Charitable donations contribute to development, that is why countries around the world work towards creating a tax system that recognises and encourages donations. This article provides an insight into what the Nigerian revenue system says about tax-deductible donations and how it can be improved.
Donations and financing community projects are some of the common charitable ways of contributing to the development of society. Many corporations and well-meaning individuals often incorporate these in their corporate social responsibility strategy. Hence, it is common for corporations and individuals to occasionally give out cash and material contributions to NGOs, ecclesiastical bodies, public funds, and educational institutions.
Recognizing the importance of donations, there is a global consensus to make them tax-deductible expenses. As a result, corporations can leverage the cost of their charitable activities to reduce their tax liability. In a way, this serves as a motivation for donors to keep up the good work. Nigeria is not exempted. The current tax landscape recognizes donations as tax-deductible. This article provides an insight into tax deductions and the legal framework for tax-deductible donations in Nigeria.
How does Tax Deductions Work?
Think of it as a reduction of a taxpayer’s liability. It is a deduction in the amount a taxpayer is to remit as tax. Generally, individuals and companies have a duty to file their tax returns for the year and pay their taxes to government authorities. For a company, the amount of tax to be remitted is dependent on its size. While large companies (companies that have an annual gross turnover of 100 million and above) are expected to pay 30% of their income, medium-sized companies (those with a turnover between 25 to 100 million) are required to pay just 20%.
A company can reduce the amount of tax to be paid by deducting the cost spent on carrying out charitable and other business projects. For instance, tax laws permit organizations to first subtract the cost of donations from their end-of-the-year profits before calculating how much it is to remit in taxes. This is simply what is known as a tax deduction. In essence, a tax deduction is a means by which a taxpayer lowers his liability by reducing his taxable income.
As an illustration, if company ABC made a profit of 150 million in 2020. But, in the same year, it made charitable donations in cash to a COVID-19 fund totalling an amount of 10 million. In determining how much is to be remitted in tax, the company will first deduct the 10 million from the general profit of 150 million before deriving the 30% of its income that it owes in tax. By implication, the company lowers the amount in which it ought to remit. Thus, the company pays 30% of 140 million as tax instead of paying 30% of 150 million.
Given the current tax landscape in Nigeria, tax-deductibility of donations is restricted to corporate entities alone and does not apply to the personal income of individuals. Consequently, an individual cannot reduce his tax liability by deducting the money expended on donations from his income. Note that our focus is exclusively on the tax-deductible status of donations and not on other allowable deductions such as business expenses incidental to the production of profits, i.e., salaries of employees, rents, cost of acquiring property and capital, etc.
... whenever a company makes a charitable donation to a fund set up by the government for the purpose of a pandemic or natural disaster, the cost of such donations is now recognized as being tax-deductible – that is, can be used to reduce the company's taxable income.
What Laws Govern Tax Deductions?
Two primary legislations contribute to the legal framework of tax deductibility regarding donations in Nigeria. They are the Companies Income Tax Act (CITA) and the Finance Act, 2020.
Companies Income Tax Act
Part 3 of the CITA (as amended) covers tax deductions. Section 24 accounts for general deductions that may be made before determining the portion of a company's income subject to tax. Here, allowable deductions include expenses such as;
- Interest payable on loans acquired as capital for the company
- Liability incurred in respect of property acquired for business purposes
- Salaries or wages of employees and company executives
- Pension contributions
- Other managerial and maintenance expenses, etc.
Moreover, Section 25 specifically establishes the tax deductibility status of donations. It provides that donations which companies make to specific funds, bodies, or institutions in Nigeria, or for any charitable purpose, in general, are deemed tax-deductible subject to certain listed conditions to wit;
- The donation must have been made out of the company's profits; it should not be expenditure of a capital nature.
- The allowable tax deduction cannot exceed 10% of the company's assessable profits for the year the donation was made.
- The fund, body, or institution to which the donation is made to must be registered and incorporated in Nigeria. Furthermore, it must be specified in the 5th schedule of the Act.
- Donations made by the company must not be any form of payment for a value.
- Finally, where a donation is revenue or capital in nature, it may be deductible if it is made to a tertiary institution.
However, the deduction must not exceed an amount equal to 15% of the company’s total profits or 25% of the tax payable for the year the donation was made (whichever is higher).
Importantly, for a company's donation to be tax-deductible, it must be made specifically to either of the following entities: a public fund, statutory body or institution, ecclesiastical, charitable, educational, or scientific institutions – all of which must be registered in Nigeria and included in the 5th schedule of the Act. Currently, 42 entities are already recognized for this purpose. More so, the Act empowers the minister of finance to make amendments to this schedule by an Order in the Federal Gazette.
Earlier this year in March, the Federal Inland Revenue Service (FIRS) issued a circular detailing the procedure in which funds, bodies, and institutions may be listed under the 5th schedule of CITA for the purpose of being recipients of tax-deductible donations. Entities not included in the 5th schedule that desire to receive tax-deductible donations must follow the procedure highlighted in this circular to get listed.
Finance Act, 2020
This Act expanded the scope of tax deductions of donations by amending Section 25 of the CITA. In doing so, it cleared the uncertainties surrounding the tax-deductible status of donations made in respect of the COVID-19 pandemic. By virtue of the Act, donations made in cash or kind to any fund set up by the government or its agencies in respect of any pandemic or natural disaster are deemed tax-deductible expenses. The deduction remains subject to 10% of the company's assessable profits after other allowable donations have been deducted.
The import of the foregoing is that whenever a company makes a charitable donation to a fund set up by the government for the purpose of a pandemic or natural disaster (such as COVID-19), the cost of such donations is now recognized as being tax-deductible – that is, can be used to reduce the company's taxable income.
Why are donations tax-deductible? What is the rationale?
The answer is not far-fetched. It is as simple as this – government authorities recognize the positive impact that charitable activities and community service programs have on individuals, institutions, and the society at large. It thus seeks to promote and encourage this practice amongst corporate entities. Therefore, companies are encouraged to give donations, having in mind that at the end of the financial year, the expenses incurred can be used to lower their tax liability. This serves as an advantage to companies as they can strategically plan their activities in order to reduce their annual tax liability to the revenue authorities.
The events of the COVID-19 pandemic further demonstrate the social utility of this status. One cannot overlook the impact of the donations made by companies in the private sector to government funds and institutions in support of the fight against COVID-19. As of April 2020, the cash donations made by companies already peaked at about 21 billion naira, excluding other donations in kind. It is arguable that without donations being tax-deductible, companies may not have been easily spurred to make such significant contributions.
Although the tax-deductible privilege seems very commendable, it certainly has its drawback. Companies in Nigeria and in the world at large are empowered to take advantage of tax deductibles to constantly limit their tax liabilities, thereby reducing the country’s tax base. What this ultimately translates to is a reduction in the tax revenue accruing to the government.
Extending the scope
Given the utility of tax-deductible donations, it is recommended that the government consider extending this practice to the personal income of individuals. This will invariably encourage the practice of making donations amongst individuals that would in turn benefit society. For instance, in the United Kingdom (UK) and South Africa, the extant tax framework permits individuals to subtract the cost of donations as tax-deductible expenses before determining their tax liability.
These two countries are worthy of emulation by virtue of their relatively strong tax-to-GDP ratios, which represents the significant value that taxes contribute to their economy. In 2018, South Africa ranked 4th in Africa for tax-to-GDP ratio with a percentage of 27.8. Whereas, that of the UK increased from 32.9% in 2018 to 33.0% in 2019.
An expected counter-opinion to this recommendation may centre around Nigeria’s recent efforts to focus more on taxation for generating needed revenue, especially in light of the aftereffect of the COVID-19 pandemic and the attendant drop in oil prices. While this recommendation may easily appear to be counter-productive to the government’s effort, it is still tenable to some extent. If donations are tax-deductible on personal income, individuals will do more charitable giving, thus contributing to the improvement of the welfare of the society — the same goal that the government aims to achieve with collecting taxes in the first place. So, it’s a win-win.
A second recommendation is that the government should also devise a means to ensure that the tax-deductible arrangement in respect of donations is not unduly exploited by both individuals and companies. With a good strategy in place, there can be a check to the excesses that the tax-deductible system may present, ultimately ensuring that the government is not losing out in the long run.
Olayinka Shado | Research Assistant, Fiscal Policy | email@example.com
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