Capital Gains Tax On Payments To Employees For Loss Of Employment

Sunday, January 06, 2019 06.22PM /By Yomi Olugbenro of Deloitte Nigeria

TheLagos Internal Revenue Service (LIRS) has issued a public notice, appointingemployers as its agent, requesting employers to deduct and remit capital gainstax on payments to employees as compensations for loss of employment. See: AppointmentOf Payers Of Capital Sum Inclusive Of Employers As Collecting Agents

Let’slook at this issue of taxing severance benefits.

WhilstLIRS agrees that compensation for loss of employment are free of personalincome tax, it seek ways to proactively collect capital gains tax as may beprescribed by Capital Gains Tax Act, by holding employers responsible.

Simplyput, withholding tax (WHT) rules which applies under Personal Income Tax Act(PITA) is now being “imported” into Capital Gains Tax Act (CGTA). LIRSpurportedly rely on its powers to appoint anyone as its collection agents.

Thisdirective is fraught with multiple issues, including differentiating betweentermination benefit and terminal benefit, tax treatment of these differentbenefits, application of withholding tax on capital gains and employers’obligation thereon.

Twotax laws are relevant in explaining the issues here – PITA and CGTA. PITA,which is the primary income tax law which govern employers’ PAYE (or WHT)obligation says compensation for loss of employment is not taxable.

CGTA,on the other hand says “capital sum” derived by way of compensation for loss ofemployment is taxable. That is, CGT of 10% rather than normal PIT. However,CGTA does not contain provision for applying withholding taxes or “PAYE”.

Thefirst issue is to determine whether a given severance benefit constitutecompensation for loss of office or just normal end of service (terminal)benefits. That is, do terminal benefits and termination benefits mean the same?

There’sno specific definition of compensation for loss of employment either PITA orCGTA. By general English usage, terminal benefit refer to final entitlements(often pre-agreed) paid upon expiration of agreed tenure of service.

Terminationbenefit refer to compensation for unexpected redundancies often triggered by aclosedown, downsizing, business reorganization etc. Termination benefits may beseen as compensation for loss of employment.

LIRSissued an initial public notice in 2017 which provides that terminal benefitsshould be taxed as regular employment income under PITA (part of PAYE) whiletermination benefits should be taxed as capital gains at 10% (under CGTA).

Let’sassume, without conceding, that LIRS’ position on the meaning and applicabletax law for terminal benefit and termination benefit is correct. There’s amajor issue with application of WHT and employer’s duty on capital gains.

Taxis a matter of law. It can only be applied in manner prescribed by the law.Whereas PITA makes specific provision on how PAYE/WHT is applied on incometaxable under PITA, there’s no withholding tax rule on gains taxable underCGTA.

Ifindeed compensation for loss of employment is considered as capital sum liableto tax under CGTA, tax can only be applied in manner prescribed under CGTA.Capital gains tax are paid by taxpayers on self-assessment basis. Not via WHTrule.

Powerto appoint collection agents for tax purposes is contained in PITA, not CGTA.The rule for adoption of PITA administrative process covered in section 43 ofCGTA, at best, does not clearly relate to WHT practice. It will be a rulestretched too far.

Employersare likely to resist importation of the provision of withholding tax rulecontained in PITA to CGTA. Individuals earning capital gains should be calledto account for their taxes in manner prescribed by CGTA.

WhileI agree with the provision of CGTA that “capital sum” paid as “compensation forloss of employments” constitutes capital gains against which the provison ofCGTA should apply, CGTA does not indicate employer’s obligation as withholdingtax agents for CGT.

Thedilemma faced by tax authorities is the enormity of the administrative burdenof chasing millions of individual taxpayers in collecting due taxes. So theylook for a convenient way out. But no one wants a burden unless legallyimposed.

Governmentsshould rather focus on revamping tax laws in Nigeria to close identified lapsesand bring our laws to modern realities. Our laws are laden with rules that havelost touch with emerging realities. That’s a big issue needing solution.

Attemptsat refurbishing a 1967 law via public notices and expecting same to fit intomodern realities of twenty-first century will only generate legal tussles thatwill multiply disputed tax cases. We must pay attention to real issues.

Thegreatest challenge facing the country is paucity of revenue but we are notaddressing it with the vigor required. Both the executive and legislatureshould be working hard on regulatory intervention to address our challenges.

Wecannot resolve our current low tax penetration challenge unless the law isfixed. We need new set of laws that will consolidate existing taxes, introducemodern rules, be wide-covering and administratively covenant.

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