Menu

MSMEs may further weaken with the new tax exemptions 20 Feb 2020

The 2019 Finance Act is a populist legislation. It exempts small businesses with less than N25 million in annual turnover from paying Companies Income Tax (CIT) and from collecting Value Added Tax (VAT). Medium-sized businesses, whose annual turnover range from N25 million to N100 million, are to pay 20 per cent as CIT, instead of the previous 30 per cent. A number of staple food and locally-made consumer products, rightly including sanitary pads, have also been exempted from VAT.
    
But the foregoing does not mean that the government is retreating from taxation. The new tax law increased the VAT rate from 5 per cent to 7.5 per cent. Indeed, the federal government wants to increase tax revenue to fund its expansionary 2020 budget; and the higher VAT rate is intended to help the state and local governments to be able to pay the increased national minimum wage. To achieve these objectives, the policy thinking was to tax more those with higher income.

Populist policies such as this usually have their downsides, if not altogether flawed. But, certainly, the new finance law is far from a worthless piece of legislation. At least, it is an attempt to increase government revenue and bring some new entities into the tax net. This will potentially improve the implementation of the budget, narrow the deficit, and slow the pace of growth of public debt. Conventional wisdom also says the 2019 Finance Act will help in spurring growth of Small and Medium Scale Businesses (SMEs). Nevertheless, the broader implications of the tax exemptions for small businesses is worth determining.

A joint survey by National Bureau of Statistics (NBS) and Small and Medium Enterprises Development Agency of Nigeria (SMEDAN) found that there were 41.5 million registered Micro, Small and Medium Enterprises (MSMEs) in Nigeria in 2017. Only six African countries, excluding Nigeria, have human population exceeding the number of MSMEs in Nigeria. Many countries, including Poland, Morocco, Saudi Arabia and Uganda have less human population than the number of MSMEs in Nigeria.

By exempting the huge proportion of MSMEs in Nigeria from paying CIT, the effective Nigerian tax net has shrunk considerably. The new finance law is, therefore, a setback to – or a reversal of – efforts to widen the tax net. To avoid this reality, it was better that small businesses pay the bare-minimum of tax that would a little bit more than cover the cost of collection. But for that cost to not be prohibitive for taxation, government would need to deploy technology for the payment of tax. However, efforts to simplify tax payment, using technology, have largely failed to gain traction despite the thrust of policy in this direction.

Therefore, the exemptions serve to legitimise government’s failure to collect taxes from businesses that constitute the informal sector. Formalisation of informal sector operators, which include but is not limited to taxing them, is an important stimulus for economic growth. By not paying taxes, small businesses are not likely to enjoy more services from the government. Before the enactment of the new finance law, many Nigerians believed the social contract between them – and, by extension, their small businesses – and the government had collapsed. This law is unlikely to change this situation.

It has become clearer now that the exemptions granted small businesses may not be sustained. According to the Minister of Finance, Zainab Ahmed, every appropriation bill will henceforth be presented with a new finance bill, which is likely to amend some provisions of the Finance Act of the preceding year. The likelihood of an amendment to the tax exemptions in the 2019 Finance Act would increase, if as expected, there is a significant gulf between the level of tax revenue the government expected and what it actually collected, despite the amendments in other tax laws to expand taxable entities and goods. The additional revenue that is accruable to the federal government from the VAT increase would be marginal, given that it receives only 15 per cent of the sum collected, with the remaining 85 per cent shared among the state and local governments.

But the overall effect of higher VAT on the Nigerian middle and upper classes, as well as increased tax burdens on big businesses will weaken consumption at household level, reduce business volumes of SMEs, and likely induce lay-offs. Such unintended consequences could even reduce the rate of business formation in the MSMEs sector.

One of the more important reasons Nigerian small businesses should remain effectively in the tax net is that the environmental footprints of their operations are considerable. For now, the need to address their unsustainable environmental practices are overlooked. But the country’s fiscal outlook does not provide any new source of funding for the environmental reform that needs to be introduced for a more sustainable small businesses sector. The businesses have to contribute their taxes to the funding of such reform.

The number of SMEs in Nigeria is not only staggering. SMEs contributed 48 per cent to the GDP in 2018; they account for 50 per cent of industrial jobs and approximately 90 per cent of the number of businesses in the manufacturing sector. It is a wrong policy to not tax a whopping 48 percent of the total economic production. The government cannot afford the largesse of the CIT and VAT exemptions, except it plans to shirk its responsibility of providing infrastructure, security and facilitate the provision of utilities to serve SMEs.

However, the exemptions have provided a policy reset. The government should now be very deliberate in rebooting the MSMEs sector. In subsequent years, the finance legislation should gradually rollback the tax exemptions, probably capping the CIT rate at 15 per cent for small businesses. The money raised, net of the cost of collection, should be used to setup a MSMEs fund. The fund should finance specific projects that will help in formalising the informal sector, deliver projects that service SME clusters, improve environmental practices, provide business education to start-up entrepreneurs, and provide grants for expansion into export markets.

It is a well-founded concern that such a fund would be mismanaged by the bureaucracy that is chronically corrupt and inept. But if the government cannot deliver the needed services and support to small businesses, it will hardly be helpful leaving them to struggle on their own while not taxing them.