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The nation is currently facing significant issues with tax avoidance and evasion, as there is a noticeable difference between estimated and collected tax revenue. This problem has historical roots, as people have always viewed tax collectors negatively. Even in biblical times, the Jews held contempt for tax collectors. This negative attitude persists today, leading taxpayers to employ various methods to frustrate tax authorities.
The negative attitude towards taxation is unpatriotic considering its recognized role in the economy. Every government depends on taxation for socio-economic development and reducing wealth inequalities.
Various legislative and judicial attempts have been made to impose liability on taxpayers in appropriate cases. The Nigerian tax Acts do not provide a definition of tax, so resort has been made to decided cases to determine its meaning. However, even the judicial attempts at defining it lack precision, possibly due to the diverse functions of taxation in society.
In spite of the difficulty at definition, some definitions proffered by some leading authorities in the field may be examined.
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In the words of Chief Justice Lathman of the Australian Supreme Court in Matthews v. Chucory Marketing Board,3 a tax "is a compulsory exaction of money by a public authority for public purpose, or taxation is raising money for the purpose of Government by means of contribution from individual persons". Similarly in United States v. Butter,4 Chief Justice Roberts of the United States of America Supreme Court, said tax is "… an exaction for the support of Government …" He debunked the continued conception of tax as the "expropriation of money from one group for the benefit of another".
In simpler terms, tax can be defined as the compulsory payment of money demanded by the Government of a country from its citizens.
Professor C.S. Ola and Dr Ekenze Oliver of Buitas Consultancy have both provided comprehensive definitions of tax. According to Professor Ola, tax is the compulsory payment of money by citizens to the Government. Dr Oliver further explains that tax is a levy imposed by an organization or Government on its citizens for the purpose of providing common goods and services for everyone's benefit. He also highlights that tax is meant to generate revenue for the authorized expenditure in a Government budget.
According to the definitions provided, a tax is a mandatory payment that helps support the population and promotes fairness in society and the economy. In Nigerian tax legislation, there is no differentiation between tax evasion and tax avoidance. Tax avoidance involves intentionally reducing one's tax obligation by taking advantage of legal loopholes, resulting in a taxpayer paying less than their legally mandated amount to the tax authority.
According to Professor Wheatcraft, tax avoidance entails skillfully following regulations and outwitting the internal revenue and government, all while avoiding dishonest practices. Similarly, Lord Tomlin stated in the IRe v. Duke of Westminster case that individuals have the right to organize their finances in a way that reduces their tax responsibilities. Even if some view this method as inappropriate, both the commissioner of Inland Revenue and fellow taxpayers cannot force them to pay more taxes.
Despite the common perception that tax avoidance is unpatriotic and anti-social, it must be acknowledged that it is not deemed immoral or illegal unless explicitly prohibited by lawmakers. In contrast, tax evasion encompasses intentional efforts to avoid or neglect tax obligations, including fraudulent actions like submitting inaccurate returns. This definition suggests that tax evasion not only contradicts moral principles but also violates tax legislation.
The Royal Commission on "Taxation of profits and Income" distinguished between Tax Avoidance and Evasion. Tax Evasion entails not paying required taxes, which can range from fraudulent information to late submissions or payments. In contrast, Tax Avoidance involves arranging financial affairs to be liable for taxes only due to these arrangements. This is legal unless a specific rule deems it otherwise. The court will not support the tax authority if a taxpayer exploits tax laws or their absence to avoid obligations.
Tax avoidance schemes refer to strategies employed by individuals and businesses with the aim of legally diminishing their tax obligations.
(a)
Income splitting schemes:
One strategy to reduce taxation is to distribute income among multiple individuals rather than having it all taxed under one person. This approach is especially favored in a progressive tax system like ours, where the marginal tax rate is high. Income splitting enables the individual transferring the income to decrease their tax burden, while the recipient may face a lower tax rate on the received income. Additionally, they might be eligible for tax relief or complete exemption if the transferred income falls within the exemption range.
(b)
Settlement and Trust Income:
The use of settlement schemes and trust income is a common method employed by taxpayers to avoid taxes. According to income tax law, the income from a settlement, trust, or estate is considered the beneficiary's income if the beneficiary has an immediately vested interest. However, if the interest is dependent on an event, it is considered to belong to the settlement rather than the transferor or beneficiary. The case of Federal Board of Inland Revenue V. Nasir exemplifies this type of scheme. In this case, Nasir transferred his property in Lagos to himself and six other family members as tenants in common through a deed of gift, and later implemented a deed of settlement.
The Board of Inland Revenue wanted to make Nasir responsible under the Income Tax Management Act (ITMA) of 1961. According to this act, if someone creating a settlement takes advantage of any portion of the income from that settlement, or if they possess a direct or indirect power to control the assets or income of the settlement, then the settlor would be considered responsible for that income. The Board's argument was that the settlor could appoint the income or property to anyone, including those they have control over, and thus regain ownership through indirect means. However, in Nasir's case, the court ruled that the trust or settlement document must explicitly grant the settlor or another person the authority to utilize the income. Since this was not stated in the document, the court rejected the Board's claim that the settlor had benefitted from the settlement.
(c)
Family Income:
The concept of family income in Nigeria refers to the income recognized by law or custom as a collective income that involves multiple individuals whose interests are uncertain. This recognition and acceptance of family income under Native Law and Custom can be used as a strategy to avoid paying taxes. The tax law does not impose strict conditions on transferring income or assets that generate income within a family. This is because the transferor of such income would typically pass away before the property becomes part of the family's assets.
(d)
Avoiding the valuation of assets is advised.
A person may intentionally prevent the valuation of their assets in certain situations. This occurs when their assets are tied up in the company while their liquid cash is outside the company. The available cash is not enough to cover the significant liability for estate duty that would arise if the shares were valued based on the assets. The consequence of such valuation would be that the company may face liquidation or have to rely on financial assistance from external parties. These external parties may demand an active role in managing the company's affairs. To avoid this situation, a possible solution is for the company to go public by converting into a public company. This way, the asset basis of valuation would not apply to the shares or debentures, if they are of a class that has been granted permission to trade on a recognized stock exchange during the year as part of the normal business operations. Another option is to distribute these assets through settlement shares.
(e)
Profits can be capitalized by issuing new shares.
Section 8(3) of the Company Income Tax Act 1990 states that dividends distributed through shares and debentures are taxable. However, only shares satisfied by bonus debentures are subject to taxation, while those satisfied by bonus shares are not. This enables the issuance of shares funded by profits to existing shareholders, reducing the company's taxable income.
(f)
Tackling tax avoidance by transnational enterprises in Nigeria.
Tax avoidance is now a concern globally, including in countries like Nigeria. The rise of international economic transactions has created significant taxation difficulties. As a result, multinational corporations engaging with developing nations like Nigeria often use unfair transfer pricing methods to lower their tax liabilities.
As beautifully expressed by an insightful author:14(a) "There are two ways to achieve this: either by selling goods to a subsidiary in a tax haven at prices below what would be considered fair, or by a parent company overpricing its exports to foreign subsidiaries. In doing so, the parent company inflates the cost of imports for the final products or raw materials. This allows the corporation to increase its profit margin, which can be hidden for tax purposes. As a result, the taxing country sees artificially lower profits and collects less in taxes. By transferring profits between companies within the group, the relevant company's tax liability is distorted as a consequence.... These manipulations can have a detrimental impact on overall economic development and tax revenues in developing countries like Nigeria." Despite the implementation of measures to prevent these types of abuses, they have proven ineffective.
Since 1968, the Company Act has mandated that expatriates conducting business in Nigeria must establish subsidiaries within the country. The goal of this requirement was to guarantee that foreign companies had sufficient control over their Nigerian operations. Nevertheless, this approach had an adverse effect as it allowed foreign companies to take advantage of the situation. Consequently, these so-called subsidiary companies were not truly Nigerian entities; instead, they operated more like branch offices for their foreign parent companies. Consequently, these subsidiaries lacked autonomy and were unable to function independently.
The Nigerian Companies were heavily reliant on foreign companies, leading to the Expatriate Companies determining how much revenue the Nigerian subsidiaries could use for their local currency needs and pre-arranged tax payments. Tax evasion is more apparent in the direct assessment method which taxes the self-employed, such as businessmen, contractors, traders, and professionals, compared to the indirect assessment method which taxes employees.
There is a common belief that self-employed individuals pay less than 10% of their personal income tax to the Government annually, while employees are responsible for paying the remaining 90%. This unethical practice is also prevalent among civil servants and other salaried workers, who exploit the personal allowances and relief provided by law. Consequently, almost every Nigerian civil servant deceitfully claims to be married with four children in order to enjoy these benefits. Tax evasion remains a pervasive problem in the country, as stated by Sosonya14(b): "tax evasion has become so widespread that there now exist a cash economy of a widespread proportion which the tax man has no control".
Tax evasion can occur in multiple ways, such as through lack of voluntary compliance in paying taxes, making false claims related to family, capital allowances, dependents, life assurance premiums, etc., as well as by underreporting or falsely declaring income from trade, business, profession, vocation, or employment. Omitting to disclose the gross amount of dividends, rents, etc. received from foreign sources within Nigeria and making false claims regarding contributions to pension schemes and National Provident Fund are also common methods of tax evasion. Both the Federal and various state governments have implemented various tax measures to effectively address and reduce tax evasion in Nigeria.
Most of these measures, which are found in various Legislations15, give power to government departments, Ministries, agencies or any commercial bank to demand a tax clearance certificate from individuals or companies with whom they have any transaction or business dealing. This certificate should cover the three years prior to the current year of assessment. The introduction of provisional tax within 30 days by corporate entities or the declaration of interim dividends by the Government are also commendable efforts to prevent tax evasion. Similar anti-evasion measures have been adopted in some states.16
In 1974, the internal revenue division of the former Western State implemented administrative reforms to address tax evasion. Contractors were required to provide proof of tax payment before being awarded a contract. When retired civil servants applied for gratuity or pension, their tax reports were thoroughly reviewed. Additionally, legislation was enacted to enforce tax payment by performing musicians before they could perform. Non-compliance with these directives resulted in significant penalties. These tax evasion measures were not limited to the Western State but also applied to the former Eastern and Northern States.
18 Our tax codes include various measures and sanctions to address this problem. One provision, section 66 of the Companies Income Tax Act, grants the Board the authority to seize and sell the assets and property of tax payers who fail to pay their taxes. In extreme cases, this includes the seizure of premises. The court's approach to tax avoidance schemes is known as the "Form and Substance Approach." According to this approach, a tax payer should be taxed based on the structure of their business arrangements, rather than the actual underlying substance.
According to the case of IRC v. Duke of WestMinster, where a taxpayer has cleverly planned their financial affairs, they cannot be legally taxed by examining the nature of the transaction. In this case, the Duke of WestMinster made certain annual payments to his gardeners based on a deed of covenant. These payments were allowed as deductions under the Income Tax Act 1928. However, the use of the deed of covenant was a form of tax avoidance to lower the Duke's tax liability. A higher rate certificate was required for taxable adults to obtain licenses for taxes. The revenue authorities argued that the transaction should be disregarded as the yearly payments were actually monthly payments in substance. The Court of Appeal and the House of Lords rejected this argument. Lord Tomlim stated that the deed of covenant was genuine and had been given its proper legal effect.
The text emphasizes the importance of not ignoring or treating certain arrangements differently when it comes to taxation. The "doctrine of substance" is seen as an attempt to make someone pay taxes even if they have legally structured their affairs to avoid it. The court does not consider the name or label of a transaction in determining tax liability. Instead, they focus on the legal rights of the taxpayer and the revenue and disregard any naming conventions. The nomenclature used has no legal significance.
The courts do not consider fake and dishonest transactions. However, once a transaction is genuine, the court will examine all the surrounding circumstances to determine the rights and responsibilities of the parties involved. Tax payers were influenced by the Westminster principle and began organizing their affairs in a way that would minimize their tax liability. They split their transactions in the hope that the court would only focus on each part of the transaction separately, rather than looking at the transaction as a whole. The first indication that a significant departure from the Westminster principle was forthcoming was seen in Judge Eveleigh's dissenting opinion in the Floor v. case in the Court of Appeal.
Davis22 jokingly stated that he sees this cue 88 as one where the court does not need to consider each step taken individually.
In 1982, the West Minister principle was challenged in the House of Lords case of W.T. Ramsay Ltd v IRC. The case involved an artificial self-canceling transaction. Ramsay Ltd purchased the share capital of Caithmead Ltd for £185,000.34. Subsequently, Ramsay Ltd borrowed £437,500 from a finance company and lent two equal loans of £218,750 to Caithmead Ltd, both with an interest rate of 11%. The first loan was repayable after 30 years, while the second loan was due after 31 years. According to the arrangement, Ramsay Ltd had the right to increase the interest rate on one loan and decrease it on the other by the same percentage, but this right could only be used once. One week later, Ramsay Ltd decreased the interest rate on the first loan to 0% and increased it on the second loan to 22%, making the second loan more valuable.
Ramsay Ltd sold the second loan to a third party for L 391,481, making a profit of L 172,731 since the original loan cost the same amount. Shortly after, Cathmead became liquidated and repaid the first loan, with the valuation of Cathmead on liquidation being L 9,387. Ramsay Ltd had paid L 185,034 for the loan and incurred a capital loss of L 175,647 on the shares. However, this loss could not be used to offset the capital gain on the sale and lease back transaction because it was considered a self-canceling transaction. The House of Lords refused to analyze the transactions step-by-step.
It was observed in the case of IRC v Burmah Oil Co. Ltd. that the Ramsays case marked a turning point in the judicial attitude towards tax avoidance schemes. The House of Lords re-examined the scope of the West Minster principle and stated that it would be dangerous for those who advise on such schemes to assume that Ramsay's case did not bring about significant change in the court's approach to pre-ordained series of transactions aimed solely at avoiding tax liability. The court emphasized that steps inserted into these transactions solely for the purpose of tax avoidance, without any legitimate commercial purpose, should not be taken lightly. The case of IRC v Duke of Westminster does not provide much guidance on what methods of ordering one's affairs are considered effective by the court in reducing tax liability if business transactions were conducted straightforwardly.
The new approach, demonstrated in Ramsay Ltd and Burmah Oil case, does not completely overturn the Westminster case, but instead restricts its application. The difference lies in the fact that under the Westminster principle, the court had to examine a transaction as a whole to ascertain the rights and obligations established under common legal principles and enforce them. Conversely, the new approach mandates the court to enforce the entire transaction, potentially disregarding certain subsidiary rights and obligations that have emerged but are secondary to the overall essence of the transaction.
The new approach clearly indicates that some judges were starting to recognize the crucial role of taxation in a nation's development, as well as the importance of ensuring that taxation generates the necessary revenue and that any measures to avoid tax should be condemned. In fact, most judges, aside from a few exceptions, understand that their judicial role goes beyond simply making declarations and acknowledge the complexity of modern business and the imperative of addressing the widespread issue of tax avoidance.
The legislature has implemented strong measures to reduce or prevent tax avoidance schemes by taxpayers. Accordingly, our tax codes now include certain concepts and provisions to target situations where the revenue suspects collusion between the taxpayer and a third party that can be exploited to the detriment of the revenue. These provisions are known as specific anti-avoidance provisions.
(a)
Family Income.
The use of family income to avoid taxes has been reduced by defining family income as the income of a family that is recognized under any law or custom in which the interests of individual members of the family are undetermined or uncertain.2S
(b)
The scope of anti-avoidance provisions has been broadened by giving a broader interpretation to the words used in tax laws. This includes including schemes specifically designed for avoiding taxes, and also includes transactions that could potentially be used for tax avoidance purposes.
Thus, the term "dividend," which traditionally refers to the portion of a trade or business's profits distributed to shareholders, has been expanded to include any distributed profits, regardless of their nature, including nominal value of bonds, shares, debentures, or securities awarded to shareholders. However, this does not apply to capital profits earned before or during the winding up or liquidation. The extended definition implies that any profit distributed under any circumstances is taxable for the shareholder.
(c)
Deeming Provisions
The use of deeming provisions allows for the classification of money as 'income' that would typically not be subject to taxation. Similarly, these provisions can classify a sum as income for a specific individual, even if it would not normally be considered as such. In Lagos and the former Western State, benefits in kind, such as employer-provided living accommodation, are treated as taxable income for tax purposes. Overall, deeming provisions are phrases that artificially interpret words to provide a comprehensive description, encompassing what is obvious, uncertain, and seemingly impossible in ordinary terms.
(d)
Income Splitting Schemes are a way to distribute income among different individuals or entities.
In order for income splitting schemes to be effective in reducing tax liability, certain conditions must be met. It must be ensured that the individual transferring the income does not benefit from it in any way and cannot regain control of the income in the future. Therefore, for the transfer to be effective, it must be legally enforceable against the recipient and must be an absolute transfer. Income splitting through a settlement in favor of a minor or unmarried child of the individual establishing the settlement is not considered effective for income tax purposes as long as the individual is still alive. However, once the child gets married or turns 21 (if unmarried), the transfer will become effective.
(e)
Income Splitting with incorporated entities
Section 17 of the Companies Income Tax Act 1990 addresses income splitting using incorporated bodies. This provision allows the Federal Board of Inland Revenue to intervene when a Nigerian company, controlled by no more than five individuals, refuses to distribute profits to shareholders as dividends. The purpose behind this refusal is to lower the tax payment of the Nigerian company, rather than any legitimate reason for not distributing the profits. Consequently, the Board has the authority to nullify such income splitting arrangements between an individual and their company by issuing written directions and serving them to the company. Although the section does not specify the nature of control, it suggests that if the shareholding controlled by no more than five individuals exceeds 51%, it could be sufficient grounds for such a transaction.
The Dilemma of Tax Avoidance and Evasion. (2016, Oct 05). Retrieved from https://studymoose.com/tax-evasion-essay
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