The recent VAT exemption on Capital Market transactions

You may already be aware of the recent waiver of Value Added Tax (VAT) on Stock Market transactions by the Federal Government of Nigeria. In case you don’t, here is a brief overview.

Overview

The Value Added Tax (Exemption of Commissions on Stock Exchange Transactions) Order, 2014 was recently released via an Official Gazette dated 30 July 2014 which became public in October. Based on the Order, the list of “Services Exempt” from VAT has been amended to include Commissions on Stock Exchange Transactions effective from 25 July 2014. The exemption is applicable for a period of five years from the date of commencement.

Specifically, the exemption relates to Commissions:

· earned on traded value of the shares,

· payable to the Securities and Exchange Commission (SEC),

· payable to the Nigerian Stock Exchange (NSE); and

· payable to the Central Securities Clearing System (CSCS)

The purpose of the exemption is to encourage more trading in securities at the NSE. This is clearly a laudable objective but how well the incentive will achieve this is far from being clear.

So what does this really mean?

VAT is an indirect tax and therefore it is borne by the final consumer. With respect to capital market transactions, any VAT charged on commissions and fees was passed on to issuers and investors as the case may be while stockbrokers, issuing houses, SEC, NSE and CSCS act as collecting agents. Given that VAT on services is not claimable as offset against output VAT, the cost is fully borne by the investors.

Therefore, with this exemption, it is expected that investors will benefit from reduced cost of transactions in the capital market. The exemption would also reduce compliance costs for stakeholders such as stockbrokers and the regulators in accounting and remitting VAT to the Federal Inland Revenue Service (“FIRS”). In practice however, the FIRS will still expect that nil VAT returns should be filed on a monthly basis.

Beyond the broad benefits outlined above, I thought to provide further insights regarding what the exemption really means and the likely impact based on publicly available information, which is by no means easy to come by.

Just to be clear from the onset, I am not against the granting of tax incentives provided they are granted for the right reasons; well thought out; properly articulated, carefully implemented and diligently monitored. I also fully support any and every initiative to develop and deepen the Nigerian capital market. After all, I am one of the privileged circa 2% of Nigerians (and you heard me, 2%) who are direct investors in the stock market. The issue however goes beyond me or any individual for that matter.

Here are some analyses of the incentive before I draw my conclusions:

· Based on the 3rd Quarter 2014 NSE Fact Sheet, the average daily value traded was N6.9 billion.

· Total commissions, fees and stamp duties payable on equity transaction was 1.87% for “Buy” and 2.19% for “Sell” resulting in a combined transaction cost of 4.1%. The rates are lower for fixed income securities such as government and corporate bonds.

· The VAT element of the combined transaction cost of 4.1% is 0.186% as a percentage of transaction value.

Based on the above, assuming about 250 workdays per year (that is, excluding weekends and public holidays), and disregarding the slight impact of the relatively lower cost of bond trading, the annual savings to investors (and by implication, cost to government) arising from the VAT exemption is N3.2 billion per annum at the level of Q3 value traded.

In simple terms, an investor who invests N1 million would now save N855 when buying and N1,005 when selling. It remains to be seen how this would sway existing or potential investors to deal in the stock market. In any case, the impact may well be more psychological than real.

The annual cost of N3.2 billion will be borne by the Federal Government to the tune of N481 million, States N1.6 billion and Local Governments N1.12 billion. This is based on the sharing formula of 15%, 50% and 35% respectively for the federal government, states and local governments in the VAT act. Given the dwindling resources available to government, this seems like a huge cost that may have very little impact. The money could have been more effective if spent on developing both hard and soft infrastructure for the stock market. One big challenge is that re-introduction of the VAT after the expiration of the Order in the next 5 years will be resisted. It will indeed be far more unpopular at that time than the popularity of the exemption now.

The only tax left on stock market transactions is stamp duty of 0.075%. There is withholding tax of 10% on dividends which may be considered as stock market related to some extent. There is no withholding tax on government and corporate bonds. Interestingly, the most developed capital markets in the world such as those of South Africa, the United States, United Kingdom, China and Japan have one form of tax or another including capital gains tax of over 20% in some cases. Therefore, there is little or no correlation between taxation of stocks and capital market growth.

What lessons can we learn from this?

Throwing incentives at everything without a careful impact analysis not only drains the treasury but may actually be counterproductive especially in view of the dwindling oil revenue. Government should develop the habit of quantifying the cost of tax incentives and waivers against the likely impact or benefits. As a nation, we can no longer afford to be complacent or arbitrary in our approach to tax matters. Times are changing fast.