What is Withholding Tax?
Withholding tax is not an income tax like personal income tax or company income tax. It is an advance payment of income tax aimed at reducing the tax liabilities of the taxpayer. Withholding tax is chargeable on specific transactions and it is deductible at the source of income inflow. This tax is charged at the rate of 5% -10% depending on the transaction.
Business owners (including unregistered business entities) have the responsibility to charge and collect withholding tax where appropriate.
How is Withholding Tax in Nigeria Calculated and Deducted?
Withholding tax is deducted directly from the source — at the point of transaction – where revenue comes in.
Here’s an example:
A business owner enters into a contract of supply worth NGN 2-million. The relevant withholding tax rate is assumed to be 5%. The purchaser upon the payment of the purchase sum would deduct NGN 100,000 from the invoice of the supplier and pay to the relevant tax authority.
When paying the withholding tax, the business owner would collect evidence of payment known as a withholding tax credit note from the tax authority and issue it to the supplier. The supplier at the end of the tax year when paying his income tax can use the withholding tax credit note to reduce his income tax liability.
Where the tax withheld is that of the business owner’s company, payment should be done to the FIRS authority within 21 days after deduction.
If the tax withheld is the personal income tax of the business owner, payment should be made to the relevant state tax authority within 30 days after deduction.
What is the effect of Withholding tax on a Business Owner tax liability?
Withholding tax reduces a business owner’s income tax liability. If the withholding tax remitted is more than the business owner income tax liability, the business owner can apply for a refund.
The tax authority is to pay such a refund within 90 days after the tax assessment. Where the tax authority fails to pay the refund, the business owner has the right to bring a claim against the tax authority. This right ceases to exist after six years of the assessment.
In practice, the tax authority often proposes to the business owner to use such excess to offset future income tax liabilities. Nonetheless, if the excess withholding tax remitted is more than the personal income tax of the business owner, it is not refundable.
A Withholding Tax Credit note is a document issued by the tax authority showing that the taxpayer has undergone a withholding tax deduction.
If contains the following information:
- The credit note number;
- The name of the taxpayer who charged and remitted the WHT;
- Name of the beneficiary whose income withholding tax was deducted from;
- Nature of the transaction;
- Date of the transaction;
- Amount deducted; and
- The period covered and the name of the bank through which the remittance was carried out.
A business owner cannot use a withholding tax credit note to pay a late returns penalty.
Failure to pay withholding tax attracts a penalty of 10% per annum of the taxes withheld under Section 82 of the Companies Income Tax Act. (Lagos State Board of Internal Revenue v Cradle Productions and Services Limited TAT/LZ/PIT/054/2021).
Under the Personal Income Tax Act, the penalty is 10% of NGN 5000 or 10% of the tax withheld, whichever is higher. This is paid in addition to the tax due and often includes an interest at the prevailing commercial rate under Section 74(1) of PITA.
Is there a WHT Law in Nigeria?
No. There is no specific law in Nigeria known as the Withholding Tax Act. Nevertheless, since withholding tax is a form of prepaid tax on income tax, the income tax laws govern withholding tax in Nigeria.
These laws are the Personal Income Tax Act (PITA) and Company Income Tax Act (CITA), which were amended to provide for withholding tax. These laws also provide for withholding tax rates and the transactions and income, which are to be subject to withholding tax.
In addition to these laws, the Withholding Tax Regulations, 1997 governs the payment of withholding tax in Nigeria.
Agents for collection of withholding tax include the following:
· Individuals, Business Owners (Sole Proprietors)
· Statutory Bodies and Public Authorities.
However, for corporate entities and sole proprietors not registered with the Corporate Affairs Commission, and get a withholding tax deduction, the relevant state tax authority is responsible for collection.
For unregistered sole proprietors and companies operating within the FCT, the FIRS is responsible for the collection.
What transactions/Income can be charged Withholding Tax and at what Rate?
Most withholding tax is deducted from transactions involving a purchase or supply contract, rather than sales done in the course of everyday business.
Here is an example:
If you sell general merchandise like cereal, butter, detergent, etc. it is not subject to withholding tax on income from the daily purchase of such items. However, when a customer makes a large order for cereal, it becomes a contract of supply and income earned would be subject to withholding tax at 5%.
Here are key transactions subject to withholding tax:
Dividends, Interests and Rents:
Income from dividends, interests, and rents are subject to a withholding tax rate of 10%.
Dividends paid to a business owner are subject to a withholding tax rate of 10%. Where the dividend received is from an oil-producing company, it is not subject to withholding tax.
Where the business owner’s company pays dividends to its shareholders, it is to deduct withholding tax before paying the dividends to its shareholders.
Rent paid to a business owner from leasehold properties or transactions are subject to withholding tax at a 10% rate. Examples of such rental income includes agricultural rent, rent from tenancy agreement, etc.
Nonetheless, rents from the charter or lease or hire of equipment, goods, and non-leasehold properties are not classified as rental income. These transactions are classified as contracts of service.
Interests paid to a business owner on any income or transaction is subject to withholding tax at 10%. Interests paid on an interbank deposit are not subject to withholding tax.
Hire/ Charter/ Lease of an Equipment Contracts
Income from the hire/charter/lease of an equipment is subject to a withholding tax rate of 10%.
The hire/ charter/ lease of equipment or chattels or non-leasehold properties are contracts of service. Income paid to a business owner from these contracts is subject to withholding tax at the rate of 10%.
Income from royalties is subject to a withholding tax rate from 5% and 10%.
Royalties are payment for the right to use a moveable or intellectual property such as a patent.
Royalties earned by a business owner operating as a sole proprietor are subject to withholding tax at the rate of 5%. While royalty earned by a business owner’s company is subject to withholding tax at the rate of 10%.
Construction (Roads, Buildings and Bridges)
Income from construction agreement is subject to a withholding tax rate of 2.5% and 5%.
Any income obtained from construction contracts of all kinds is subject to withholding tax at the rate of 2.5% for business owners operating as a company. While business owners operating as sole proprietors are to charge 5%.
Commission, Consultancy, Technical, Professional/ Management Service Fees
Business owners operating as companies, who receive any of these services can charge withholding tax on the fee paid at the rate of 10%. Business owners who operate as sole proprietors can charge withholding tax at the rate of 5%. Consultancy and Technical services are classified as special services requiring special skills or knowledge.
According to FIRS Information Circular No. 2006/02 services provided by a business that has the name ‘consultancy’ as part of its name may not classify as a consultancy or technical service. The content of the service would be looked into to see if it amounts to a consultancy service. Where it does; the appropriate rate will apply.
Here is an example;
If an engineering company is carrying out a construction activity, the proper classification for the services is ‘‘construction’’ as opposed to Professional/Technical services.
Similarly, the use of industrial machinery to provide a service does not classify such service as ‘‘technical’’. This is because most industries require that only arrangements that involve a transfer of Technology would classify as technical.
Moreover, withholding tax is chargeable on all types of contract activities and arrangements, other than sales done in the ordinary course of business.
The application of this is quite wide and may apply to all kinds of contracts, especially among manufacturing businesses.
To limit the application of this to all manufacturing contracts, the FIRS came up with the following exceptions, where withholding tax would not apply:
- Complimentary Contracts:
Where there is a complementary and dual relationship between the parties, withholding would not be chargeable.
Here is an example:
A cocoa farmer supplies cocoa to a chocolate factory, the purchase price of the contract would not be subject to withholding tax . This is because a complementary relationship exists between the parties.
- Tripartite Contractual Relationships:
A tripartite contractual relationship which can ease into a dual relationship may or may not be charged withholding tax depending on the circumstances.
Here is an example:
Where a manufacturer of chocolate hires an agent to source cocoa from a cocoa farmer for his chocolate factory. This relationship may ease into a dual relationship where the manufacturer decides to directly source cocoa from the cocoa farmer.
If the tripartite relationship exists and the manufacturer finances the sourcing of the cocoa, the purchase price of the contract would not be subject to withholding tax. Nonetheless, the agent’s service fee is subject to withholding tax.
However, where the agent funds the sourcing of the cocoa, the purchase price is subject to withholding tax.
- Distributors and Dealers Relationships:
Where a manufacturer delivers its normal products to its distributors and dealers for sale, the purchase price of the contract would not be subject to withholding tax. As such, contracts are sales made in ordinary course of business. However, the commission earned by the distributors and dealers would be subject to withholding tax.
What Income/Contracts are not subject to Withholding Tax?
The following income received by a business owner is not subject to withholding tax:
- Any income exempted from income tax under the Personal Income Tax Act and Company Income Tax Act, is not subject to withholding tax.
- Income obtained from the payment of an insurance premium or dealership is not subject to withholding tax.
- Interests paid on interbank deposits are not subject to withholding tax.
- Dividends paid by an oil producing company are not subject to withholding tax.
- Sales in the Ordinary Course of Business:
The Withholding Tax Regulations 1997 exempt income from sales done in the ordinary course of business from withholding tax. In practice, the revenue authority mandates business owners to charge withholding tax on all forms of contracts. As failure to do so attracts a penalty from the revenue authority.
Nevertheless, business owners and legal experts have over the years challenged this practice of the revenue authority. As it has led to a reduction in the profit of business owners.
Legal experts are of the opinion that the FIRS lacks legal authority to support this practice. This is because the FIRS lack circulars, laws, or regulations clearly defining and justifying this practice.
However, the decision of the Tax Appeal Tribunal in (Tetra Pak v FIRS) states that sales from the ordinary course of business should be exempt from withholding tax.
It further stated that defining what ‘sales in the ordinary course of business’ was a question of fact. As in his opinion the tax authority has the obligation to determine whether a business activity is ‘sales in the ordinary course of business.’ In determining so, the following guidelines are to be considered:
- the history of the business owner;
- frequency of the transaction;
- nature of transactions/activities listed in the memorandum of association; and
- practice in the taxpayer’s industry.
Business owners should embrace the aim behind the introduction of withholding tax. This is because it encourages voluntary compliance and reduces the cost of collection for the government.
Moreover, business owners should be careful to deduct the appropriate withholding tax rate. As charging the wrong rate may lead to a reduction in profits or an illusioned increase in profits. Therefore leading to penalties levied by the tax authorities as well as loss of income by the business owner.
If you have further questions about the withholding tax and how it relates to you, book a free session with an expert.