PwC Nigeria: Business Reorganisation in Nigeria – Key Tax Considerations
A popular saying has it that change is the only constant in life. This is true, especially in business. Organisations have to continuously re-examine their legal and operating structures to ensure they are fit for purpose and are able to compete favourably in the modern business world. This review often results in some internal and, sometimes, external restructuring activities.
Considering the renewed focus on Africa as the next investment frontier, and given that Nigeria is the largest economy on the continent, investors with operations in Nigeria may find it inevitable to restructure their businesses for various reasons. Whatever the motive, business executives must be aware of the possible tax implications before taking the leap.
Business re-organisation usually takes the form of internal restructuring or mergers and acquisition (M&A). Internal restructuring could involve changes to the functions, assets and risks of different operating units within the organisation or entities within a group as, for example, centralisation of procurement, changes to holding company location, central treasury function, shared services centre and so on. M&A essentially deals with the buying, selling, dividing and combining of different entities that can help an enterprise reposition for sustainable growth.
“Considering the renewed focus on Africa as the next investment frontier, and given that Nigeria is the largest economy on the continent, investors with operations in Nigeria may find it inevitable to restructure their businesses for various reasons.”
The distinction between a “merger” and an “acquisition” has become increasingly blurred especially from a financial reporting viewpoint. However, from a regulatory perspective, the difference has not completely disappeared. Generally, a merger is a legal consolidation of two companies into one entity either through a scheme of arrangement or a scheme of merger.
Under a typical scheme of arrangement, the net assets and business of a company (say A Limited) is transferred to another company (B limited). In this regard, company B’s identity is retained while company A is liquidated. However, under a scheme of merger, companies A and B combine into one. By so doing, both companies lose their individual identities for a new company to emerge which may well be named AB Limited. On the other hand, an acquisition occurs when one company takes over another and establishes itself as the new owner. The target company still exists as a separate legal entity.
The Nigerian Situation
Re-organisations in Nigeria are highly regulated. Entities that want to merge require some forms of notification and approval from the Federal Tax Authority – the Federal Inland Revenue Service (FIRS), and other regulators such as the Securities and Exchange Commission (SEC). The FIRS would usually request for a security or guarantee from any of the parties to the merger in respect of any established or potential tax liabilities.
Also, a court approval is required for a merger of all listed and large private companies. In practice, the entire process takes between 6 to 12 months to complete. On the other hand, these requirements are less stringent in the case of an acquisition.
Investors will typically consider the alternatives of either a share or an asset deal. In a share deal, the buyer acquires shares of the target company. Since the company is acquired intact as a going concern, this form of transaction carries with it all known and inherent liabilities and other risks of the target entity. These risks are thus transferred to the acquirer as all shareholders share proportionately in the residual risks or rewards of the companies they own.
In contrast, the investor simply buys the business or net assets of the target company in an asset deal. This is usually done through a special purpose vehicle that can start the business on a clean slate. This may leave the target company as an empty shell depending on the relative scale of the deal.
Re-organisations are becoming increasingly common in the Nigerian business terrain due to a number of factors. These include minimum capital requirements stipulated by regulators in some sectors, local content regulations, deals and transactions around disposal of onshore oil and gas assets by international oil companies, divestment by government from power assets, divestment from passive assets by telecommunications companies, sale of rescued banks, the disposal of non-banking subsidiaries by financial groups and so on.
In the past, many investors did not pay sufficient attention to the tax issues when undertaking a re-organisation exercise. The result is usually tax inefficiency, and loss of shareholder value due to unanticipated tax costs. The importance of a robust tax due diligence and planning in a re-organisation cannot be over-emphasised and sometimes, tax issues can be a deal breaker.
Key Tax Considerations and Common Pitfalls
The FIRS will be interested in whether a re-organisation would lead to tax base erosion and possible tax revenue leakage. This, in many cases, means that affected companies may have to pay more taxes where there is no specific waiver in the law.
Generally, where assets are being transferred from one legal entity to another, certain tax liabilities may arise such as value added tax (VAT), capital gains tax (CGT), stamp duty, and claw-back of capital allowances.
In the case of a share deal, there is no VAT, no CGT and claw-back of capital allowance is not applicable but may be subject to a nominal stamp duty payment.
In deciding which option to take, investors need to balance the almost tax free share acquisition approach with the potential legacy risks of the target. Another downside is that the investor in a share deal does not get tax deduction for his investment given that the tax base of the underlying assets remains the same.
Certain provisions exist in the tax law to eliminate or significantly reduce the tax costs in an internal re-organisation. This however requires specific approval of the FIRS which cannot be guaranteed. Another key consideration for internal structuring is transfer pricing (TP) especially between separate legal entities within a group. This is particularly the case given that the TP regulations in Nigeria are applicable to cross border and domestic related party transactions alike.
In summary, the decision as to which approach to use from a buyer’s perspective is determined by how much historic liabilities are within the business, how to minimise the applicable transfer taxes to the seller, and how to maximise tax deductibility of acquisition costs. Some structuring possibilities are available to mitigate transaction taxes and other commercial non-tax liabilities.
A major pitfall to bear in mind is the creation of a holding company or intermediate parent companies. This could happen where a special purpose vehicle (SPV) is set up in Nigeria to acquire the shares of a Nigerian target company. Generally, Nigerian holding structures create significant tax leakages. This is because holding companies are exposed to “excess dividend tax” on any income that has not been subject to corporate income tax such as capital gains and tax exempt income like dividends. The effect of this rule is that intermediate or ultimate holding companies that earn dividend from other Nigerian operating companies or capital gains from the disposal of shares will be caught by the excess dividends tax when they further distributes such profits.
Another peculiar issue in respect of intermediate holding companies is minimum tax. The minimum tax provision requires income tax to be calculated based on other parameters such as net assets, for businesses with low or no taxable profits. However, companies that have 25% direct foreign equity are exempt from minimum tax. The effect is that the operating company may be exposed to minimum tax because its shares are held 100% by a Nigerian intermediate holding company.
Added to this is the commencement rule. Setting up a new SPV as a result of a re-organisation in whatever form could lead to double taxation (effectively up to 60%) of the profits of at least 12 months in the first 3 tax years due to the application of commencement rules.
New companies may apply for tax incentives such as “pioneer” status incentive which confers corporate income tax exemption on such companies for up to five years. This incentive also needs to be carefully planned otherwise it may result in an overall tax cost rather than tax benefit.
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