The Federal Inland Revenue Service (FIRS or “the Service”) recently published the Non-Interest Finance (Taxation) Regulations 2022, which set a framework for the taxation of financial institutions offering non-interest financial products and services in Nigeria. The regulations take effect on April 1, 2022.
Below is a summary of the pertinent instruments specified under the various product categories, together with their associated tax treatment under the Regulations:
1. Sale-based products- (i) Murabaha (Cost plus mark-up) -Where a financial institution, at the instant of a customer, purchases an asset from a vendor and resells it at a markup to the customer, this practice is known as Murabaha.
The first purchase will be treated as a loan made by the financial institution to the customer, as this will be regarded as a loan and will not be liable to WHT or VAT. The second purchase price excluding the markup will be classified as a loan payback and will not be subject to VAT, stamp duties, or capital gains tax (CGT).etc
(2) Istisna or Parallel Istisna-This is a situation in which a financial institution agrees to finance a customer’s project for the building or manufacture of products or assets and hires a third party to complete those tasks.
The Financing of the customer’s project shall be treated as a loan and not be able to VAT and WHT. The transaction between the financial institution and the Third party shall be subject to VAT and WHT also the Istisna contract sum payments, excluding the mark-up paid either instalment or full by the customer to the financial institution shall be deemed principal repayment which repayments shall not be liable to VAT, stamp duty and capital gain tax. Also, only the customer will be permitted to treat the cost of acquiring the asset as a QCE for income tax purposes and claim capital allowances thereon (as amended) in accordance with the Second Schedule of the Companies Income Tax Act.
(ii). Salam or Parallel Salam-This is a situation in which a financial institution enters an agreement with a customer to purchase specific commodities at a deferred delivery date in exchange for an advanced price fully paid immediately and subsequently enters into another agreement with a third party for the sale of the commodities.
The financial institution’s and the customer’s agreement will be treated as a loan arrangement and will be exempt from VAT and WHT. The transaction with the third party, on the other hand, will be handled as a regular sales transaction and will be subject to VAT and WHT as such.
2. Equity-based products
(i) Musharakah-Where the financial institution and the consumer enter into a joint venture to finance the acquisition of an asset or a project, and both split profits in a predefined ratio Losses, on the other hand, are borne based on capital contribution. The consumer may later decide to purchase the financial institution’s stake in the partnership.
The financing of the acquisition shall be deemed as a loan and the share of loss attributable to the financial institution shall only be allowed deduction where it is proven to the satisfaction of the FIRS that such loss was as a result of expenses wholly reasonably exclusively and necessarily incurred towards generating a taxable income also, the agreement to transfer the financial institution’s interests to the consumer will be subject to stamp charges.
(ii) Diminishing Musharakah-Where the financial institution in partnership with a customer, jointly acquired an asset from a vendor under the understanding that the customer shall eventually acquire the financial institution’s share of the ownership interest in the asset and the customer has the exclusive right to possess and use the asset etc
According to the Regulations, the financial institution’s contribution will be regarded as a loan given to the customer and will not be taxed. However, the customer’s periodic rent payments will be considered interest and subject to WHT. However, the agreement reached between the customer and the financial institution to transfer the latter’s interest in the asset will be subject to stamp duties etc
(iii) Mudarabah as deposit- Where a customer provides capital to a financial institution, which acts as a manager, and the financial institution uses the capital provided to generate profit, both parties are entitled to a percentage of the profit generated by the use of the capital provided in the transaction based on a predetermined ratio.
The regulations state that the customer’s part of the profit will be treated as a return on investment and taxed in the same way as a traditional return on investment.
3. Lease-based products
(i) Ijarah wa iqtina (Finance lease)-Where a financial institution acquires an asset from the vendor and leases it to the customer who has the option to buy the asset at the end of the lease period, The asset’s ownership and significant upkeep remain with the financial institution while the customer retains just the beneficial interest in the asset for the term of the lease. The customer will pay the finance charges on an agreed-upon periodic rental price for the use of the asset
The transaction between the financial institution and the vendor shall be subject to VAT and WHT and Stamp duties, and only the customer may treat the capital portion and mark-up as capital expenditure etc
(ii) Ijarah (Operating lease) -Where a financial institution acquires an asset from the vendor and leases it to the customer, who pays the financial institution rentals for the use of the asset as may be agreed upon. The asset’s ownership and significant upkeep remain with the financial institution, while the customer retains just the beneficial interest in the asset for the term of the lease.
The transaction between the financial institution and the vendor for the purchase of the asset shall be subject to VAT, WHT, and Stamp duties, the lease rental paid by the customer shall be subject to VAT and WHT, and the financial institution may treat the capital portion as capital expenditure in accordance with the second schedule of the Companies Income Tax Act. etc
4. Fee or Agency-based products
Takaful – This is an agreement between a group of participants or policyholders to maintain and manage a common fund on their behalf for a fee and each participant agrees to donate a portion or all of the participant’s takaful contribution to the common fund to indemnify any member that suffers a loss.
The agreement with the Takaful operators and the policyholder will be subject to stamp duties and Takaful shares of participants’ contribution shall not be subject to VAT Where a takaful operator invests in a common fund on behalf of the participant, a management fee or a portion of the fund’s return on investment will be subject to VAT. The amount distributed as a surplus of returns on investments to the Operator will be subject to WHT as well. 5. Other investment products
( i) Sukuk This is an arrangement between an originator or sponsor of financial securities and an investor wherein a special purpose vehicle (SPV) is established solely to issue securities for the purpose of raising funds to finance a project, business ventures, purchase of an asset and other Sharia-compliant. The securities are structured based on the principles of non-interest finance that are approved by the Securities and Exchange Commission (SEC) and other relevant agencies.
The arrangement will be treated in the same manner as conventional bonds as provided under CITA (Exemption of Bond and Short Securities) Order 2011. The Regulations also state that the SPV, which is a pass-through vehicle, shall be subject to tax administrative procedures including the filing of returns.
(ii) Islamic Fund Management -This is an arrangement between a fund manager and investors to pool funds together for investment and generate returns in line with Shariah principles approved by the Securities and Exchange Commission.
The Regulations state that the funds will be treated in the same way as traditional fund management transactions under the CITA Act (as amended).
(iii) Islamic Real Estate Investment Trusts-This is an arrangement between a fund manager and investors to pool funds together for investment in real estate in line with Shariah principles approved by the Securities and Exchange Commission.
The Regulations require that such arrangements be treated in accordance with the CIT Act’s definition of a conventional real estate investment trust (as amended)