Let’s take this slowly. Shall we?
Mr. Moni, Mr. Ego and Mr. Kudi are Lagos big boys who run Chop Life Ltd., a steel company in Victoria Island. They have been looking for means to make Chop Life evade taxes because they are tired. They think taxes are taxing tasks thought by the taxman to torture the masses. lol.
On a more serious note, from the way the taxman in Nigeria has Chop Life Ltd’s information and always submits letters asking them to pay big big money as taxes, they just want an escape route, you know? A way that not all the profits they make in Nigeria will be taxed.
Since Naija don cast, they looked for other countries with low tax rates and found Mauritius! Then they created another steel company in Mauritius named Fogo. They also made sure that Fogo is not traced at all to Nigeria to prevent the Nigerian Taxman from doing long throat and claiming the right to tax the profits of Fogo in addition to that of Chop Life.
In planning how to evade taxes with Fogo, they considered their options which are:
The lawful option without evading tax:
- Chop Life manufactures steel tubes as usual with a cost price of 5 million dollars and sells as usual to third parties e.g. Life is Eazi Ltd., for about 10million dollars. Chop Life then makes its usual profit of about 5million dollars.
- Chop Life manufactures and sells the same type of steel tubes to Fogo – one of its ‘new customers’, for 9million dollars, and makes 4million dollars profit.
- The Nigerian taxman will subject this 4million profit of Chop Life to Companies Income Tax (CIT) at the rate of 30% so Chop Life makes final profit of 2.8million dollars.
- When Fogo resells the steel tubes it bought from Chop Life to a Mauritian company for 10million dollars, it makes profit of 1 million dollars which is taxed at a Mauritian CIT rate of 15%.
- This means Fogo makes a final profit of 850,000 dollars.
- Total final profit of Mr. Moni, Mr. Ego and Mr. Kudi is 850,000 dollars of Fogo + 2.8 million dollars of Chop Life = 3,650,000 dollars.
The tax evading option:
- Chop Life sells steel tubes to Fogo for 6 million dollars instead of 9 million dollars.
- Chop Life makes profit of 1 million dollars and after Nigerian CIT of 30% is removed, Chop Life makes a final profit of 700 thousand dollars.
- Although Fogo bought the steel tubes at a reduced price – 6m dollars from Chop Life, it resells the steel tubes to a Mauritian company for 10 million dollars.
- Fogo makes profit of 4 million dollars and after Mauritian tax of 15% is removed, Fogo makes final profit of 3.4 million dollars.
- Total final profit of Mr. Moni, Mr. Ego and Mr. Kudi is 700,000 dollars of Fogo + 3.4 million dollars of Chop Life = 4,100,000 dollars.
If Mr. Moni, Mr. Ego and Mr. Kudi didn’t shift the profits, the Nigerian taxman would have received 1.2 million dollars in tax, but by evading, the Nigerian taxman received just 300 thousand dollars, losing 900 thousand dollars to tax evasion. So the Nigerian Government gets less taxes than they should.
Imagine having two goats. One tiny goat with stunted growth while the other goat is so large, it could be mistaken for a mini cow. Then imagine starving this goat who is already stunted while regularly stuffing the mini cow goat with great grass and nutrients. The stunted goat will obviously never get better, would probably die. Profit shifting seems fresh till you realize that if everyone shifted profits and avoided tax, Nigeria would be in the same position as the stunted goat. It seems like it already even is!
The Big question is: Have our Lagos big boys gotten away with evading tax by creating and controlling another company abroad then shifting profits made in Nigeria to this other country?
It may interest you to note at this point that Controlled Foreign Corporation (CFC) Rules exist. They are created to prevent taxpayers with controlling interest in a foreign company from shifting profits from their country of residence to that foreign company. This is the focus of this article.
The home country is where the taxpayers are resident, which is Nigeria in our Lagos boys scenario. The home country calls the shots! It determines what makes a foreign company “controlled”. It has to be the one to make the CFC rules because it’s the one being deprived of taxes. So, the CFC rules are a way to ensure that the home country gets the money it should ordinarily have gotten as taxes.
When the CFC rules of a home country regard a foreign company as controlled, this has nothing to do with the controlled foreign company itself. It has everything to do with the owners or controllers. This is because the CFC Rules force the owners or controllers to include in their personal income tax assessment, the profits of the controlled foreign company in proportion to their ownership and it subjects those profits to tax. The CFC Rules do not impose tax on the foreign company or anything like that.
Thus, Mr. Moni, Mr. Ego and Mr. Kudi through CFC rules, must include in their personal assessment, profits earned by Fogo in proportion to their ownership or control. These profits will then be taxed in Nigeria. So all the money they were trying to shift away and even more, will get back in the hands of the Nigerian taxman. Evil laugh
CFC rules therefore operate to prevent local taxpayers with “controlling interest” in a foreign subsidiary from stripping profits from their country of residence.
Remember that the home country calls the shots and determines what makes a company controlled.
In the U.S.A, a “controlled” company is defined according to the number of shares owned by U.S. citizens. The U.S tax law a defines a CFC as a corporation that operates abroad with U.S. shareholders having 50 percent or more of the control of that corporation. A U.S. shareholder of a CFC is defined as a person who owns 10 percent or more of the voting power in the CFC. This person is required to report the income derived and pay tax in proportion to their shareholding.
In the UK, CFC rules are not targeted at resident individuals but at resident companies who are shareholders of foreign companies. Weird right?
A shareholder is deemed by UK law to have control if it owns 40% or more of the voting rights in the CFC. To enforce tax on the CFC, the UK CFC must be subject to tax that is lower than it would have paid, if it were resident in the UK. So, if the company is in Nigeria and it is deemed a UK CFC, UK CFC rules will only apply if the Nigerian companies tax rate is less than the UK rate.
Many other countries also have a framework for controlled foreign corporations, e.g. Russia, Germany, Japan, Australia, New Zealand, Brazil and Sweden.
To answer the big question above, the Lagos boys can not get away with evading tax if Nigeria has CFC rules. They may even end up paying more money than they ever imagined as taxes, because the main job of CFC rules is to make tax evasion antics backfire.
Nigeria, how far?
Nigeria likes bursting our bubbles. In the above paragraphs, this handsome guy has been preaching about how CFC Rules solve profit shifting problems to a large extent, etc. Well, it will interest you to know, that Nigeria does not have any CFC rules, sigh. Nigeria is the one pouring sand sand in its own garri and helping tax evaders feed the mini cow goat. What then can the righteous do?
It is likely though that CFC rules will soon become part of our laws. I pray o.
At this point in our economic history, it is important that we promulgate and give effect to CFC rules. Nigeria remains a major victim of profit shifting from multinational enterprises. Vice President, Professor Yemi Osinbajo, was reported stating that Nigeria lost about $178 billion to illicit financial flows over 10 years. We need the CFC rules to plug holes through which our taxes are smuggled to other countries!
Do I hear an Amen?!
David Akindolire is a premium graduate of Obafemi Awolowo University. There, he was the President of The Tax Club and a Founder at the Career Advancement Program.
He jointly organized a number of academic events that focused on encouraging specialization and affording undergraduates a clearer view of graduate life.
David is a dazzling writer and speaker. He represented the university at a number of debates and moot competitions. He remains keen on futuristic areas of law including taxation and media. He is a current graduate intern with PwC.