THE TAX SYSTEM
1 Taxation is the most important source of government revenue. Taxes may be classified under four categories.
(i) Direct Tax
(ii) Indirect Tax
(iii) Progressive Tax
(iv) Regressive Tax
(a) Direct Tax
A direct tax is a tax levied directly on the incomes of individual and business firms. It has effect on the individual or the company solely on the basis of the amount of income received during a given period or the capital owned or acquired.
Forms of Direct Taxes
* Company income tax
* Capital income tax
* Personnel income tax
* Education tax
* Petroleum profit tax
* Unearned income tax
(b) Indirect Tax
These are taxes on goods and services. Indirect tax is levied on a persons outlay rather than his income, that is, the tax are paid indirectly through the purchase price of a good or service and they are collected by the person selling the item.
Forms of Indirect Taxes
* Excise tax (tax on local manufactured goods)
* Import duties & export duties
* Value added tax (formally sales tax)
(c) Progressive Tax
A tax is progressive if the rate of tax increases as the individual’s capacity to pay increases. If the proportion of income taken by tax rises faster than income, the tax is said to be “highly progressive” if the proportions are the same, the tax is proportional.
(d) Regressive tax
A tax is regressive where the rate of tax decreases as income rises or where the tax paid represents a smaller proportion of higher income than for lower incomes.
2 Effect of Tax on Your Choice of Trading Medium
The factors set out below are of general importance in deciding whether you should trade through a limited company or as a sole trader. Their relative weight will depend on your circumstances and your plans for the future.
(a) Tax and Profits
The tax system makes no distinction between an individual and his business. Thus any profits a sole trader makes are aggregated with any other income he may have, irrespective of whether they are withdrawn from business for personal use or retained in the business. Income tax is currently levied at the lowest rate of 5% on the 1st N30,000, 10% on the next N30,000, 15% on the next N50,000, 20% on the next N50,000 and 25% on the balance.
Profits arising in a company are taxed at the rate of 30% of the total profits and education tax at the rate of 2% of assessable profit. A company’s trading profit has no income tax implications for the shareholders unless the company pays dividend, when the gross dividend becomes part of the shareholder’s total income for the tax year in which it was paid. Though withholding tax deducted from such dividend shall be the final tax on the dividend. If a director is receiving remuneration, the remuneration is subject to incur tax in the hands of the director, but is fully deductible in computing the company’s taxable profit except where the company is into property holding and investment where deductible directors fees has been limited to a certain sum per director for a maximum of three directors.
(b) Private Expenditure and Benefits Paid for by the Business
Private expenditure and benefits paid for by the business are disallowed in computing a sole trader’s trading profits subject to income deductible for company income tax purpose. But, for directors of the company, any such expenditure will result in a charge to income tax in the hands of the directors under the benefit in kind rules.
(c) The Payment of Tax Liabilities
Under the PAYE system, tax deducted from employee’ pay must be remitted to the tax office within 10 days after the end of the month, failing which penalty at 10% per annum and interest at 21% will be charged where a direct assessment is made eon an individual, the tax liability must be paid within 14 days to avoid interest and penalty charges.
Company income tax is payable within two months form the date of the notice of assessment and in any case not later than 14th of December of that year of assessment. Where a company file returns on self assessment basis. The cheque for payment of the tax liability must be attached to the returns being filed. Companies not filing returns on self-assessment basis are expected to pay provisional tax within three months of the commencement of each of assessment.
(d) Capital Gain Tax
Capital gain tax is also important if the business will use assets which could give rise to changeable gains on their disposal.
Capital gain tax is payable by both individual trader and company at the rate of 10% on the chargeable gain. The disadvantage of having gains accrue to a company, however, is that an effective double charge to tax can arise. Tax is payable firstly by the company on disposal of the chargeable assets. It will also be payable by the shareholder however, when they dispose of their shares (since the shares value will reflect the gains made by the company).
3 Definition of Terms
Tax Avoidance
Tax avoidance is a deliberate act of the tax payer to pay less than ought to pay legally. It is an act of winning games without actually cheating. It involves the tax payer identifying the loopholes in the tax laws and take advantage of them. It is permissible under law. However, in recent times some tax avoidance schemes have been declared null and void and their real intentions were declared to be tax evasion.
4 Tax Evasion
Tax evasion is an illegal method of reducing one tax liabilities such as incorrect return by omitting or understating one’s income or non-declaration of income and incorrect information. It is punishable with fines payment of double the amount which has been undercharged etc.
5 The Value Added Tax (VAT)
Value added tax is tax charged on value added during the course of production of goods and services. It is a multi-staged level of tax collected on sales at all stages of sales and distribution. VAT is imposed at the single rate of 5% on the invoice value of goods services.
Goods Exempted from VAT
(i) Basic food items
(ii) Medical and pharmaceutical products
(iii)All exported goods
(iv) Books and educational materials
(v) Fertilizers, agricultural and veterinary medicine.
(vi) Agricultural machinery and equipments.
Important Points to Note
Accounts
You should record all income and expenditure exclusive of any VAT. The rate should be recorded in a separate account showing the balance due to or from the Federal Inland Revenue Service through the local VAT office.
Accounting for VAT
An analysis of the accounting records of a typical wholesale who buys VATable products from the manufacturers and sells to the retailer will show all that is Basics to VAT accounting. ………….or service he pays VAT. Cash account is credited for the payment and a corresponding amount is debited to the VAT account if the business. This is the input tax. When he sells VATable products, he collects VAT. Cash account is debited with the amount received while a corresponding amount is credited to the VAT account. This is output tax (where the transaction is on credit the cash account is not involved. Rather, an account is opened for the creditor or debtor as may be appropriate to take the contra entry).
If the output tax is more than the input tax, the excess is remitted to the government. When the remittance is made, the cash account is credited and the corresponding debts goes into the VAT account. The account is then ruled off for the month.
In the event of input tax being more than the output tax (which may occur when purchases outstrip sales) a cash refund by the tax authority is required. When the cash refund us received from the tax office, cash account is debited with the amount of the refund while the VAT account is credited to balance the VAT account which is then ruled off for the month.
Claiming of Refund
A VAT invoice is necessary so that a VAT registered purchaser can reclaim input VAT suffered. The issue of such an invoice usually sets the tax point for a supply. A VAT invoice must show the following details:
(i) The supplies name, address and registration number.
(ii) The date of issue, the tax point and an invoice number.
(iii) The name and address of the customer
(iv) The type of supply (sale, hire purchase).
(v) The rate of any cash discount
(vi) A description of the goods or services.
Registration with Federal Inland Revenue Service
The following are the necessary steps to be taken to register with Federal Inland Revenue Service.
A formal letter would need to be written to the Federal Inland Revenue Service applying for registration.
1 Taxation is the most important source of government revenue. Taxes may be classified under four categories.
(i) Direct Tax
(ii) Indirect Tax
(iii) Progressive Tax
(iv) Regressive Tax
(a) Direct Tax
A direct tax is a tax levied directly on the incomes of individual and business firms. It has effect on the individual or the company solely on the basis of the amount of income received during a given period or the capital owned or acquired.
Forms of Direct Taxes
* Company income tax
* Capital income tax
* Personnel income tax
* Education tax
* Petroleum profit tax
* Unearned income tax
(b) Indirect Tax
These are taxes on goods and services. Indirect tax is levied on a persons outlay rather than his income, that is, the tax are paid indirectly through the purchase price of a good or service and they are collected by the person selling the item.
Forms of Indirect Taxes
* Excise tax (tax on local manufactured goods)
* Import duties & export duties
* Value added tax (formally sales tax)
(c) Progressive Tax
A tax is progressive if the rate of tax increases as the individual’s capacity to pay increases. If the proportion of income taken by tax rises faster than income, the tax is said to be “highly progressive” if the proportions are the same, the tax is proportional.
(d) Regressive tax
A tax is regressive where the rate of tax decreases as income rises or where the tax paid represents a smaller proportion of higher income than for lower incomes.
2 Effect of Tax on Your Choice of Trading Medium
The factors set out below are of general importance in deciding whether you should trade through a limited company or as a sole trader. Their relative weight will depend on your circumstances and your plans for the future.
(a) Tax and Profits
The tax system makes no distinction between an individual and his business. Thus any profits a sole trader makes are aggregated with any other income he may have, irrespective of whether they are withdrawn from business for personal use or retained in the business. Income tax is currently levied at the lowest rate of 5% on the 1st N30,000, 10% on the next N30,000, 15% on the next N50,000, 20% on the next N50,000 and 25% on the balance.
Profits arising in a company are taxed at the rate of 30% of the total profits and education tax at the rate of 2% of assessable profit. A company’s trading profit has no income tax implications for the shareholders unless the company pays dividend, when the gross dividend becomes part of the shareholder’s total income for the tax year in which it was paid. Though withholding tax deducted from such dividend shall be the final tax on the dividend. If a director is receiving remuneration, the remuneration is subject to incur tax in the hands of the director, but is fully deductible in computing the company’s taxable profit except where the company is into property holding and investment where deductible directors fees has been limited to a certain sum per director for a maximum of three directors.
(b) Private Expenditure and Benefits Paid for by the Business
Private expenditure and benefits paid for by the business are disallowed in computing a sole trader’s trading profits subject to income deductible for company income tax purpose. But, for directors of the company, any such expenditure will result in a charge to income tax in the hands of the directors under the benefit in kind rules.
(c) The Payment of Tax Liabilities
Under the PAYE system, tax deducted from employee’ pay must be remitted to the tax office within 10 days after the end of the month, failing which penalty at 10% per annum and interest at 21% will be charged where a direct assessment is made eon an individual, the tax liability must be paid within 14 days to avoid interest and penalty charges.
Company income tax is payable within two months form the date of the notice of assessment and in any case not later than 14th of December of that year of assessment. Where a company file returns on self assessment basis. The cheque for payment of the tax liability must be attached to the returns being filed. Companies not filing returns on self-assessment basis are expected to pay provisional tax within three months of the commencement of each of assessment.
(d) Capital Gain Tax
Capital gain tax is also important if the business will use assets which could give rise to changeable gains on their disposal.
Capital gain tax is payable by both individual trader and company at the rate of 10% on the chargeable gain. The disadvantage of having gains accrue to a company, however, is that an effective double charge to tax can arise. Tax is payable firstly by the company on disposal of the chargeable assets. It will also be payable by the shareholder however, when they dispose of their shares (since the shares value will reflect the gains made by the company).
3 Definition of Terms
Tax Avoidance
Tax avoidance is a deliberate act of the tax payer to pay less than ought to pay legally. It is an act of winning games without actually cheating. It involves the tax payer identifying the loopholes in the tax laws and take advantage of them. It is permissible under law. However, in recent times some tax avoidance schemes have been declared null and void and their real intentions were declared to be tax evasion.
4 Tax Evasion
Tax evasion is an illegal method of reducing one tax liabilities such as incorrect return by omitting or understating one’s income or non-declaration of income and incorrect information. It is punishable with fines payment of double the amount which has been undercharged etc.
5 The Value Added Tax (VAT)
Value added tax is tax charged on value added during the course of production of goods and services. It is a multi-staged level of tax collected on sales at all stages of sales and distribution. VAT is imposed at the single rate of 5% on the invoice value of goods services.
Goods Exempted from VAT
(i) Basic food items
(ii) Medical and pharmaceutical products
(iii)All exported goods
(iv) Books and educational materials
(v) Fertilizers, agricultural and veterinary medicine.
(vi) Agricultural machinery and equipments.
Important Points to Note
Accounts
You should record all income and expenditure exclusive of any VAT. The rate should be recorded in a separate account showing the balance due to or from the Federal Inland Revenue Service through the local VAT office.
Accounting for VAT
An analysis of the accounting records of a typical wholesale who buys VATable products from the manufacturers and sells to the retailer will show all that is Basics to VAT accounting. ………….or service he pays VAT. Cash account is credited for the payment and a corresponding amount is debited to the VAT account if the business. This is the input tax. When he sells VATable products, he collects VAT. Cash account is debited with the amount received while a corresponding amount is credited to the VAT account. This is output tax (where the transaction is on credit the cash account is not involved. Rather, an account is opened for the creditor or debtor as may be appropriate to take the contra entry).
If the output tax is more than the input tax, the excess is remitted to the government. When the remittance is made, the cash account is credited and the corresponding debts goes into the VAT account. The account is then ruled off for the month.
In the event of input tax being more than the output tax (which may occur when purchases outstrip sales) a cash refund by the tax authority is required. When the cash refund us received from the tax office, cash account is debited with the amount of the refund while the VAT account is credited to balance the VAT account which is then ruled off for the month.
Claiming of Refund
A VAT invoice is necessary so that a VAT registered purchaser can reclaim input VAT suffered. The issue of such an invoice usually sets the tax point for a supply. A VAT invoice must show the following details:
(i) The supplies name, address and registration number.
(ii) The date of issue, the tax point and an invoice number.
(iii) The name and address of the customer
(iv) The type of supply (sale, hire purchase).
(v) The rate of any cash discount
(vi) A description of the goods or services.
Registration with Federal Inland Revenue Service
The following are the necessary steps to be taken to register with Federal Inland Revenue Service.
A formal letter would need to be written to the Federal Inland Revenue Service applying for registration.
The letter should be accompanied by:
- A photocopy of the company’s certificate of incorporation or formal letter of business name registration in case of sole-proprietorship.
- A copy of the company’s memo and articles of association, this is not necessary in case of sole-proprietorship.
§ For a company, the following additional information need to be supplied:
o The date of commencement of operation.
o The registered office of the company
o The names and address of the directors
o The address of the company’s bankers
o The principal activity of the company
o The date to which the company’s account would be prepared annually
o The shareholding of the company
However, for company that has commenced operation to obtain a tax clearance certificate, the company must be registered with the Federal inland Revenue Service. If the company has operated for not less than twelve month, a copy of the company’s audited financial statements together with the tax computations thereon must be filed at the tax office within six months of the company’s accounting year end.
Also, for a company that has not commenced operations and has been incorporated for over six months a statement of affairs of the company must be filed with the Federal Inland Revenue Service. In addition, to obtain tax clearance
11 The PAYE Scheme and Procedure
PAYE scheme is a method of collecting tax due on employment incomes including pensions. The employer is regarded as an unpaid agent of the Tax Authority and as such expected to deduct tax on salaries and wages, bonuses, allowances and benefit in kind.
This system ensures that tax is withheld monthly from employees salaries and wages before the employees are paid. The employer is obliged to pay taxes withheld to the relevant tax authority not later than the 14th day of the month following that of deduction.
Procedures
Returns of income and claims for allowances and reliefs are usually filed by each employee with the revenue at the beginning of each tax year. These are examined and filed in the respective employees personal files at the tax office. The allowances due to each employee are computed by the revenue on the basis of the information contained in the returns. These are entered on tax deductions cards and initiated by the appropriate officer.
Liability of Employer
An employer who is required to make deductions from the emoluments paid to an employee shall account to the relevant tax authority in such manner as the relevant tax authority may prescribe for the deduction made.
If the employer fails to make the deduction or fails to account properly for it, the amount of the tax together with a penalty of 10% per annum of the amount plus interest at the prevailing commercial rate shall be recoverable from the employer. The employer can also be held liable for failure to make correct return of his employees and their pay.
- A photocopy of the company’s certificate of incorporation or formal letter of business name registration in case of sole-proprietorship.
- A copy of the company’s memo and articles of association, this is not necessary in case of sole-proprietorship.
§ For a company, the following additional information need to be supplied:
o The date of commencement of operation.
o The registered office of the company
o The names and address of the directors
o The address of the company’s bankers
o The principal activity of the company
o The date to which the company’s account would be prepared annually
o The shareholding of the company
However, for company that has commenced operation to obtain a tax clearance certificate, the company must be registered with the Federal inland Revenue Service. If the company has operated for not less than twelve month, a copy of the company’s audited financial statements together with the tax computations thereon must be filed at the tax office within six months of the company’s accounting year end.
Also, for a company that has not commenced operations and has been incorporated for over six months a statement of affairs of the company must be filed with the Federal Inland Revenue Service. In addition, to obtain tax clearance
11 The PAYE Scheme and Procedure
PAYE scheme is a method of collecting tax due on employment incomes including pensions. The employer is regarded as an unpaid agent of the Tax Authority and as such expected to deduct tax on salaries and wages, bonuses, allowances and benefit in kind.
This system ensures that tax is withheld monthly from employees salaries and wages before the employees are paid. The employer is obliged to pay taxes withheld to the relevant tax authority not later than the 14th day of the month following that of deduction.
Procedures
Returns of income and claims for allowances and reliefs are usually filed by each employee with the revenue at the beginning of each tax year. These are examined and filed in the respective employees personal files at the tax office. The allowances due to each employee are computed by the revenue on the basis of the information contained in the returns. These are entered on tax deductions cards and initiated by the appropriate officer.
Liability of Employer
An employer who is required to make deductions from the emoluments paid to an employee shall account to the relevant tax authority in such manner as the relevant tax authority may prescribe for the deduction made.
If the employer fails to make the deduction or fails to account properly for it, the amount of the tax together with a penalty of 10% per annum of the amount plus interest at the prevailing commercial rate shall be recoverable from the employer. The employer can also be held liable for failure to make correct return of his employees and their pay.
