The Cake that is Cut Twice and Section 19 of the Companies Income Tax Act

AUTHOR: IBRAHIM MUHAMMED

Student (LL.B), Faculty of Law, University of Lagos

If you were to cut a cake twice that was promised to be cut only once, you will not only have fewer portions to share but you would have reneged on your initial promise to cut it once only. This simple analogy explains the utilisation of Section 19 of the Companies Income Tax Act (CITA) to tax company dividends which by virtue of Section 80 (2) of CITA is to be taxed at a rate of 10%. CITA and other relevant tax statutes represent the promise and the FIRS is the knife that cuts the cake of company revenue twice whenever section 19 of CITA is invoked. Thus, companies are not taxed 30% but 60% in reality.

The law of taxation is to be applied literally unless it is ambiguous and all ambiguities are to be resolved in favour of the tax payers. Hence, it is submitted in this paper that the decision of the Tax Appeal Tribunal on 18^th July 2014 in Oando Plc v FIRS 4 TLRN 113 was not only per incuriam but also contrary to global best practice on industrialisation polices.

Section 19 states:

Payment of dividend by a Nigerian Company:

Where a dividend is paid out as profit on which no tax is payable due to-

1. No total profits; or
2. Total profits which are less than the amount of dividend which is paid, whether or not the recipient of the dividend is a Nigerian company,

is paid by a Nigerian company, the company paying the dividend shall be charged to tax at the rate prescribed in subsection (1) of section 40 of this act as if the dividend is the total profits of the company for the year of assessment to which the accounts, out of which the dividend is declared relates.

Section 19 which is an omnibus provision enables the FIRS to deduct from would-be tax evaders who either do not have a total profit or have profit but have paid out more dividends than the declared profit. It is commendable and more prudent to charge the dividends and not the profit in determining the accurate tax liability of the company when the company has either through acts of fraud or negligence reported profits that are less than dividends paid out to shareholders, for companies cannot be used as an instrument of fraud as was stated in Adams v Cape Industries [1990] Ch 433. Likewise, “whenever a company declares no profit but goes ahead to pay dividends, the company represents to its shareholders and indeed the whole world that it has made profit and it must therefore pay tax” as was stated per Abdullahi Mustapha CJ in Oando Plc v FIRS Supra.

However, it is argued that section 19 cannot be invoked when the source of the revenue is via non-taxable avenues. For indeed even the laws of taxation should not permit the rescission of rights created after a party has presented facts that have caused another individual to act and alter their position. The FIRS should be bound by the principle of legitimate expectation (Stitch v AG Federation (1986) 2 N.S.C.C 1389) like all other administrative arms of government after they have caused individuals to rely on facts presented.

It is important to note that the Tax code of any given jurisdiction are implemented not only for the single purpose and total fixation on revenue generation but also with the aim of facilitating trade and commerce. Thus, tax incentives such as tax holidays, free trade zones, and multilateral and bilateral agreements are examples of would be non-taxable revenues even when a company has made profit in a financial year. Furthermore, nothing prohibits a company from retaining already taxed revenues for any purpose it so deems and there is also a possibility of excess dividends whenever dividends are shared out.

Should section 19 be applied to the non-taxable incomes and to re-tax these already taxed revenues?

The Tax Tribunal in the case of Oando Plc v FIRS II (2013) 11 TLRN 169 at 173 stated four steps required to determine whether Section 19 is applicable.

1. Firstly, why was no tax paid? This could either be as a result of there being no taxable profits or taxable profits being less than dividends paid out to shareholders
2. The second step is to regard any dividend paid as the taxable profits of the company.
3. Thirdly, the actual taxable profit for the current year should be deducted from the dividend (deemed taxable profit) to determine the excess.
4. The final step is to apply the tax rate of 30% to the excess under step 3.

With regards to the first step, it is argued that the existence of non-taxable profits needs not mean that the company declared a loss but should be construed to mean that there existed extrinsic legal reasons and exemptions that resulted in there being no taxable profits. Examples are Pioneer companies as stated in Industrial Development (Income Tax Relief) Act, Section 3 (6) that are tax exempt for up to the first 3 initial years after incorporation or companies that are part of a free trade zone agreement. Furthermore, there exists an irrefutable presumption that any dividend paid is to be from the profit of the company for indeed a company may not pay dividends unless it has recorded a profit else the directors would be personally liable. Thus, the source of the profit is of import and must be examined closely. Thus, a company that made N1, 000,000 should not be taxed through section 19 if it operates exclusively within a 0% Free Trade Zone or is a Pioneer Company.

Furthermore, the second and third step is unsatisfactory as it does not take cognizance of the possibility of mixed funds or already taxed profits. A company is free to regulate its affairs as it deems. Therefore, there is nothing illicit in paying taxes on profits for the year but not paying out dividends till next financial year. Thus, excess dividends or retained profit of previous year may be used to pay dividends or may be mixed with the profit of the taxable new financial year to pay dividends. By making the dividend paid out to be the deemed taxable profit, the law may be applied on already taxed profits or non-taxable profits of previous years and brings double taxation. With regards to retained profit it is important to examine each case on its own facts. Are the retained profits used to reinvest or for accumulated earnings. The latter is a situation in which the company is portrayed in such good lights that the stocks are deemed to be of premium value and thus should be taxable whilst the former ought not be taxable in order to stimulate industrialisation and the economy. To fight this tax avoidance strategy, the proper measure is not to apply section 19 but to apply Accumulated Earnings Tax as is done in the United States. Unfortunately, the FIRS does not tax retained profits but seeks to double tax through section 19. Retained profit used as reserved fund on the other hand ought to not be taxed if the aim of government is not only to generate revenue but to also stimulate industry.

Another salient provision on taxation of dividends is Section 80 (3) of CITA which states that:

Dividends received after the deduction of tax shall be regarded as franked investment income of the company receiving the dividend and shall not be charged to further tax as part of the profits of the company.

Thus, even when a company invests in another company through the purchase of shares and receives dividends, the income is non-taxable since the company invested would have either paid tax on the profit or would have paid withholding tax on behalf of the investor.

Conclusively, it is important to note that the tribunal’s decision is contrary to the obiter dictum the Federal High Court judgment in Oando Plc v FIRS (2009) 1 TLR 61 where section 19 was stated impliedly to not apply where the dividends are from retained earnings. While the Tax Tribunal is not bound by this obiter, it is submitted that it represents the true application of section 19 and that the apparent conflict between section 19 and 80 of CITA should be resolved in favour of the tax payer.

In conclusion, Section 19 of CITA should be amended to clearly state that:

1. Already taxed profits should not be taxed again by virtue of deemed dividends being seen as the profit.
2. Exempted revenue is either immune from being considered as profit or are still to be considered as part of profit taxable whenever the company is paying out dividends even though it has declared 0% profit.

This amendment will prevent the FIRS and the Government from acting the role of the knife that cuts twice a cake promised to be cut only once.

Ibrahim Muhammed is a 500 Level Law Student with passion for Commercial Litigation, Intellectual Property and ADR.