Making a payment in full without any deductions or subtractions, even where these deductions/subtractions are required by law.
What happens when there is a Gross Up?
The answer is quite simple. When there is a gross up, someone shifts their tax burden!
How? Think of yourself as a CEO. Your Company – Rock Ltd. is making cool cash, over 300 Million Naira yearly. As the story goes, Rock Ltd. is about to pay rent of 20 million naira to Infinity Ltd. for a lit office space in Victoria Island. You must already know that the tax laws require that 10% must be withheld on all Rent transactions. This simply means that Rock Ltd. will pay Infinity Ltd. 90% of Twenty Million Naira which is 18 Million (₦18,000,000).
Rock Ltd. is obliged to remit the remaining 10% (₦2,000,000) to the FIRS – the relevant tax authority in charge of administering Companies Income Tax.
After remittance, congratulations are in order because Rock Ltd. would have successfully withheld tax in accordance with the law. (For further information about how Withholding Taxes work, click here to watch our video on WHT).
However, before you could do the above, the unthinkable happened.
In the Rent agreement, you have just read that Infinity Ltd. wants to receive ALL of the 20 million naira, no shaking. What this means is that not only will Rock Ltd. be parting with 20 million naira, it will also have to kiss extra ₦2,000,000 goodbye. This will go to the FIRS.
In sum, Infinity don Gross up!
Infinity Ltd. has successfully shifted its tax burden of ₦2,000,000 to your Company. So instead of receiving ₦18,000,000, it receives all of ₦20,000,000 and Rock Ltd. still has to suffer the ₦2,000,000 tax on its behalf. This life no balance.
Position of the Law on Grossing Up
In case you missed it, Section 27(l) of the Companies Income Tax Act as amended disallows “taxes or penalties borne on behalf of another person” for Companies Income Tax purposes.
Remember that Companies Income Tax is broadly paid on income minus expenses. That is ₦50,000,000 Income minus ₦30,000,000 Expenses = ₦20,000,000 Taxable Profit which is then subjected to tax. Also, remember that not all expenses may be “allowed” by the FIRS. So if the FIRS believes that ₦10,000,000 out of the Company’s Expenses was not incurred wholly, reasonably, exclusively or necessarily, it can add back that ₦10,000,000 Expense to the ₦20,000,000 Taxable Profit, such that CIT is paid on ₦30,000,000.
Section 27(l) above eliminates any hope of FIRS treating the extra ₦2,000,000 that Rock Ltd paid on Infinity Ltd’s behalf as allowable. The law is clear that it is a disallowable expense. What will actually happen is that the ₦2,000,000 will be added back to Rock Ltd’s Taxable Profit and subjected to CIT at 30%. E what? E choke.
We hope that with these few words of ours, you would remember what the effect of Gross Up is when next you come across the Tax Term!
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