Taxation of Unincorporated Businesses in Nigeria
Unincorporated businesses are usually the sole proprietorship or the partnership business. They can be defined as a commercial enterprise that is privately owned by one person or more than one person(s), it has unlimited liability due to the fact that the business has not been formally registered as a company. Most of the businesses that are run in Nigeria are in the hands of the sole proprietorship and partnership.
According to investopedia.com, a Sole proprietorship can be defined as a sole trader or a proprietorship, is an unincorporated business that just one owner who pays personal income tax on the profit earned on the business to the relevant tax authority. A sole proprietorship is one the very easy businesses to set up as it is one of the most common form of ownership in Nigeria. The profits and debts incurred in the business are that of the owner alone because the owner exercises total control over the business. Examples of sole proprietorship businesses in Nigeria are Local grocery stores, Wholesalers and Retailers of marketable goods, Nail salons and Barbing salons etc.
According to investopedia.com, a Partnership can be defined as a formal arrangement by two or more parties to manage and operate a business and share its profits. Setting up a partnership business is a little bit more complex than that of a sole proprietor but it is still also easy to set up. The profits and debts are both incurred by the partners in the business depending on the amount each partner invested.
TAXATION OF SOLE PROPRIETORSHIP AND PARTNERSHIP IN NIGERIA
The taxation scheme for both the sole proprietorship and partnership are somewhat similar. Before any business in Nigeria is liable for tax payment, it must get all the necessary documents and ensure that the business owner registers and obtains the Tax Identification Number (TIN) from the State Board Internal Revenue in order to make the necessary payments of taxes such as the Personal Income Tax (PIT), Capital Gains Tax (CGT), Withholding Tax (WHT) and also the Value Added Tax (VAT). The Finance Bill 2020 mandates that before organization or an individual open a bank account( whether an existing account or a new account), the individual or organization must have gotten the Tax Identification Number (TIN).
PERSONAL INCOME TAX
Personal Income Tax (PIT) can be defined as a direct tax that is charged on the income of an individual or a sole proprietor. The Personal Income Tax Act (PITA) as amended in 2011 divided individuals into two groups which are the employees (PAYE) and the self-employed. The study deals with the latter which is the self-employment tax. The self-employment tax is a tax that is paid by either a sole proprietor or a partner based on the amount of profit earned.
Both the Sole proprietor and Partnership business are not liable to pay income tax as an entity but rather they pay income tax on their share of profit after distribution of profit or loss has been made. They are responsible for filing their tax returns themselves and paying the relevant taxes when due according to the provisions of the Personal Income Tax Act (PITA).
A business owner in Nigeria is liable to pay tax in Nigeria for each year of assessment on the aggregate amount for every source of income. This will include profits made from the business, salaries, wages, fees, allowances or any other gains or profit gotten from employment including benefits, compensation.
The following personal reliefs are allowed against a sole proprietor or partner taxable income
|Consolidated Relief allowance (CRA)
|Higher of N200,000 or 1% gross emolument plus 20% of gross emolument
|Child( must be under 16 years of age or receiving full time education)
|N2,500 per child( to a maximum of 4 children)
|N2,000 per relative( to a maximum of 2 relatives)
|Life Insurance or deferred annuity premiums
|Actual amount of premium for self and spouse
|Employed tax payer with disabilities
|Greater of 20% of earned income or N3000
|Gratuity paid by employer
|Actual amount of gratuity received
|National Housing Fund Contribution
|2.5% of his basic salary
|8% of gross monthly emolument subject to minimum of basic + housing allowance + transport allowance
|Loan Interest paid on owner-occupied residential houses
|Actual interest paid
The taxable income left after deducting the relevant allowances shall be subjected to tax. The following tax rates would be applied:
|CUMMULATIVE TAXABLE INCOME
|CUMMULATIVE TAX PAYABLE
|N300,001 – 600,000
|N600,001 – 1,100,000
|N1,600,001 – 3,200,000
ALLOWABLE DEDUCTIONS UNDER PERSONAL INCOME TAX IN NIGERIA
These can be defined as expenses incurred that are related to the business purpose. PITA provides that all outgoings and expenses wholly, exclusively, necessarily and reasonably incurred during that period and ultimately borne by the business of individuals in the production of their income are deductible in the process of determining the assessable income to be used for tax purposes. They include:
Interest on loan
Rent and rates( must be related to the business)
Bad debts written off
Repairs and maintenance of any asset employed in the business
Contribution to a pension scheme
Provision of doubtful debts of a specific nature
NON ALLOWABLE DEDUCTIONS UNDER PERSONAL INCOME TAX
These can be defined as expenses incurred that are not related to the business purpose. They include
Fines and penalties
Depreciation of any asset
Any loss or expenses recoverable under insurance
Taxes on income or profits levied in Nigeria
COMPUTATION OF PERSONAL TAX LIABILITY IN NIGERIA
List the earned income from all the sources, such income gotten from employment, business trade, profession and vocation
List the unearned income from all sources such as dividend, rent and interest minus the related expenses to obtain the unearned income
Add the earned income and the unearned income to arrive at the total income
Deduct all the non-taxable income from the taxable income
Grant the capital allowances
Grant all the applicable loss relief and allowances
Then apply the tax rates in the table above to the chargeable income
Mr. Ekenne is a sole proprietor of the Marvel store Enterprises, and is ordinarily resident in Lagos state but has a place of residence in Osun state, a property that he rented out. The accounts of his business in 2019 were as follows:
Cost of sales (1,947,460)
Gross profit 8,550,020
Less General expenses (398,061)
Net profit for the year 8,151,959
The following information is also relevant:
General expenses includes the following:
Depreciation of motor van 35,000
Mr. Ekenne personal drawings 30,000
Staff salaries 48,000
School fees for Mr Ekenne’s son 7,500
Donations to Church 40,000
Bad debts written off 12,000
1% provision for doubtful debts 8,050
Refurbishment of gen. set 16,750
Repairs and Maintenance 11,000
Other allowable expenses 189,761
Marvel Store Enterprises operates principally in Lagos state
The cost of sales includes the cost of goods stolen from the warehouse worth ₦27,000 but it is recoverable from Insurance
Mr. Ekenne received dividend from quoted companies in 2010 amounting to ₦25,075. He also received director’s fees from some of these companies amounting to ₦8,500 in the year 2019
From his property in Osun state, he received gross rent amounting ₦45,000. Repair expenses on the property agreeable with the revenue was ₦2,500 in 2019
Mr. Ekenne has an aged mother in his village whom he maintained with a total of ₦2,000 in 2019. His mother who is a retired school teacher has an annual pension of 600
He estimates that he gave a total of ₦2,600 to roadside beggars in 2019
Capital allowances as agreed with the revenue are: ₦25,000 for his business and ₦18,000 for his property
Compute Mr Ekenne tax liability for the year 2020 and what appropriate tax authority will assess him?
Assume that the rate of withholding tax on dividend and director’s fees to be 15%
Computation of Tax liability for 2020
Profits as per accounts 8,151,959
Add non-allowable expenses:
School fees 7,500
Donations to church 40,000
Provision for doubtful debts 8,050
Refurbishment of generator set 16,750
Goods stolen from warehouse 27000 164,300
Adjusted profit 8,316,259
Less capital allowances (25,000)
Gross Director fees (8500 x 100/85) 10,000
TOTAL EARNED INCOME 8,301,259
Gross dividend (27075 x 100/85) 29,500
Gross rent 45,000
Less expenses (2500)
Less capital allowance (18,000) 24,500
TOTAL INCOME 8,355,259
Less Gross dividend (29,500)
Assessable income 8,325,759
5,000 + (20% x 301,500) 65,252
Dependant Relative 1,400 (66,652)
Chargeable income 8,259,107
First N300, 000 at 7% 21,000
Next N300, 000 at 11% 33,000
Next N500, 000 at 15% 75,000
Next N500, 000 at 19% 95,000
Next N1, 600,000 at 21% 336,000
Over N3, 200,000 at 24%(8,259,107 – 3,200,000) 1,214,186
TAX LIABILTY 1,774,186
Withholding tax on Directors Fees (15% x 10,000) (1500)
TAX PAYABLE 1,772,686
Note that Mr. Ekenne has more than one place of residence but since he spends more time in Lagos state and his business operates principally in Lagos state. The relevant tax authority for tax remittance is the Lagos State Internal Revenue Service (LIRS). This applies even though he has another place of residence in Osun state and he derives income from there.
Although, sole proprietors and partners will be required to fill a certain compulsory document called FORM A which is the Income Tax Form for Return of Income and Claims for Allowances and Reliefs. It entails the personal details and the amount of income expected to be earned by the sole proprietor or partner for the current year of assessment. Tax payers are expected to fill and file their form within 3 months from the beginning of each calendar year. Attached in this article is a sample copy of the FORM A.
VALUE ADDED TAX (VAT)
Value Added Tax (VAT) can be defined as a type of indirect tax that is imposed on the supply of goods and services in a given state. VAT is governed by the Value Added Tax Act Cap V1, LFN 2004 as amended. It is mostly eventually borne by the final consumer of the goods and services. VAT in Nigeria was calculated at a flat rate of 5% before the Finance Bill 2020 that was signed in October 2019 by the President amended the rate to 7.5%. Section 7 of the VAT act grants the power of administration of VAT on the Federal Inland Revenue Service (FIRS) in Nigeria.
However, effective February 2020, businesses with Turnover less than N25,000,000 in any given are exempted from charging VAT on theirs services or products. Furthermore, sales by a small business to a big business with a turnover of over N25,000,000 in any given year will still attract the charging VAT by the small business but the payments will made by the big business to the Federal Inland Revenue. The small business eventhough it charged the VAT will not collect it but rely on the big business to deduct at source and make remittance.
Every VAT collected by every business owner must be remitted to the Federal Inland Revenue Service (FIRS) on or before the 21st day of the month following the month the goods and services were sold. That is Value Added Tax (VAT) collected in March must be remitted before the 21st of the following month which is April.
This type of VAT is paid on raw materials, goods are services that will be used for production purposes or goods for resale or goods imported directly for resale. When computing, Input VAT on overheads, services and general administration should be treated as an expenses in the profit and loss account while Input VAT on any capital item and item should be capitalized together with the cost of the item or the asset
This type of VAT is charged on goods and services supplied and it is collected by a supplier from its distributors, agents, clients, consumers on goods and services supplied to them.
When Output Vat is greater than Input VAT, the tax payer is required to remit the excess to the Federal Inland Revenue Service (FIRS) but when the Input VAT is greater than the Output VAT then the tax payer is entitled to a return from the Tax board.
There are exempted goods and services that are not subject to VAT. They include
Medical and Pharmaceutical products
Basic Food items
Sanitary pad (proposed by the Finance bill)
Books and educational materials
Fertilizer (locally manufactured), agricultural and veterinary medicine, farming machinery and farming transportation equipment
Services rendered by community banks
Plays and performance conducted by the educational institutions as part of learning
CAPITAL GAINS TAX
When a sole proprietor or partnership business sells an asset and make gain on the sale of the asset, the business must pay 10% of the chargeable gains made from the sale of the asset. The capital gains is the difference between the sales proceeds from the sale of an asset.
ASSETS CHRGEABLE UNDER CAPITAL GAINS TAX
Options, debts, and incorporeal property
Any currency other than the Nigerian currency
Any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired
Assets situated outside Nigeria
EXPENDITURES ALLOWABLE FOR DEDUCTION FROM THE SALES CONSIDERATION
Expenditure wholly, exclusively and necessarily incurred for the acquisition of the asset
Incidental cost on the acquisition of the assets
Expenditure wholly, exclusively and necessarily incurred in enhancing the values for the assets of the disposal
Expenditure incurred on asset for the purpose of establishing, preserving or defending the title or right over an asset
Incidental cost of making the disposal
GAINS NOT CHARGEABLE
Section 26 of the Capital Gains Tax Act in Nigeria exempt some capital gains from taxation. They are:
Gains of ecclesiastical, charitable or educational institutions, statutory and diplomatic bodies are exempt from such taxation
Where trustees or nominees transfer assets to beneficiaries they are not considered to be disposing the asset, hence the transaction does not attract Capital gain tax (CGT)
Gains made upon a disposal of business assets where the proceeds are now spent in acquiring new business assets
WITHHOLDING TAX (WHT) IN NIGERIA
Withholding tax (WHT) can be defined as an advance and indirect source of taxation deducted at source from the invoices of the tax payer. The main purpose of the withholding tax is to capture as tax payers might have evaded. Withholding tax rate are usually 10% or 15% depending on the type of transaction carried out. Withholding tax can also be said to be an advance payment of income tax. The WHT tax must be remitted to the relevant tax authorities on or before the 21st day of the month following the month in which the deductions were made.
When a business or an individual supplies goods or services to another company, there will be an evidence of payment which is known as an invoice in the course of the transaction. Take for example, the amount paid by the person who is purchasing the goods is N5, 000,000 and the relevant tax rate is 10%, then upon payment the person purchasing the goods will deduct N500,000 from the invoice of the supplier and then remit it to the relevant tax authority.
The person purchasing the goods is meant to acquire an evidence of remittance of tax payment in the form of a withholding tax credit on behalf of the supplier where he purchased the goods from. The supplier can then use the Withholding tax credit to reduce the income tax payable for the year.
RELEVANT DOCUMENTS NEEDED FOR FILING WITHHOLDING TAX RETURNS
Evidence of payment from transaction such a bank teller or an electronic receipt
Schedule of WHT deducted indicating the : Name of the supplier or vendor, Tax Payer Identification Number (TIN) of the company or individual (supplier or vendor ) from which the tax was withheld and the remaining amount
Withholding tax is applicable on some type of transactions as indicated below:
WITHHOLDING TAX RATES IN NIGERIA
|Types of Payment
|Withholding Tax rate for companies
|Withholding tax rate for individuals
|Dividend, Interest and Rent
|Hire of equipment
|Commission, Consultancy, Technical and service fees
|Construction (Roads, Buildings and Bridges)
|Contracts other than sales in the ordinary course of a business
The penalty or the failure of a business to remit its Withholding tax (WHT) as at when due is 10% of the amount not deducted or remitted. Most companies are ignorant and most times pay double taxes. That is why a business should always engage with a consultant before taking some certain measures. This is because Withholding tax (WHT) credit note can be used to offset the income tax liability for the year
If you are a Sole Proprietor,in partnerships, your business profits are not chargeable to tax. It is the share of profit gotten from the sole proprietorship or partnership that is chargeable to tax. Therefore, sole proprietorship and partnership businesses must ensure compliance with all tax related payments. The best way to avoid double taxation or reduce the income tax liability of a business is by hiring a professional consultant who has a good knowledge of the tax system in Nigeria. The consultant will help in conducting these various payments and also giving the right advice when needed to help the business grow, avoid penalties and fines. Embracing and applying the knowledge in this article will also help in the long term success of the business.
To learn more about how we can help meet your tax obligation as an Unincorporated Business or Partnership, please call 08023200801, 08075765799 or email firstname.lastname@example.org.
Onamakinde Dare Daniel is a recent graduate of Obafemi Awolowo University with a Bachelor’s degree in Management and Accounting. He is an accountant who has passion for tax matters due to its ever dynamic nature. He hopes to build a career in taxation and he’s currently serving as an intern at Matog consulting Ikeja.