A controversy over who should collect value added tax (VAT), the goods and services tax levied on the price of a product or service at each stage of production, distribution or sale, is being fought between Nigerian states and the federal government.
Writing on the PwC tax blog, Taiwo Oyedele, fiscal policy partner and Africa tax leader at PwC West Africa, explains that there are seven top taxes in Nigeria. Three of the taxes are collected by state governments and local governments (personal income tax, property taxes, and stamp duties) while the remaining four (companies’ income tax, petroleum profits tax, VAT, import and excise duties) are collected by the federal government and shared with the states and local governments.
The federal government through the Federal Inland Revenue Service (FIRS) collects VAT in each of the 36 states of the federation, remitting certain percentages to state and local governments every month. The distribution formula includes 15% to the federal government, 50% to state governments, and 35% to local governments.
Oyedele says VAT has become the fastest-growing tax revenue in Nigeria displacing personal property tax (N1.52 trillion – $3.7bn) and company income tax (N1.41 trillion) in 2020 to claim the top spot at N1.53 trillion. Top contributing sectors were other manufacturing (10.07%), professional services and telecoms (10.6%), commercial and trading (5.06%), breweries, bottling and beverages (3.90%), and transport and haulage (2.84%).
A flawed formula?
However, some states argue that the federal collection of VAT is defined by structural inadequacies and unfair distribution among the 36 states and the Federal Capital Terriroty (FCT). Wealthier states are leading a revolt against the current state of affairs, arguing that they should keep more of the cash raised in their own states.
The houses of assembly of Lagos and Rivers states have passed bills to begin collecting VAT themselves in the hope of claiming more of what they believe is their due. In September, Lagos state House of Assembly speaker Mudashiru Obasa complained that the state could be contributing 55% of the VAT collected in the country but only received a “paltry sum” in return from the federal government.
However, any state attempt to seize VAT or other tax collection is likely to be fiercely contested by the federal government. The Court of Appeal in Abuja has granted an injunction pending an appeal for states to maintain the status quo, meaning that both Lagos and Rivers states are likely to desist from actually collecting VAT until a definitive judgment is made by the Supreme Court, which is likely to ultimately decide the issue.
From bad to worse?
Some tax experts say that state collection of taxes could make the situation worse.
“Nigeria’s tax system is in a bad shape, which is set to get worse with the recent developments,” says Oyedele.
He says state collection will be negatively impacted by a lack of collection capacity and auditing systems, leading to a higher cost of tax collection, especially in states where consultants and other forms of agency structures are used for tax collection.
“People will pay more, but the government will collect less due to the inefficiency of collection and leakages. There will be a higher cost of goods and services arising from input VAT claims and refund complications in addition to items that are not exempted under the state’s VAT law such as rent, tuition, processed foods such as amala, suya, jollof rice, and ogbono soup.”
The federal government would continue to have a monopoly on lucrative import VAT, taxes on international transactions and taxes collected in the FCT, which includes the capital city Abuja.
Oyedele says that small businesses with turnover of less than N25m that are currently exempted under the national VAT might have to contribute more under states’ VAT laws.
Bamgboye Emmanuel, managing partner of Empyrean Professional Services, an accountancy and tax firm in Lagos, says that allowing states to collect VAT would cause chaos.
“If the state governments start collecting VAT, the consumers will bear the final burden because the cost of goods will go up and the masses will suffer because there may be a constant increase of VAT, which will affect the masses ultimately.”
Calls for transparency
Emmanuel and Oyedele both say that in order to ward off the threat of a wider states’ revolt, the federal government must be transparent in the distribution of VAT among the states.
Emmanuel says that the system should be more generous to states who contribute a disproportionate amount of VAT: “The federal government should collect VAT and there should be equality based on the collection. Equality means it should be reflective of what they collect from each state. Leaving it to the federal government would be best, and the federal government should give more to the states that contribute more VAT.”
He believes that state governments struggling to generate VAT need to explore other areas to create business opportunities, including by reforming land rights and improving the ease of doing business.
Oyedele says that “creating a conducive business environment to stimulate the economy and creating employment will inevitably lead to more tax revenue for all levels of government.”
Addressing inequality between states
Yet Nigeria’s vast regional inequalities, especially between urban and rural states, could leave poorer states stranded in a vicious cycle if they are deprived of VAT handouts from wealthier areas. Some believe that sharing between states is at the heart of the federal system of a united Nigeria and is a check on the power of the wealthier states.
Oyedele has an alternative solution that he believes should address the current inequality between states.
“This inequity should be addressed by allocating any domestic VAT collected from each state entirely to the respective state,” he argues.“Only VAT collected on imports, international services, and inter-state transactions should be paid into the VAT pool and shared based on derivation. This will address the current controversy without creating new problems.”