Tax planning, avoidance and evasion: disclosure, anti-avoidance rules, thin capitalisation and tax havens

Two companies in the same trade report similar profit before tax. One pays far more tax. The difference is not luck. The cheaper one chose hire over purchase, timed its asset purchases, kept its accounting date away from a bad commencement year and claimed every incentive open to it. All of that is legal.

A third company in the same town leaves rent income out of its return and writes in costs that were never incurred. That is also a way of paying less, and it is a crime. The exam tests where the line falls, and what the tax authority does on each side of it.

This topic covers tax planning, mandatory disclosure of planning arrangements, tax avoidance and how the law fights it, tax evasion, the comparison between them, thin capitalisation, tax havens, treaty shopping and the non-tax factors in choosing a location. The previous topic covered tax practice management. The next covers tax audit and investigation.

Key terms in plain English

Syllabus check

This topic is in syllabus area E (tax management and planning, 10% of marks). It covers:

• tax planning, mandatory disclosure, avoidance and evasion, and the differences between them;
• thin capitalisation, tax havens, treaty shopping and non-tax factors;
• advising on planning activities and strategies.

CAMA 2020 and tax planning

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Direct and indirect taxes

Direct taxes fall on income, profit or gains and are paid by the taxpayer to the authority: personal income tax, company income tax, hydrocarbon tax with company tax for petroleum companies, and the development levy. Indirect taxes are added to the price of goods, services or instruments and borne by the end user, while the seller remits them: value added tax, customs and excise duties and stamp duties.

If the person who remits the tax does not bear it, the tax is indirect.

Tax planning

Tax planning is a conscious effort to organise income and spending so as to lower tax within the law, at every point in time. Tax is a statutory duty and the penalties for non-payment are severe, but no one is bound to pay more than the law requires. Planning looks ahead for ways to cut or defer tax.

It aims to secure all allowances, exemptions and reliefs, takes account of the timing of asset purchases and disposals, the choice of accounting date and the effect of the commencement and cessation rules, and looks at when profit is earned and tax paid. Planning must itself be lawful and fully compliant: all taxes due are paid on time.

Checklist.

• The taxes and levies that apply, and the critical dates: returns, objections, monthly PAYE, year-end PAYE, withholding tax, VAT, pension, housing fund and tax payments.
• Timing of acquisition and disposal of assets, and of capital allowance claims.
• Hire of an asset instead of purchase: the full hire charge is deductible.
• Specific rather than general provisions for bad debts and similar items.
• Gains: the exemption thresholds and any relief on reinvestment.
• Incentives: the economic development incentive, export processing and free trade zone reliefs, exempt income and agriculture.
• Where to invest: for example government bonds, and dividends that are franked investment income.
• Pay structure for staff, with the tax effect of benefits in kind; PAYE and withholding tax deducted correctly.
• Company size: a small company with turnover up to ₦100 million and fixed assets up to ₦250 million pays 0%.

A corporate review looks at income sources, expenses, deductions, profit distribution and rates against the law. Multinationals can also plan internationally by using differences in rates and reliefs between countries, although more and more countries restrict profit shifting.

Mandatory disclosure (NTAA s. 30)

A person who enters into, or intends to enter into, a transaction or agreement whose principal purpose is a tax advantage must give the tax authority information on it without notice or request. “Transaction” includes a course of action, agreement, scheme or arrangement.

The authority may make regulations on the information to be given, the form and manner, the time limit and administrative penalties for non-disclosure, false, incomplete or late disclosure. Authority guidance puts the time limit at 30 days from the earliest of the date the arrangement is implemented, the date the taxpayer becomes aware of it, or the date of the transaction document. Failure to disclose is an offence under s. 127.

A tax advantage means:

• a relief or bigger relief
• a repayment or bigger repayment
• avoiding or reducing a charge or an assessment
• avoiding a possible assessment
• deferring a payment or advancing a repayment
• avoiding an obligation to deduct or account for tax

Tax avoidance

Avoidance is arranging affairs to pay the least tax, by studying the law and using gaps. Avoiding VAT by not buying the goods is the simplest case. To the extent that no law is broken it is legal. The courts have said so.

In Ayrshire Pullman Motor Services v IRC, Lord Clyde said that no one is under any obligation, moral or otherwise, to arrange his affairs so as to enable the revenue to put the largest possible shovel into his stores, and the taxpayer is entitled to be astute to prevent, so far as he lawfully can, the depletion of his means.

In FIRS v American International Insurance Co (Nig) Plc, Belgore CJ said that tax is an obligation, not a duty, and that one is not a bad citizen for organising a trade lawfully to cut the burden. When a scheme is stretched, the transactions have form but no substance and no commercial effect, and the authority steps in.

High rates make elaborate schemes worth the cost, so widespread avoidance suggests the system needs reform.

Anti-avoidance legislation

In the United Kingdom the courts developed a doctrine against schemes with pre-ordained steps and steps with no commercial purpose. In Ramsey v IRC a scheme to create allowable losses was genuine in every step but self-cancelling and produced neither gain nor loss, so it was disregarded. Furniss v Dawson extended the idea to a step inserted only to avoid tax.

A taxpayer can defend by showing the steps had a commercial reason and tax saving was not a main object. General rules have worked poorly in Australia, New Zealand and Canada, which supports specific rules.

Nigeria:

• NTAA s. 46, artificial transactions. If the authority thinks a disposition is not given effect to, or a transaction that reduces tax is artificial or fictitious, it may disregard it or make adjustments to counteract the reduction and assess accordingly. A transaction between connected persons is deemed artificial if it is not on arm’s length terms.
• NTAA s. 47, prohibited tax avoidance arrangements. The authority may counteract an arrangement by adjusting, disregarding or recharacterising it, unless the taxpayer proves that the benefit is in line with the object and purpose of the tax law. An arrangement is prohibited where it is reasonable to conclude that its main purpose is a tax benefit, the advantage is contrary to the object and purpose of the law, it misuses or abuses the law, or it lacks commercial substance in whole or in part. “Arrangement” covers any agreement, understanding, scheme, transaction or series of transactions, enforceable or not.
• NTA s. 192, related party arrangements at arm’s length, with the Transfer Pricing Regulations.

Tax evasion

Evasion is the breach of the tax law by neglecting to pay tax due or by making fraudulent or untrue claims: understating income, overstating spending, false claims for reliefs, omitting income, and the failure to file that is common in Nigeria. It is more common where the system seems unfair or governance is opaque. The authority treats it seriously and may reopen assessments beyond the usual limit of six years.

The evader may be prosecuted and fined or jailed. Unless the sum is large and the taxpayer will not co-operate, the authority will often settle out of court for a lump sum covering tax and penalty.

Avoidance and evasion compared

Thin capitalisation

A company is thinly capitalised when it is funded far more by debt than equity. It worries creditors, who carry the risk of a company that has to repay most of its capital with interest and has little reserve, and tax authorities, who fear excessive interest deductions. Banks and insurers must hold a minimum of paid-up capital because their failure harms others.

Authorities limit the interest deduction, particularly on loans at non-commercial rates from connected parties; some limit it only for groups with foreign entities.

Nigeria (Third Schedule, para 2 NTA 2025). Interest is normally deductible. Interest on a loan from a foreign related party is limited to 30% of EBITDA. The part above that is excess interest and is disallowed. A disallowed amount may be carried forward and claimed in later years within the 30% limit, for up to five consecutive years after the year it arose.

The rule does not apply to Nigerian subsidiaries of foreign banks or insurers.

Tax havens

A tax haven is a state or territory that charges little or no tax on profit from transactions carried on there. The OECD looks at three factors:

• nil or nominal tax and a presentation as a place for non-residents to escape high tax
• protection of financial information against foreign scrutiny
• lack of transparency in the legal and administrative rules, such as secret rulings

Havens are grouped into primary (where profit ends up, with shell companies owning the group’s intellectual property), semi-havens (producing goods for sale outside, with free zones or territorial taxation) and conduit havens (collecting and passing on income, such as Luxembourg and the Netherlands). Using all three is the “Dutch sandwich”. Other examples are Switzerland, Ireland, Jersey, the Isle of Man, Bermuda, the British Virgin Islands and the Cayman Islands.

Uses: personal residence (tax exiles), corporate residence (subsidiaries in many countries) and asset holding through an offshore trust or company.

Counter-measures:

1. Controlled foreign company rules, which attribute the offshore profit to the home taxpayer.
2. Transfer pricing rules, aided by the OECD guidelines.
3. Limits on deductions and withholding tax on payments to offshore recipients.
4. Tax on receipts from the haven entity, sometimes with notional interest.
5. Exit charges on unrealised gains when a person or company emigrates.

Others include forced disclosure of tax schemes. Criticisms: idle cash that is costly to bring home; a heavier burden on the poor; links to fraud, money laundering and terrorism; and few convictions.

Treaty shopping

A resident of country C, which has no treaty with country A, sets up a company in country B, which has a treaty with A, and invests in A through it to claim the A to B treaty.

The principle of reciprocity is breached because A and B residents get no matching benefit from C. The answers are anti-treaty-shopping rules and limitation on benefits clauses that deny benefits to companies not truly resident in the treaty country or set up for the purpose.

Nigeria’s NTA 2025 (s. 121) gives treaty benefit only to a resident that is the beneficial owner of the income. Refuses it where a principal purpose is to obtain the advantage.

Non-tax factors in choosing a location

• Economic and political stability.
• Adequate physical, business, accounting and legal infrastructure.
• Little bureaucracy.
• Good communication channels.
• Freedom to negotiate and repatriate profit.
• An effective banking system.
• A reliable dispute resolution system, including arbitration, and respect for the rule of law.
• A common commercial language, and a few highly skilled professionals, since holding companies need few staff.

Worked examples

1. (a) Planning: the hire charge is deductible and the law allows the choice.
2. (b) Evasion: omission of income, criminal, and earlier years can be reopened.
3. (c) Avoidance that is artificial: the authority may disregard it under ss. 46 and 47 NTAA.

1. Year 1 limit = 30% × 400 = ₦120m.
   Excess interest = 150 − 120 = ₦30m, disallowed.
   Extra tax at 30% = ₦9m.
2. Year 2 limit = 30% × 600 = ₦180m.
   Interest is ₦100m, so there is ₦80m of room.
3. The ₦30m brought forward can be claimed in year 2, because it fits within the room, and it is within the five years.

1. The earliest of the three dates is 10 February, the date of the transaction document.
2. Disclosure is due 30 days later, on 12 March.
3. Failure to disclose is an offence.

1. The shell is not the beneficial owner of the dividend, and a principal purpose of the structure is the treaty benefit.
2. The benefit is refused and the domestic rate of 10% applies.

How to score full marks

• Define planning, avoidance and evasion in one line each, with legality.
• Cite NTAA ss. 30, 46 and 47 and NTA s. 192.
• Compute thin capitalisation with the 30% EBITDA limit, then carry forward.
• Give the three OECD factors for a tax haven.
• Add a remedy for each abuse: CFC rules, transfer pricing, limitation on benefits.

Common mistakes in the exam

• Calling avoidance illegal.
• Forgetting that evasion lets the authority go beyond six years.
• Using the wrong base for thin capitalisation: it is EBITDA, not profit or turnover.
• Losing the five-year carry forward limit.
• Listing only two of the three OECD factors for a tax haven.
• Writing about avoidance with no mention of the anti-avoidance rules.

Quick revision

• Planning legal; avoidance legal until artificial; evasion illegal.
• NTAA s. 30 disclosure (30 days, offence s. 127); s. 46 artificial; s. 47 prohibited arrangement.
• Thin capitalisation: 30% of EBITDA, five-year carry forward, banks and insurers excluded.
• Tax haven: nil tax, secrecy, no transparency.
• Treaty shopping: beneficial owner and principal purpose tests.
• CAMA 2020: ss. 54, 119, 305, 308, 377(1), 378.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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