidays, preferential tax rates and income exemptions. Research has shown that profit-based incentives are more effective in attracting investment and are being used broadly by developed nations. These countries rely more on investment tax credits and favourable treatment of R&D credits. Consequently, many less-developing countries are moving away from cost-based to profit-based incentive schemes.
Proliferation of tax incentives – Undoubtedly, Nigeria has many incentives that have been driven by the need to compete favourably with other African countries in order to attract investment. Such competition has led to the so-called race to the bottom that has benefited mostly the investors in these countries. The relevant question that still needs to be answered is whether all these incentives have yielded the desired benefits to the country.
Lack of quality data – The major dilemma that faces every government is always how to strike a balance between creating an attractive tax regime for investment and generating enough revenues for public spending. A related issue is also how to determine whether to continue, reform or stop an incentive scheme. To be able to take informed decisions on these matters, quality data must be available. Unfortunately, this has been the bane of most developing countries, Nigeria inclusive. There is no adequate data and or analytical tools and skills required to facilitate the analysis. Interestingly, Nigeria Investment Promotion Commission (NIPC) recently removed cement as a pioneer product based on an impact assessment analysis conducted. It would be desirable if such analysis is made publicly available.