Ann Olalere and Mayowa Falohun of KPMG evaluate the provisions of Nigerian tax law relating to mergers and acquisitions. They suggest amendments to the law which would encourage more mergers and acquisitions and bring in needed foreign direct investment to the Nigerian economy.
Mergers and acquisitions (M&A) deals have become popular In Nigeria as they provide an avenue for companies to meet with regulatory requirements. In 2018, the Acting Director-General of the Nigerian Securities and Exchange Commission (SEC) reported that the Commission had approved about 120 merger-related transactions in the three years up to 2018. We expect this number to increase in the future, especially for financial services sector players. This is due to the ongoing regulatory driven recapitalization for banks, insurance companies and microfinance banks.
However, the provisions of the Nigerian tax laws are insufficient in their application to M&A. While the Federal Inland Revenue Service (FIRS) issued an Information Circular in 2006 on the taxation of M&A, it did not address some of the relevant issues. It should also be noted that a circular does not carry the force of law.
In addition, the provisions of the Companies Income Tax Act (CITA) Cap. C21 LFN 2004 on trade or businesses sold or transferred have not been amended since its introduction in the CITA in 1979, except with the amendment in the Finance Act 2019 which will commence in 2020 when the Minister of Finance announces a commencement date. However, the Finance Act 2019 (the Act) merely introduces a time limit condition for related companies to enjoy the commencement and cessation exemption in an acquisition and grant value-added tax (VAT) exemption on assets sold or transferred in M&A deals involving related companies.
In this article, we will evaluate the need for the legislature to amend Section 29(9) of the CITA and grant concessions to companies undergoing merger or acquisition deals, especially considering that there are regulatory requirements for these M&A transactions.
Section 29(9) of CITA—the State of the Law
Section 29(9) of the CITA provides that where companies are related and there is a merger or an acquisition, the FIRS may direct, on application by the relevant parties, that commencement and cessation rules should not apply. This means that the company being transferred will not be seen as having ceased business, and the company emerging in the case of a merger, or the company acquiring in the case of an acquisition, will not be deemed to be a new company that has just commenced business.
The Section also provides that assets transferred during such business arrangement shall be deemed to be transferred at the “residue of the qualifying expenditure” (this is assumed to be the cost of the asset less any capital allowance claimed). Also, the buyer company acquiring each such asset shall not be entitled to any allowances deemed to have been received by the vendor company. This means that any allowance deemed to be received although not utilized, may not go to the buyer company. In addition, the surviving company can only claim annual allowance on the residue of the qualifying expenditure for any outstanding year not claimed by the first company.
This provision does not mention how any unrelieved tax loss should be treated by the emerging or acquiring company. Therefore, most companies typically approach the FIRS for clarification on how to treat unrelieved tax loss and unutilized capital allowances during mergers or acquisition.
In addition, Section 29(9) is completely silent with respect to a business sold or transferred by unrelated companies. The tax law has no provision for the treatment of unrelieved loss, unutilized capital allowances and applicability of commencement and cessation rules. While the FIRS circular on tax implications of M&A attempts to address this lacuna, judicial precedence, notably Warm Spring Waters Nigeria Limited & Ors vs FIRS in 2015 (Suit No. FHC/L/CS/157/2015), has shown that FIRS circulars are not legal documents but mere advisory opinions for the guidance of taxpayers, and do not carry the force of law.
Key Tax Considerations for Amendment to Tax Laws
Most M&A result from the need to comply with regulatory requirements or as a result of restructuring within a group; most involve applying to the Federal High Court (FHC) to sanction the proposed merger. This process will involve filing several documents, including the scheme document, originating summons, shareholder resolutions, etc. with the FHC. Upon approval of the merger by the Federal Competition and Consumer Protection Commission (FCCPC) and/or SEC (where companies involved are public companies), the companies will be statutorily required to make public the merger (in national newspapers) and file any relevant statutory documentation. As part of this process, the surviving company is allowed to assume ownership of the assets and liabilities of the transferring company.
However, in practice, a company faces barriers to utilizing the tax assets paid for after a merger or an acquisition (i.e. the unrelieved tax loss and unutilized capital allowance, which form part of the deferred tax assets). Therefore, the company may suffer the loss of the value of the tax asset, which may have been considered in the overall value placed on the M&A transaction.
Based on the above, we suggest that such companies be granted the following concessions by an amendment to the CITA as proposed below:
Inclusion of a provision under Section 29(9) of the CITA to allow automatic transfer of unrelieved tax loss and unutilized capital allowance between related companies or companies undergoing a court-ordered M&A. This provision will allow unrelieved tax losses and capital allowances computed but not utilized by the transferring company to be transferred and utilized. This will facilitate the M&A process and ease the tension around what value to place on deferred tax assets arising from unrelieved losses and unutilized capital allowance in valuing a company. It would also save the FIRS manpower hours in auditing every company undergoing M&A to ascertain what tax asset can be transferred.
Amendment of Section 29(9)(b) and (c) of the CITA to allow an asset sold between unrelated companies in a court-ordered M&A to be treated as an asset transferred at tax written down value. This provision already exists for related companies under Section 29(9)(b) of the CITA. Therefore, this concession should also be extended to unrelated companies which undergo M&A driven by regulatory requirements. This amendment will reduce the tax obligation for a ceasing company and ensures consistency in capital allowance claimable by the surviving entity going forward.
Amendment of Section 29(9) to remove the need for FIRS’ approval to enjoy these incentives. This will reduce the administrative bottlenecks involved in obtaining a timely response from the FIRS before the sale consideration is determined, based on the value placed on the tax assets being transferred.
Removal of the application of commencement and cessation rules on transfer as a result of a court-ordered M&A. This should allow regulatory driven M&A whether between related or unrelated companies to be exempted from the commencement and cessation rules. This provision will ensure a seamless continuation of the surviving business. It would also ensure that the FIRS’ attention is directed towards the continued business rather than the ceased business.
We are aware that the Finance Act 2019 has amended the onerous commencement and cessation provisions in the tax law. Therefore, this issue has been addressed.
Practice in Other Jurisdictions
Singapore tax authorities allow amalgamating companies to transfer unabsorbed capital allowances and losses to the surviving entity in a qualifying corporate amalgamation provided the businesses of the amalgamating companies continue in the amalgamated company.
Hong Kong also permits that in a merger or acquisition that does not require a court sanction, pre-amalgamation tax losses sustained in an amalgamating company would be available to offset from profits derived from the same trade or business that was previously carried on. This implies that related companies carrying on the same business can, upon merging, inherit tax assets as a continuing business which improves the overall efficiency of the group. For unrelated companies, the tax loss is lost.
Similarly, in Ghana, losses and bad debts incurred within a year prior to a change in ownership of a company are not deductible; although tax losses incurred by a venture capital financing company from disposal of shares in any venture investment shall be carried forward for a period of five years from the date of disposal.
In the U.K., tax losses and capital allowances are not automatically transferred upon asset acquisition. However, where the buyer desires to acquire a company’s trade together with its tax trading losses or capital allowances, a system can be established where a middle buyer purchases the company and then sells it to the ultimate buyer; this preserves the tax losses or capital allowances. Tax losses can be utilized by other companies within a group where the business is transferred within the group (provided, in the case of losses arising prior to April 2017, that they are utilized in the year in which they arose).
Although certain countries do not permit transfer of unabsorbed capital allowances and losses, they provide other benefits to support amalgamating companies. For example, the South African Revenue Service, permits interest incurred on debt used to finance acquisition of shares to be tax deductible where a South African company acquires at least 70% equity shareholding in another South African operating company. Also, where a business is sold as a going concern within a group, VAT is payable at zero rate (i.e. charged with VAT but at 0%), subject to certain conditions.
To Sum Up
The 2019 Finance Act would have been an avenue to introduce the required changes to this section: however, the issues noted here have not been addressed by the Act. On the contrary, the amendment introduced by the Act to Section 29(9) attempts to discourage companies from undertaking M&A solely for the purpose of avoiding tax, by including a section rescinding benefits enjoyed where assets of the surviving company are disposed within 365 days after the date of the transaction.
The Act now exempts VAT on assets transferred in a business reorganization between related parties. While this is laudable, inclusion of the exemptions highlighted above will significantly impact M&A in Nigeria and permanently address the lacuna in Section 29(9) of CITA.
Further, the amendments we are proposing will encourage more M&A in the different sectors of the economy, as they will ease one of the difficulties companies face in meeting with regulatory-driven M&A. It may also enable them attract buyers, both local and foreign, and encourage foreign players to support the relevant companies in meeting the necessary capital requirement. They would also bring in much-needed foreign direct investment that the Nigerian economy requires to bridge the budget deficit in 2020 and beyond.
Ann Olalere is Manager and Mayowa Falohun is Senior Adviser Tax, Regulatory & People Services, KPMG in Nigeria.
The authors can be contacted at: ann.olalere@ng.kpmg.com; mayowa.falohun@ng.kpmg.com
