Inside Tax : Issue 25 - Impact of tax waiver on bonds and short-term government securities
In recent times, the financial and money market sectors of the Nigerian economy have witnessed substantial growth, so much so that bonds issued by the Federal Government of Nigeria are sometimes oversubscribed. One of the reasons that may be adduced for this is the tax benefits from these investment vehicles and recent tax laws in this direction. Notable amongst these are the Companies Income Tax (Exemption of Bonds and Short-term Government Securities) and Value Added Tax (Exemption of Proceeds of the Disposal of Government and Corporate Securities) Orders – “the Orders”.
The Orders exempt gains from disposal of bonds and government short-term securities from income taxes and value added tax, thereby creating tremendous potentials for these debts instruments.
Prior to the introduction of the Orders, section 8(g) of the Companies Income Tax Act (CITA) provides for trading income (as opposed to gains from long term investment) realized from the acquisition and disposal of short term market instruments, treasury bills, treasury bonds or debenture to be taxed at 30%.
In the same vein, the interest or yields from such securities are liable to tax with a withholding element of 10%, unless the bonds were issued to a foreign entity with a tenor of 7 years and a moratorium (on interest and principal) of at least 2 years. For companies holding such assets on a long term basis, there was a partial exemption. Section 31of the Capital Gains Tax Act, exempts capital gains from the disposal of stock and shares and other Nigerian government securities and treasury bonds from tax. The exemption was limited as it did not apply to interest derived from holding such assets and bonds/debentures issued by corporate entities.
The Orders issued pursuant to the provision of section 23(2) of CITA and 38 of Value Added Tax Act (VATA) have expanded the type of assets covered under the waiver to include bonds issued by corporate bodies in addition to those issued by the Federal Government and State Governments.
The relevant waivers provided by the orders are set out below:
- Income tax exemption on the Interest/yield on the securities thereby obviating withholding tax requirements
- Income tax exemption on the gains accruing on the disposal of the securities. This applies irrespective of the type of income – trading income or capital gains
- Value added tax on the disposal on the securities.
The introduction of these incentives was widely acclaimed by stakeholders and investors in the Nigerian financial and capital market sectors as the importance of these Orders go beyond the “free income” gotten from such investments. The importance transcends the micro level; it has a macro impact on the economy. This is evidenced by the growth in the rate of Foreign Direct Investment in Nigeria (FDI) in 2013; demonstrating increasing investors' confidence in the Nigerian financial and capital market.
On another note, the Orders have curbed one of the issues hindering Nigerian companies' access to long term funds which has been a bane to their development. The removal of taxes on corporate debt enables firms to raise long term capital on the bond market to cater for their huge capital outlay more cheaply than short-term bank loans. It also puts them at par with federal government bonds, thereby making corporate bonds as equally attractive. This has a multiplier effect on the market as private and foreign investors are attracted to the bond markets.
While looking at the benefits of the exemption, it is vital to take a cursory view of its downsides; especially to corporate and state government bondholders. A major challenge to this exemption is that each of the Orders limits its waiver to corporate and state bondholders to a period of 10 years with effect from January 2012. The limitation and uncertainty regarding possible extension of the exemption creates doubt for companies which might otherwise have been willing to invest in bonds with tenors that exceed the life of the exemption granted by the Order. This is more so as the time limit does not apply to Federal Government Bonds.
It is also unclear whether the exemption will apply only to instruments issued after the commencement date or whether it will extend to instruments issued before the date on which the exemption took effect, but which are yet to mature. The Orders are silent as regards this. Arguably, the conservative position would be for the exemption to apply to all income or interest that will accrue to bondholders and investors in short term government securities with effect from the commencement date, irrespective of the instruments' date of issue.
Additionally, the exemption from VAT may appear superfluous as the provision of VAT Act relates to “goods” and services and there is this other view that “chose in action” which includes securities that are not goods; therefore should not be subject to VAT. This view became more pronounced in the celebrated case of CNOOC Exploration Production Nigeria Ltd vs Attorney- General of the Federation & Ors, where it was held that interest in a mining lease (a chose in action) does not qualify as “goods”. While the jury is still out on the full impact of this view, it would have been better for the waiver to apply to transaction costs related to the issuance or transfer of bonds. further explanation of the definition of “goods” under VATA may also be required.
While we understand that there is a move to grant further exemption on the transaction cost, there is no legislation backing this; therefore, all fees relating to the issuance and disposal of bonds are still subject to VAT.