Nigeria has been grappling with an unprecedented foreign exchange crisis since the inception of the current administration in 2023. This has resulted in several monetary policy interventions by the Central Bank of Nigeria (CBN) in a bid to drive down the exchange rate and minimize market fluctuations. Despite the honest desire of the Federal Government to maintain market stability and make exchange rates business friendly, the CBN’s monetary policy intervention has yielded much results.
While the CBN have continued to come up with different policies and measures to arrest the foreign exchange situation, the banks and other companies with huge foreign exchange assets reported huge realized exchange gains and profits in their latest full year financial reports for 2023. This is the premise upon which the Federal Government issued the Finance (Amendment) Bill, 2024 (The Bill) which seeks to subject realized exchange gains of banks to Windfall Tax.
In this alert, we will explore the term “Windfall Tax”, discuss how it has been adopted globally and its consequences in the Nigerian context.
What is “Windfall Tax”
In recent economic and fiscal policy discuss, you may have heard or come across the term “Windfall Tax” severally. Though a very new concept in the Nigeria fiscal landscape, it is not new in the global space.
Windfall tax is a special tax imposed on companies or individuals who have earned unexpected or extraordinary profits due to external circumstances such as government policies or incentives, period of economic surge or hyper-inflation. Unlike the standard taxes based on regular income or profits, windfall taxes subject gains that are deemed excessive or unearned to additional tax from the perspective of fairness, equity, and public interest.
The Nigerian Windfall Tax
The windfall tax was introduced in Nigeria via the the Finance (Amendment) Bill, 2024. The Bill seeks to amend the Finance Act, 2023 to provide for the imposition of windfall tax, introduction of deferred payment agreements in respect of the tax, among others.
The Bill suggests that realized exchange gains reported by financial institutions may be subject to tax at 50%. Further, the Bill provides for a retrospective application of the tax on exchange gains as the period covered, as specified in the Bill, is the financial year commencing 1 January 2023 to 31 December 2023, or any period within the financial year not aligned with the calendar year comprising twelve calendar months of the bank’s financial activity.
The Bill also stipulates that the banks must enter into a deferred payment agreement with the FIRS and complete the settlement of the tax payable on or before 31 December 2024. Failure to fully settle the tax payment by this date will attract penalty at 10%, interest at the Monetary Policy Rate (MPR), and imprisonment of the principal officers of the bank for a period not more than 3 years.
Experience from Around the World
United Kingdom
In 2022, the United Kingdom (UK) government introduced a windfall tax on the profits of major oil and gas companies. This measure was aimed at addressing the cost-of-living crisis exacerbated by rising energy prices.
The tax rate was 25% on the excess profits of energy companies, and the tax revenue was directed towards supporting vulnerable households through energy bill relief. While the tax generated significant funds to assist those affected by high energy costs, it also sparked debates about its impact on future investments in the energy sector.
South Africa
In 2023, the South African government introduced a windfall tax on the mining sector to address the economic imbalances caused by soaring mineral prices and to channel additional resources into the national budget.
The windfall tax is set at 33% on profits exceeding a specific threshold defined by the government. The tax is currently proposed as a temporary measure, with regular reviews to assess its effectiveness and impact. However, there are concerns that the tax may influence global market dynamics and investor perceptions of South Africa’s mining sector.
Italy
Italy introduced a windfall tax in 2022 targeting companies in the energy sector due to extraordinary profits from soaring energy prices.
The tax rate was 33% on profits deemed excessive and the tax revenue was used to ease the economic burden on families and businesses. The tax has been effective in generating revenue for public support, but there have been concerns about its impact on the investment climate in the energy sector.
Practical Realities
The windfall tax can be a source of quick tax revenue for government during periods of economic downturn as seen in the UK and Italy. Notwithstanding, the Federal Government need to approach it with careful attention.
The Bill envisages the retrospective application of the windfall tax on exchange gains reported in 2023 financial year. This may result in several legal disputes between the banks and the FIRS. The National Tax Policy, 2017 explicitly provides that there should be no retroactive application of any tax laws. Also, the Federal High Court in a decided case - Accugas Ltd. vs. FIRS ruled that the provisions of the Finance Act 2019 cannot be applied retroactively to periods, transactions, activities, and income earned prior to the date the Act was enacted.
Recall that the banks have filed and paid income tax on the exchange gains at 30% when completing their annual income tax returns for 2023 financial year. If the Bill is passed into law as it is, the banks would have to account for additional 20% of their realized exchange gain as windfall tax. This would create unanticipated cashflow impact and result in higher effective tax rates for the banks.
Conclusion
Government around the world has continued to leverage windfall tax to address unexpected profits and fund public initiatives. While windfall taxes promotes economic fairness, contributes to government revenue and helps to regulates extreme market fluctuations, it does have significant negative consequences.
It may discourage future investment, may be perceived as unfair and result to unintended economic consequences. Worse-still is the fact that the government intends to apply the tax retrospectively. The government may need to revisit this proposal and consider a more proactive approach.
