Microfinance banks and the VAT legislation: Is there a case for exemption?

http://ifttt.com/images/no_image_card.png

Introduction
The primary aim of new National Tax Policy is to introduce new strategies that will enable government achieve its objectives of creating an enabling environment for businesses to thrive while simplifying the tax system. This underlying principle is expected to be applied in the purposive interpretation of ambiguous provisions of the tax laws.

Nigeria’s banking sector has few controversies resulting from ambiguity in the tax laws.  One of the most prominent of these controversies is the applicability of value added tax (VAT) to financial services rendered by microfinance banks. Federal Inland Revenue Service (FIRS) typically expects microfinance banks to charge VAT on services rendered to their customers based on relevant provisions of the Value Added Tax Act, Cap V1, LFN 2007, as amended (VATA or the Act). However, many microfinance banks have challenged FIRS’ position on the grounds of alternate interpretation of VATA that supports exempting VAT on services rendered by these institutions.

This paper examines the current legislative provisions guiding the applicability of VAT on services of banks and other financial institutions and arguments against the imposition of VAT on services rendered by microfinance banks in Nigeria.

History of microfinance banks
Microfinance banks metamorphosed from three types of financial institutions - Universal Banks, Community Banks and Non-Governmental Microfinance Banks.  The erstwhile community banks were introduced in the 1990s under the Community Banking Decree of 1992 to bridge the gap in credit capacity between high-income earners and low-income earners in Nigeria. The community banks were small-scale and non-discriminatory in their dealings with customers. They were established to assist the Federal Government in improving the ability of grass root customers in the informal sector to access credit facilities.

In December 2005, the Central Bank of Nigeria (CBN) released a microfinance policy known as Microfinance Policy, Regulatory and Supervisory Framework (“CBN Policy”), which serves as the framework for the establishment of microfinance banking in Nigeria.  According to the CBN, the formal financial system only provided financial services to about 35% of the economy, while the remaining 65% were excluded. This 65% were serviced by the informal financial sector such as non-governmental organization microfinance institutions, money lenders, credit unions, etc.

The CBN Policy provides for two categories of microfinance banks; namely, microfinance banks licensed to operate as a “unit banks” and microfinance banks licensed to operate in a State. All existing licensed community banks at the time were required to transform to microfinance banks within 24 months from the effective date of the CBN Policy, subject to meeting the specified capital and other conversion requirements.

VAT and microfinance banks
VATA, being the primary legislation governing the imposition and administration of VAT in Nigeria, provides for the imposition of VAT at 5% on all supply of taxable goods and services except those specifically exempted in the First Schedule to the Act.

Generally, VAT is applicable to fees and commissions charged by banks and other financial institutions for services rendered. However, it was clarified in FIRS Information Circular that rewards for activities of these institutions that constitute returns on investment are not liable to VAT. These rewards include interest on loans/advances, overdraft facilities, savings accounts, bank deposits and interbank placements, dividends, profit on disposal of securities, etc.

Considering that there is no specific VAT exemption for microfinance services in VATA, the above may therefore suggest that VAT would apply to microfinance services. This supports the current practice by FIRS of requesting microfinance banks to charge VAT on fees earned from services rendered to their customers, provided the rewards do not constitute returns on investment. However, this FIRS’ practice may not be consistent with the tax laws for the following reasons:

1. Part II of First Schedule to VATA specifically exempts services rendered by Community Banks, People’s Banks and Mortgage Institutions from VAT. However, VATA does not define what constitute a “community bank” for VAT purposes.

A working definition in Paragraph 6.0 of the CBN Policy refers to community banks as microfinance banks licensed to operate as unit banks. Given that operations of unit banks are required to be community based, it could be argued that the provisions of VATA relating to community banks are also applicable to microfinance banks licensed to operate as unit banks.

1. From the legislative sequence of events, one may argue to a large degree of conviction that services provided by microfinance banks (or at least, those licensed to operate as “unit banks”) should be clearly exempt from VAT.
   
   VAT became part of Nigerian tax regime in 1993. The original legislation, VAT Decree No. 102 of 1993 includes services rendered by Community Banks, People’s Bank and Mortgage Institutions as exempt services.  At the time this legislation was promulgated, Nigeria used to have community banks and People’s Bank but not microfinance banks. These categories of financial institutions have now been replaced by microfinance banks following the CBN’s directive in December 2005. 

Although, there have been amendments to VATA post-2005, failure to replace community banks and People’s Bank with microfinance banks on the list of exempt services was a clear oversight. As the successor in title to erstwhile community banks, with the transition necessitated by legislation (i.e. the CBN Policy), microfinance banks should naturally enjoy the VAT exemptions that community banks and People’s Bank enjoyed.

1. The CBN Policy provided a framework for certain fiscal and regulatory incentives to be granted to microfinance banks that emerged as a consequence of CBN’s directive of December 2005, including exemption from VAT. Paragraph 12.1 of the CBN Policy states that “CBN shall collaborate with appropriate fiscal authorities in providing favorable tax treatment of microfinance banks’ financial transactions including exemption from VAT on lending and tax on interest income and revenue”.  There is no evidence that CBN and FIRS have collaborated in implementing this policy.

Though, the CBN Policy is not a law in itself; it however provides a guide as to the intentions of the CBN when issuing the directive for the establishment of microfinance banks in Nigeria, one of which was to exempt financial transactions of the banks from VAT, in consonance with the provision of VATA as it relates to services provided by the defunct community banks.

Conclusion
There is no doubt that the erstwhile community banks are similar, if not the same, as microfinance banks, given the nature of their operations and the strategic intent behind their establishment. Hence, the provision of VATA which exempts services rendered by community banks from VAT is also applicable to microfinance services.

Further, in order to support the Federal Government in actualizing its objective of promoting Nigeria’s economic development through microfinance banking, the FIRS must suspend its current practice of subjecting financial services rendered by microfinance banks to VAT. The FIRS may consider issuing a circular or guideline to provide clarity to stakeholders in this regard. Also, there may be a need to update the list of exempt services in Part II of First Schedule to VATA by replacing the term “Community Banks” with “Microfinance Banks”.

The foregoing will go a long way towards resolving the existing controversy. It would also ensure fair treatment of microfinance banks and promote compliance with extant VAT legislation in Nigeria.

Okunade is the senior manager, Tax & Regulatory Services, Deloitte Nigeria