A synopsis of the key highlights, the grey areas and the blind spots!

ARGUABLY the two most dynamic aspects of life and living today are technology and taxation. While technology is not the focus of this discuss, taxation clearly is. As you may already be aware, listed and significant public entities are required to adopt the International Financial Reporting Standards (IFRS) for the preparation of their financial statements for year 2012. Other public interest entities and small and medium-sized entities are to convert for the first time with their financial year 2013 and 2014 respectively.

One of the major challenges that all entities adopting IFRS will face is the tax implications of various transition adjustments that may arise from recognition, de-recognition, reclassification and re-measurement of certain items in the financial statements which are to be treated differently under IFRS compared to the respective treatments under Nigerian accounting regulations.

To address this issue the Federal Inland Revenue Service (FIRS) on 23 April 2013 released an Information Circular on the Tax Implications of Adopting the International Financial Reporting Standards in Nigeria. This is to give clarity on the tax effects of transition adjustments, provide guidance on the preparation of first IFRS-based tax returns and outline possible areas where parallel records may have to be maintained for tax purposes post adoption.

It is important to state that the FIRS do not have powers to amend the tax laws or issue a new regulation other than to give effect to the existing provisions of the tax laws. There are however some areas where the provisions of the law are ambiguous or where the law is silent due to the fact that an issue may not have been envisaged at the time of enacting the law many years ago.

This article outlines the key provisions of the FIRS Information Circular, the positive sides of the clarifications provided, the grey areas which remain controversial and the blind spots being the areas not addressed by the FIRS.

Some of the key highlights include the fact that impairment losses on non current assets will not to be allowed for tax purposes, while amortisation of certain intangible assets such as software will be allowed as tax deductible. Borrowing cost capitalised with the cost of asset will qualify for capital allowance. Stock of spare parts and servicing equipment should continue to be carried as inventory and expensed for tax purposes. This is also applicable to returnable packaging materials which will continue to be treated as inventories. This means input VAT can be claimed as before.

The granting of interest free loan, price reduction and complementary goods by an employer to his employees is regarded as benefit-in-kind subject to tax in the hands of the employees. Financial Instruments (FI) classified as Fair Value through Profit or Loss (FVTPL) are trading revenue in nature and therefore liable to companies income tax, except they are specifically exempted from tax. FI classified as Held to Maturity Investments (HTM) or Available for Sale (AFS) are capital instruments. Consequently the Capital Gains Tax Act will apply to gains or losses derived from such instruments.

The FIRS will disregard any notional, implicit or effective interest rate used in calculating any interest income or expense. In all cases, only the contractual interest rate will be allowed. Any fee elements included in the effective interest amount will be isolated and subject to VAT and withholding tax (WHT) as appropriate notwithstanding that it may be described as finance charge in the accounts. Compound financial instruments will be treated in line with their legal form. For instance, a convertible loan will be regarded as a pure debt instrument for tax purposes. Also, redeemable preference shares will be viewed as equity and the related returns as dividend to be disallowed for tax purposes.

The Circular contains a number of favourable provisions which are in the interest of taxpayers. For instance, first time adopters may be granted up to 3 months extension for the purpose of filing their first IFRS based tax returns. Where a company is liable to minimum tax this will be calculated without regard to the transition adjustments which may have impacted the net assets. Also, and as already the case, there is no capital allowance for land but deductions can be claimed for the amortisation of leasehold land (effectively as rent for the use of land). Provisions for asset decommissioning will not be allowed but funds set aside in a sinking fund for decommissioning will be allowed.

There are however some grey areas. Excess dividend tax at 30% is applicable to dividend distributed from reserves resulting from any transition adjustments depending on whether the taxpayer was previously subjected to excess dividend tax or normal tax. Professional fees and valuation expenses relating to revaluation of PPE shall not be allowed for tax purposes. In order to componentise any non current assets, it is required that significant component for tax purposes must be at least 20% of the cost of the asset. This will result into additional burden for the taxpayer as a different asset schedule may be required for tax purposes given that no such threshold is required by the accounting standards.

Where capitalisation of borrowing cost is suspended at a period when active development of a qualifying asset is interrupted, the related interest expense charged to the income statement will be disallowed for tax purposes. Financial instruments designated as FVTL to be treated as a separate line of business for tax purposes if different from entity’s activities. This may prevent the taxpayer from taking deductions for eligible expenses against general business income. FVTL may not necessarily create a different line of business to be ring-fenced.

In addition, certain areas were not at all addressed in the Circular. These are the blind spots which include insurance business, withholding tax implications of share based payments for goods and services, VAT treatment of products used for promotional activities, rebates or trade discounts, and tax treatment of impairment loss on loans and trade receivables. Also, the treatment of lease arrangement between a party who has adopted IFRS and another party who is yet to adopt IFRS due to different timing required for adoption was not addressed.

In terms of filing IFRS-based tax returns, as a result of IFRS adoption, taxpayers are required to provide additional information in their tax returns. These include a reconciliation of the Nigerian Generally Accepted Accounting Principles (NGAAP) to IFRS transition adjustments showing the analysis of the tax impacts (applicable to first time adopters only). Deferred tax computation and analysis to be provided as well as a breakdown of adjustments made to Income Statement or Total Comprehensive Income in arriving at the assessable and total profit.

Others are a re-computation of income and deferred tax showing the impact of changes in estimates, change in accounting policies or errors; schedule of impairment losses recognised in the Income Statement and Other Comprehensive Income (“OCI”); the breakdown of componentised assets with the basis for determining the value of each component and a reconciliation between the total cost of non current assets under NGAAP and componentised cost of same under the IFRS for first time adopters.

In conclusion, I commend the FIRS for issuing the Information Circular to guide taxpayers. I expect that over time, some of the grey areas and blind spots identified earlier will be addressed through additional guidelines or regulations where necessary.  On issues of interpretation the Circular will be very useful in guiding taxpayers regardless of whether they agree with the FIRS position or not. However, there are a few areas where the Circular seems to have strayed beyond interpretation and guidance in which case the FIRS position in these areas will be mere indications of intention. The long term solution will be to amend the relevant tax laws a process that can be initiated by the FIRS but ultimately rests with the National Assembly.

Taiwo Oyedele is a Partner and Head of Tax and Corporate Advisory at PwC Nigeria. He is a regular writer and public speaker on accounting and tax matters.