Memo to Ambode (and 35 Others) No 2: Avoiding An IGR Decimation

On behalf of yourself and your 35 colleagues in the other states of Nigeria, please accept the sincerest thanks from me and all other salary earning Nigerians who were seeking ways to reduce our Tax burdens for providing us with a very convenient, effective and lawful way to avoid as much of our Taxes as we care. I am not a greedy, anti good governance individual so I have sparingly used your very kind gift to reduce my Pay As You Earn (PAYE) Tax burden by a mere ~50% per annum. What is a couple of million naira between friends after all? And we are friends seeing as we are both Chartered Accountants who understand how these things work. I have other friends however who aren’t as ‘obsessed’ with good governance as I am and some of them are relieving themselves of more than 90% of the PAYE burden. I repeat that you and your fellow governors handed this convenient, effective and lawful avoidance loophole to my friends and me so we are neither criminals nor are we people you should be angry with since you chose to hand us this early Christmas 2014 gift 12 months ago.

In July 2014 the Pension Reform Act, 2014 was published in a gazette without much fanfare even though it would have had massive press coverage in almost any other country. Indeed its very mooting would have caused uproar in most countries with extensive debates and the state governments, that were about to be fleeced, fighting it with every weapon at their disposal. In Nigeria, with eyes fixed on and yet blinded by our sweet light crude, no one took notice of a few changes to the boring pension law. After all, what has pension got to do with the price of gari. Yet pension industry players, who presumably lobbied this amendment through the legislative process, had tucked away, in a few innocuous sounding clauses, the ultimate poison pill for already impoverished state governments. They had subtly changed the existing constraints on withdrawal of additional voluntary pension contributions (AVC) and essentially turned them into a way of transmuting Taxable income into practically Tax free income in mere days. Under the old dispensation any AVC, over and above the minimums stipulated by law, would only be free of Tax if it is untouched for at least five years. Drawing from your AVC within the five year lockout period would result in the Tax earlier avoided being applied.

This old provision automatically limited the extent to which AVCs could be used for Tax planning (avoidance if you like) as very few salary earners could afford to lock up significant parts of their income for five years just to gain a Tax advantage. Indeed, up to when the Pension Act was upgraded in 2014, AVC was exploited almost exclusively by (married) ladies. Please don’t ask me why. Under the new law however Tax is suffered not on the AVC cashed within five years but on the income earned by that AVC i.e. if I decide to contribute N1,000,000 monthly into my AVC account and go to my Pension Fund Administrator (PFA) the first week of each succeeding month to withdraw the full N1,000,000 I would indeed avoid paying the marginal Tax rate of 21% on the N1,000,000 thus pocketing N210,000 but would only pay 21% Tax on the income earned by the N1m for the few days it was managed by the PFA. If we presume the PFA earned N10,000 on my N1,000,000 within those days I would be paying 21% of N10,000 which is N2,100 and thus enjoy a net Tax savings of N207,900 simply by passing (laundering?) my salary through a PFA.

This has proved a very popular change indeed with all the men who didn’t dare to touch AVC with a 10 foot pole under the old regime now plowing as much of their salaries as they can spare for a few days into it. Of course the ladies too have upped their game. [b]Tax payers are happy with their suddenly much lighter Tax burdens and PFAs are smiling to the bank since some of that additional cash flow does stick in their vaults [/b]but the state governments, whose predominant Internally Generated Revenue (IGR) stream is being decimated, are still asleep at the wheel despite the much reduced flow of federal allocations that should have ordinarily turned them into Tax hawks.

It beggars belief that Nigeria had 36 state governors and a Federal Capital Territory minister on duty when this updated law was proposed. Each of the 37 had someone in charge of Finance / Revenue, all had Tax departments while several contracted Tax consultants in addition yet none thought it necessary to examine the law while it was still a mere proposal. Of course most of the current office holders were not in place 12 months ago but even those new in office have had two months to look at the books and some should have noticed an ebb in PAYE inflow. I know that knowledge of this game changing law has spread slowly with bankers the first to exploit it but it is now spreading like wildfire through other affluent sectors of the economy with the potential to half PAYE inflow by the end of 2015.

I have succeeded in reducing my Tax payment by ~50% but know of others who have aimed for and achieved a 90%+ reduction. I do not intend to treat my AVC as an overnight account because I see value in building up the funds over time into a significant amount for undertaking capital projects but many are pushing the envelope and fully exploiting the latitude the law provides by simply going to collect the AVC diverted from the Tax net from the PFAs a few days after payday. Most of those involved in this lawful gaming of the Tax system via AVC are the 20% paying 80% of the Taxes so the impact of typically 50%+ reduction in their Taxes is likely to be a 40%+ reduction in the largest IGR stream for states. States that currently bring in piffling amounts as IGR need not lose much sleep but those like Lagos, Rivers, Kano etc that depend substantially on IGR are going to get hammered. We are going to face a perverse situation where the strong and virile states will be rendered weak while the traditionally weak will suffer little ill effect.

To compound matters for Lagos and others, this IGR wipeout is coming at a time when federal allocations have already declined massively. This law must not be allowed to stand. State governments must come together to urgently move for a reversal to the status quo ante on AVC: a five year lockout period which when broken triggers the payment of full Taxes avoided on the capital contributed. This is essentially the threshold for ‘life insurance’ policies that enjoy similar Tax benefits. If Nigeria is serious about building up its pension reserves and providing long term funding for capital projects then it cannot afford to allow additional voluntary pension contributions and the pension system as a whole to be used as a convenient and legal money laundering vehicle. It is expected that those who lobbied for the insertion of this fiscal poison pill in the pension law will not be easily vanquished but the state governments must realize the existential nature of this threat and make its elimination the utmost priority.

Overall Taxes in Nigeria as a fraction of GDP are at single digit percentages since the Gross Domestic Product was rebased. This is well below the 20% minimum recommended by ECOWAS for its members and achieved by Ghana, Cape Verde and most well organized societies. Many other changes must be made to VAT, property and vehicular Taxes etc if we are to ever achieve the robust and diverse revenue base that will allow governments at all levels to withstand oil shocks better and provide the quantum of resources needed to translate our society from stagnation and poverty to growth and riches. My memo to the President on Revenue generation provides details on this and can be found at https://www.nairaland.com/2285848/memos-gmb-no-2-revenue

After we have chased the foxes out of the barn this time we must set up a surveillance system to ensure that such laws that are antithetical to public welfare are never passed again. The lobbyists have tasted blood and, even if they are defeated this time, they will come back for more. Eternal vigilance is the price of liberty and an economically thriving democracy.

Abraham Abiodun Idowu
July 25th 2015

Can someone please summarize this for me

Though I couldn't read all. I love what's its about summarily.

The lobbyists have tasted blood and, even if they are defeated this time, they will come back for more.

Very few Nigerians have this exceeding intuitive cerebral gift of qualitative indepth search of statutory gazettes and policies. The OP's analysis are damn spot on.

Thanks for the info OP. May you remainbin the top 20% for this apposite article and advice to governments to reverse this anomaly!