TAX SERIES BY ENIOLA (TAX EVASION AND AVOIDANCE) – SEASON 2
Effects of Tax Evasion and Avoidance
“If the Lord loveth a cheerful giver, how he must hate the taxpayer!” – John Andrew Holmes.
Everyone likes “awuf”.. Announce any treat to a group of people and the first, second, third and fourth questions will undoubtedly be: “Is it free???”
The average human is wary of parting with any form of money. Everyone is ‘managing themselves’. The imposition of Tax is thus not an easy pill to swallow. Instead of letting Government ‘pour sand sand in someone’s garri’, tricks that intentionally or unintentionally amount to Tax Evasion and Avoidance thus come into existence.
Tax Avoidance is taking benefits of the loopholes e.g concessions, exemptions etc, in the Tax laws to avoid paying up to the normal tax rate. It is arranging one’s affairs to take advantage of provisions in the Tax law.
Tax Evasion is using illegal means to escape paying up to the normal rate or paying at all. This is by falsifying one’s financial records and related acts that extend to not paying at all. Some Nigerians have not paid tax in their entire lives!
One swerves between the lines of the Law, the other drives head on and collides with the Law.
Tax avoidance is generally not punishable by law. It is perfectly legal. One is not to be blamed for being smart enough to prevent the Tax authorities from cutting a huge chunk out of one’s pizza. If I want to buy 3 large Tins of Milo and at the supermarket there is a ‘Buy One get One Free Promo’. It doesn’t hurt to buy 2 and go home smiling with 4 Tins of Milo instead.
There is however an argument that there is a distinction between acceptable and unacceptable Tax Avoidance. Unacceptable avoidance schemes aka aggressive tax avoidance planning are described as tax positions that are “…tenable but has unintended and unexpected tax revenue consequences…” – OECD, ‘Study into the Role of Tax Intermediaries’ (2008).
Tax Evasion is generally punishable by law with sanctions.
Tax Evasion and Avoidance frustrate the Reasons for imposing the Tax in the first place. They produce the following effects:
1. Contradiction of Tax draftsman’s intention: If everyone took advantage of the law and avoided tax contrary to the plans of the draftsman, where will the revenue come from?
2. Contradiction of Equity as a Canon of Taxation: The innocent people bear the higher burden to compensate for those who avoid their tax. Those who avoid pay less than their counterparts earning the same profit range instead of equitable, uniform taxes.
3. Stunted Economic Growth: Government is directly harmed as it doesn’t get enough revenue to function properly and redistribute income. It thus loses hundreds of millions of naira and is rendered largely handicapped.
4. Infringement of Socio-Economic Rights: Engaging in Tax Evasion does not only infringe tax laws, it infringes on the socio economic rights of the people in that jurisdiction. There will not be enough financial resources to allocate and redistribute and this hinders enjoyment of rights to health, education among other things.
Reasons for Avoiding Tax
“Anything the Government gives.. or not, it must first take away.” – Adrian Rogers.
1. No Return on Returns: Imagine writing Bar Part II Exams and awaiting the result for 2, 3, 4 years? Or forever? Every time we pay Taxes in Lagos or any State, that State automatically undergoes an Examination. When the results come out and are mainly ‘Conditional passes’ and lots of ‘Fail’, it takes courage to re-sit the Exams.
Such is the life of an uncheerful tax payer who gives Tax Returns without receiving anything to compensate in return. Ironically when everyone avoids, there won’t ever be optimum results in the first place!
2. Corruption/ Bad Governance: What use is washing a Pig when it will jump right back in the mud?
Bad Governance and Corruption means a failure of the Tax Tripod– Tax Policies, Tax Laws and Tax Administration, from the start. This fundamental flaw causes faith in the Government to be lost and tempts people to Avoid taxes thus:
3. Bad Tax Policies: Policies are the basis for the laws. They ought reflect societal needs, familiar payment methods and make room for smooth working of the Tax laws and Tax Administration or they are bound to fail.
4. Bad Tax Laws: Bad laws and inelegant drafting of the Laws give many loopholes for Tax Avoidance. They make for confusing interpretations to the detriment of the Tax system.
5. Bad Tax Administration: Lack of sound direction from the Laws, lack of expertise and information/data leads to major under collection of taxes and mismanagement of the meager Taxes collected after mass Avoidance which makes for a bigger mess of the whole situation. It becomes a vicious circle.
6. Nonchalance: We the people of Nigeria… we know ourselves. Since Tax Avoidance is not even illegal, it doesn’t hurt to Avoid. No need giving all our pizza to the government, right?
7. Multiplicity of Taxes: Too many taxes to pay, gradually leads most people down the Valley of Avoidance.
8. Lack of simplified procedure: If mass compliance is desired, filing of returns should be simplified. It is hard to climb a mountain in the first place, then I’m asked to climb it while solving simultaneous and quadratic equations? ‘Kuku kill me’.
Tax Avoidance and Evasion: Methods
Before continuing, let all lawyers or lawyers-to-be reading this remember that it is highly unethical to assist clients in evading Tax and to breach the Rules of Professional Conduct as provided in Rule 15(3) (a), (i), (j) and Rule 55(1), (2) of the Rules of Professional Conduct for Legal Practitioners.
Some methods of Tax Evasion and Avoidance are as follows:
1. Transfer (Mis) Pricing: It is the price charged for moving goods and services within a body of associated/sister companies. The Organization for Economic Cooperation and Development (OECD) defines Associated companies to mean companies which directly or indirectly control each other or have similar controlling membership.
The innocent purpose of transfer pricing is to enhance the overall value of services of that corporate family. So if Dominos in Nigeria lacks something that Dominos in South Africa has, Dominos in South Africa can sell that service to Dominos in Nigeria, to better the value of the overall brand.
Transfer Pricing is however abused and used as a major Tax Avoidance scheme between Multinational Companies. Goods and services are transferred between subsidiaries or between a subsidiary and the parent company such that the profits are high in countries with low tax rates and low in the countries with high tax rates.
For example, two sister companies Ada Company in Nigeria and Ada Company in Hong Kong are under the Parent Ada Company in Malaysia. They deal in Generators. Ada Nigeria manufactures and sells the Generators to consumers including Ada Hong Kong who resells the Generators to consumers.
If ordinarily, Ada Nigeria wants to sell to Jamiu Company, an independent non sister company who also redistributes generators for sale, it would sell one Generator at 10,000 dollars and make a profit of 5,000 dollars.
If Ada Nigeria sells to Ada Hong Kong for 9,000 dollars which is close to the original market value of 10,000 i.e arm’s length price, Ada Nigeria makes 4,000 dollars profit and after Nigerian Company Income Tax (CIT) of 30% is removed from the 4,000 dollars, Ada Nigeria makes a final profit of 2,800 dollars.
When Ada Hong Kong resells the generators for 10,000 dollars to consumers and makes a profit of 1,000 dollars, Hong Kong Company Income Tax (CIT) of 16.5% is removed and Ada Hong Kong makes a final profit of 835 dollars.
Total profit made to Ada Parent Company in Malaysia from the two subsidiaries on the transaction is 2800 + 835 dollars = 3,635 dollars.
This is a normal, fair enough transaction without Avoiding any Tax.
To engage in Tax Avoidance, Ada Nigeria sells to Ada Hong Kong at 6,000 dollars instead of the 9,000 dollars which is a highly discounted value aka ‘not at arm’s length price’. Ada Nigeria makes 1,000 dollars profit and after 30% CIT is removed, it makes a final profit of 700 dollars.
Ada Hong Kong resells for 10,000 dollars and makes a profit of 4,000 dollars. When Hong Kong 16.5% CIT is removed Ada Hong Kong makes a final 3,340 dollar profit.
Total profit made to Ada Parent Company in Malaysia from the two subsidiaries on the transaction is 3,340 + 700 dollars = 4,040 dollars.
This means that in Avoiding Tax by not charging Ada Hong Kong at arm’s length price aka market value, the profit was shifted from Nigeria to Hong Kong and was taxed lower there at 16.5% leading to an additional 405 dollars made for Ada Company in the end. This is how most multinational companies heavily avoid paying taxes.
They intentionally make reduced profits in countries where tax rates are high and move those profits to countries where tax rates are low. This means that they give government less than they should pay as Taxes.
Tax Havens are countries where the Tax rates are relatively low. These havens e.g. the Cayman Islands are employed by multinationals to avoid Tax through Transfer pricing (do the Panama Papers ring a bell???).
It is worthy of note that the OECD (Organization for Economic Co-Operation and Development ) released 2017 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. The Guidelines are seen as the international consensus on transfer pricing. It provides ways to apply the “arm’s length principle” to prevent Base Erosion and Profit sharing (BEPS) which is simply Tax Avoidance.
2. Artificial Transactions: Not all income is Taxable. Sometimes, artificial, fictitious or frivolous transactions might be added to the non-taxable income which then reduces the income that can be taxed. Section 22 of the Companies Income Tax Act allows such artificial transactions and improper reduction of taxes to be disregarded and renders such transaction taxable regardless.
3. Appreciated Gifts: Imagine buying a piece of land at 150,000 naira in 2004. Now it’s worth at least 10 million naira due to major commercial transactions in the area. If one donates the land as a gift and deducts the 10 million naira from that year’s taxable income, that’s an escape of Capital Gains Tax.
4. Submitting False Tax Returns or No returns : This is a common means of tax evasion which individuals and companies engage in. Companies keep declaring losses but don’t wind up voluntarily or get compulsorily liquidated. Many sole proprietors intentionally engage in cash transactions so that they can report incomes way lower than they actually earn. Many people also seize tax reliefs dishonestly, like claiming a large number of children to get tax allowances. However, new Consolidated Relief Allowance provisions have closed this specific loophole.
5. Avoiding Estate Duty: Giving out a lot of one’s estate before death can reduce the value of the Estate and thus the amount of Estate Tax charged. Setting up a Trust fund in a Will also protects it from liability upon death.
Employees pay tax on their salaries when they receive it. One can defer receiving some of their salary. Doing this allows the savings to grow without taxing over an extended period of time.
Other Tax Evasion and Avoidance methods abound but it is worthy of note that some of our Tax Laws – the Companies Income Tax Act, the Capital Gains Tax Act and the Personal Income Tax Act have enacted provisions to counter many of the avoidance methods.
It is still important to have a direct Tax Evasion and Avoidance legislation in Nigeria with specific methods listed and sanctions. This will curb the bad effects that these mischievous Twins have on our Economy in the long run.
Comments, questions and contributions on any of the Episodes are welcome!
Next week, we will be discussing the Voluntary Assets and Income Declaration Scheme (VAIDS).
Akinoso Eniola is a Tax and Litigation Enthusiast, a Fellow of the Obama Young African Leaders Initiative and the National Matching and International Relations Coordinator for AIESEC in Mauritius. She writes stories and articles to contribute to her AIESEC-cultured love for the SDG’s and to bring pertinent issues in Nigeria to light. The Tax Series by Eniola is her latest initiative to stimulate interest in Taxation.