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The Director of Financial Policy & Regulatory Department of the Central Bank of Nigeria (CBN), Haruna B. Mustafa, has provided reasons for the exclusion of retained earnings of banks in the proposed capitalization process.

In the latest edition of CBN podcast published on the bank’s website on Monday, the CBN Director stated that the apex bank’s exclusion of retained earnings is to ensure that deposit money banks across the country inject fresh funds into their capital base.

He stated, “What we have simply done is to nudge the banks to inject fresh capital and this is without prejudice to what the component of shareholder’s funds could be. And like we have stated in our circular, shareholders’ funds would continue to be recognised in the computation determination of banks capital adequacy ratio which is an important metric in our assessment of the soundness of banks.”

Mustafa further noted that the recapitalization program is geared towards boosting the capacity of banks to take on bigger projects for the country’s growth and development.

He also referenced the bank’s recapitalization exercise of 2004 and how it helped in insulating banks across Nigeria from the ripple effects of the global financial crisis of 2008, noting that efforts of the current recapitalisation would help to strengthen Nigerian banks against unforeseen global financial threats.

Recommended reading: Bankers oppose exclusion of retained earnings in CBN recapitalization terms

Backstory

Last month, the CBN announced an increase in the capital requirements of different tiers of banks across the country– the first of its kind since 2004/2005 recapitalisation exercise. The apex bank hiked the capital requirement for Tier-1 banks to N500 billion while national banks’ capital’s expected capital was set at N200 billion.

However, the CBN noted that new capital would comprise of paid-up capital and share premium, excluding shareholders’ funds- a policy that has generated a lot of conversation.

Nigerian bankers have voiced out their opposition to the exclusion of retained earnings, noting that it is flawed and contravenes the conventional and legal treatment of company’s capital structure.

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Banks face mixed outcomes as a tight global economy runs its course and new headwinds lurk on the 2024 horizon. Asia Pacific banks look brighter than they did at the end of 2022, reflecting improved economic conditions. Still, as expected, a few Asian banks navigate narrow corners as their economies puff across the annual finish line. However, African economies have had tougher situations, and their banks have been pulled into more difficult realities.

Fortunately, Nigerian banks have turned out better than the economy. While the economy’s growth rate fell from 3.54% in Q4 2022 to 2.31% in Q1 and 2.51% in Q2 before rising to 2.54% in Q3 2023, banks have seen their financial books grow steadily as top and bottom-line earnings rise. Earnings for the banking industry have grown 44% annually over the last three years. Nigerian bank average prices have risen by 97.4% in the past year and by 86.9% year to date (YTD).  The banking sector Index of the Nigerian Exchange Group (NGX) has risen from 2.60% in the first trading day of January to 102.03% YTD as of December 14, 2023. The rise in the Banking Sector Index reflects an improvement in their business fortunes. So why are Nigerian banks brooding over recapitalisation either by Rights Offers (new money raised from existing shareholders), or Initial Public Offerings (new money raised from new shareholders), or mergers?

At the heart of the recapitalisation conversation is the issue of the size of bank equity and tier 1 capital, given the requirements of Basle III. Analysts have questioned the adequacy of the size of Nigerian banks’ equity in the face of the naira’s depreciation and the government’s intention to attain a US$1trn economy over the next seven years. The result is that the government must achieve a gross domestic product (GDP) growth of at least 11.14% annually. To support this growth, Nigerian banks must increase their lending sizes and identify big-ticket transactions that could lead to faster-paced growth. One calculation is if N25bn was the threshold for banks when the naira to dollar exchange rate was N130.15 in 2005 (the first recapitalisation of banks in the 2000s era), with the exchange rate at N1000 to a dollar, the adjusted capital base of banks should be roughly N800bn. The new calculated base would merely keep the relative equity size of Nigerian banks where they were 18 years ago. 

Proshare analysts have pointed out that good banks may come in different sizes. Setting a standard size for all banks may not be systemically optimal. Indeed, adopting a one-size-fits-all approach may have unintended consequences, as in the early 2000s, banks with governance challenges with N2bn capital base suddenly had more severe problems when they got the large recapitalisation boost of N25bn to play with as they lost their way to becoming toxic asset dumpsites. It took the stern hand of CBN’s erstwhile governor, Khalifa Sanusi Lamido Sanusi III, to set the banks straight and reestablish systemic confidence in 2010. The Sanusi action came to a mere half-decade after the Chukwuma Soludo-led CBN decision to engineer the merger and recapitalisation of banks in 2005, shrinking the number of banks from 89 to 25 with a minimum capital base of N25bn. After eighteen years, Soludo’s N25bn threshold appears to have run its course and requires reevaluation.  

The issue, however, is that with a slow-growth economy (2.54% as of Q3 2023) and inflation in the upper double digits (27.33% as of October 2023), some analysts have argued that the timing of recapitalisation must be handled carefully to prevent a disruption to the financial system that could worsen economic outcomes. The refrain is sensible but not conclusive. As of the financial year end (FYE) 2022, none of Nigeria’s Tier 1 banks listed on the Nigeria Exchange Limited (NGX) had a share capital of N25bn despite significant shareholders’ funds. First Bank Holding Company (FBNH) had the largest share capital of N17.948bn, followed by Access Holding Company (Access Corp) of N17.773bn. 

Nevertheless, both banks had shareholders’ funds above N1trn. In other words, for the larger banks, recapitalisation would mean a reclassification of their reserves and restatement of share capital. In this light, analysts expect that in 2024, several banks will offer bonus shares to existing shareholders, while a few might opt for fresh Rights Offers (purchasing more shares by existing shareholders). 

The Liquidity Bungee Jump

Several Nigerian banks advertise consistent quarterly profits, but a few challenges restrict their growth and bottom lines. The problems include liquidity challenges in the foreign exchange market, relatively low capitalisation, high and constant discretionary CRR debt, and increased competition from emerging neo-banks. Before the recent signal from the Central Bank of Nigeria (CBN) that banks may be made to recapitalise, analysts have called for a recapitalisation of the Nigerian banking industry to support their capacity to finance big-ticket transactions, shore up their capitalisation in dollars and reposition them for sustained shareholder value. While the market awaits details from CBN on the new minimum capital base of banks, a few banks have raised fresh equity, and some have announced plans to strengthen their capital (through a Rights Issue, which offers new shares to existing shareholders, possibly at a discount). 

The Rising Tide of Raising Capital-The Rights Ways

Following the conclusion of the share capital raise of Fidelity Bank through a Private Placement of 3.04bn ordinary shares of 50k each, Shareholders of FBNH have also resolved that the company’s issued share capital be increased from N17.95bn of 35.90bn ordinary shares of 50k each to N22.43bn, an addition of 8.97bn ordinary shares and that there should be a capital raise of up to N150bn through Right Issue. Wema Bank Plc has also submitted and gotten approval from the NGX to list a Rights Issue of 8.5bn ordinary shares of N0.50 each at N4.66 per share (based on two new ordinary shares for every three ordinary shares already held by shareholders). These moves align with the call for banking sector recapitalisation since the intrinsic and dollar values of the current capital requirement have been eroded and are too weak to withstand negative shocks or finance big-ticket transactions. Some analysts have argued that many banks’ inability to meet the current N25bn capitalisation portends enough threats to the financial system. Others argued that the banks are capitalised enough for the country’s current development and should not be the victim of the country’s FX challenges. A Highcap Securities analyst noted, ‘So far, bank financials figures show that many are already over-capitalised. Their balance sheets are quite healthy and impressive.’ For banks raising new capital, this would support growth prospects, and the Right Issue approach could preserve the relative share of existing shareholders’ stakes. However, the pre-emptive Rights waiver on undersubscribed shares could dilute the shareholders’ stake.

Nigerian banks have a history of raising capital through various means, such as Public Offerings, Private Placements, Rights Issues, and Mergers and Acquisitions (M&As), for reasons that include regulatory orders, balance sheet expansion, and risk-bearing capacity strengthening. More broadly, the compelling reasons for regulatory order to recapitalise banks are:

• To meet the regulatory minimum capital adequacy ratio and mitigate risks like credit, market, operational, and liquidity risks. The capital requirement measures the bank’s ability to absorb losses and protect depositors and is currently set at 15% CAR for systemically important banks and 10% for other banks. 
• Support banks’ capital needs to fund their lending activities, invest in new products and services, and enter new markets, all necessary to finance developmental goals.
• Enhance operational efficiency and resilience, which are needed to improve financial technology infrastructure, digitise processes, and optimise cost structure. 
• Create value for shareholders and stakeholders.

Recapitalisation: Of Share Capital and Shareholders’ Funds

Nigerian banks have evolved since the 2005 bank recapitalisation, when the minimum paid-up capital was raised to N25bn from N2bn. However, the exchange rate volatility has significantly eroded the value of the capital. All the listed banks have a share capital below N25bn, with FBNH having the highest at N17.95bn and Unity Bank having the least at N5.84bn. In dollars, the share capital is lower than US$20m as FBNH has $18.87m and Unity has US$6.14m. Some analysts have argued that the share capital size is insufficient to fund a mega project to achieve the targeted N1trn gross domestic product (GDP). Hence calling for another recapitalisation. 

Meanwhile, the shareholders’ funds have improved over the years, and five banks have above N1trn, closely attaining the N2trn mark. Banks’ robust retained earnings have supported the continuous growth of the shareholder’s fund. Interestingly, most listed Nigerian banks comply with the Basell III capital adequacy ratio requirement, far above the 10.5% minimum requirement. UBA has the highest at 28.30%, and Wema has the lowest at 12.74%, excluding Unity Bank and other unlisted banks with negative CAR. The higher CAR might suggest a stronger capital position and ability to meet obligations. However, analysts still believe that the banks require fresh capital injection to drive key sectors of the economy. The recapitalisation process should follow a structured, lengthy time frame to avoid a reoccurrence of the 2005 era, which led to large mergers and acquisitions 

(see table 1 below). 

Implications for Minority Shareholders

According to a financial analyst, Olatunde Amolegbe, raising new shares through a right issue or public offering leads to lower earnings per share initially due to a larger amount of shares outstanding, but this will recede as the bank does more business and makes more money. The typical market reaction to recapitalisation is a slowdown in secondary market activities in the issuer’s shares since investors know that new shares will typically be issued at a discount, and they can buy cheaper.  

Rights Issues present an open door to existing shareholders to exercise buying rights of new shares in proportion to their existing shareholdings and at a discounted price. Minority shareholders also have these open doors presented before them and may decide to participate in the right issue even though they are not obliged to do so. However, choosing to participate or not to participate will have crucial implications.

• Right issues can potentially dilute minority shareholdings or ownership percentages. Dilution of minority shareholdings becomes possible when minority shareholders do not participate in the rights issue and, as such, reduce the shareholders’ equity stake in the company.
• The dilution of a minority shareholder’s holdings reduces the percentage of shares owned and potentially the shareholder’s rights and voting power. Voting rights may, however, be increased with minority shareholder’s decision to participate in the rights issue.
• Shareholders can trade the rights allocated to them on the domestic stock exchange. This affords the shareholders who choose not to partake in the right issue the discretion to determine whether to divest their rights, potentially realising profits or incurring losses contingent on prevailing market conditions, or to exercise their rights to acquire additional shares.
• An allotment of additional shares through the right issue may be unfairly prejudicial due to possible concerns related to share dilution. Such dilution of claims held by minority shareholders is conceivable when they are precluded from participating in the rights issue, diminishing their equity stake in the company. Sections 343-346 of CAMA 2020 (amended) grant minority shareholders legal recourse in case of prejudice.
• Concerns may arise among minority shareholders regarding the transparency and execution of the rights issue. Companies must engage in effective and transparent communication, elucidating the rationale behind the rights issue, its repercussions on current shareholders, and the planned utilisation of the raised capital. Such communication can influence earnings per share.
• Increasing the number of shares in circulation can shape the market’s assessment of a company’s financial well-being and outlook. If investors construe the rights issue as a favourable indicator, it can positively affect the company’s overall valuation and shareholders’ positions.

Price Movement: Rounding up Investors’ Sentiments 

The announcement of the Right Issues sparked a fair movement in stock prices. According to a market analyst, ‘the market has accepted the announcement of the Fidelity Bank and FBN rights issue in good faith, as their share price has increased. This means they will do more for the economy and empower businesses if they access more funds. The major fear in FBN is the power struggle between major shareholders, which has impacted the share price in the market. Fidelity is going well with no issues, while regulators must pay close attention to the FBN development as it concerns the major shareholders.’

Following Fidelity Bank’s decision to increase its share capital to 3.2bn ordinary shares, its share price rose from N4.79 on July 4 to about N9.05 on December 7. Similarly, FBNH’s share price soared from N11.05 on October 11 to N29.4 on December 6, 2023, propelled by the bank’s announcement to raise N139bn in additional capital through a Rights Issue (see chart 1 below).

Chart 1:

Analysts’ Thoughts – Capital Requirements and Financing Development 

The call for bank recapitalisation has elicited mixed opinions. A few analysts have argued that bank recapitalisation is unnecessary and represents poking a finger into the eye of an imaginary storm. They argue that if a system is not broken, there is no point in fixing it. The school’s advocates argue that Nigerian banks are performing exceptionally well, noting that they are prudentially sound and financially profitable. Raising their capital base would reduce investors’ return on equity (ROE) and push down equity prices.   

According to David Adonri of Highcap Securities, ‘banks have become over-capitalised due to the windfall from recent market reforms, while the real productive sector has become undercapitalised. Ordinarily, the proposed recapitalisation exercise should be directed at the real sector, not banks. Further, the migration of financial assets to the banking sector may reenact what happened in the past when the absorptive capacity of the real sector could not clear the excess cash in bank vaults. That eventually caused an asset bubble in the Capital Market and Housing sector. Banks are already concerned about the safe deployment of their huge funds, and capital expansion could reduce their returns on investment.’

Another school of thought argues that banks need to strengthen capital bases in a growing uncertain world to cope with potential shocks to short to medium-term loan assets. The proponents of this view argue that with Basle III compliance becoming of greater importance (as countries consider meeting the requirements of Basle IV), Nigeria’s bank leverage should be reduced by larger equity amounts. The bigger the bank equity, the lower the bank leverage and as a corollary, the lower the returns on equity (ROE). However, equity returns are only helpful if banks are safe. This school insists that bank equity must be raised in volatile exchange rates, high import dependence, and high inflation rates. Proshare analysts lean towards this school. The Proshare twist is that the recapitalisation of banks should be tier-based rather than a blanket statutory imposition on all banks regardless of the size of their operations. The analysts believe that Proshare’s tier 1 report could provide a basis for classification. The analysts have, however, admonished that the banks’ recapitalisation process should be phased to avoid systemic shocks and operational dislocations.   

The analysts, however, doubt the absorptive capacity of the Nigerian economy to handle banks with N800bn to N1trn capitalisation. The stock market would be in a wild growth mode out of sync with underlying macroeconomic triggers. In addition, the absence of quality loan assets to absorb the rush of new funds could lead to declining loan asset quality and a rise in nonperforming loans (NPLs). 

Nevertheless, analysts like Ambrose Omordion of InvestData have argued that recapitalisation will help banks expand by financing projects that can unlock economic value. ‘Beyond buying bank shares, investors should diversify their portfolio by looking at real estate and technology,’ he argues. 

In the broad scheme of things, banking sector recapitalisation appears inevitable. However, the size of the new capital base of banks and the timing of the exercise remains obscure. With banks throwing their hats, fedoras, and bonnets into the Rights Offer ring, the recapitalisation journey of local lending institutions eighteen years after the last exercise seems alive and fit.

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In an article in Businessday dated March 29, 2024, and titled “Why CBN excluded retained earnings in its recapitalisation terms”, Wasiu ALLI discussed the reasons behind the Central Bank of Nigeria’s (CBN) decision to exclude retained earnings from the capitalization terms for banks. 

In that piece, the CBN, when defining share capital, it made a key point to exclude ‘retained earnings’ from the calculation, allowing only the bank’s ordinary share capital and share premium for consideration as new regulatory capital under its new capital structure parameters.

This has elicited concerns from the professional space who argues that the exclusion of retained earnings from the components eligible for the bank’s capitalization should be reevaluated. 

This is particularly important given that the apex bank has endorsed the adoption of International Financial Reporting Standards (IFRS) by entities, as approved by the Financial Reporting Council of Nigeria (FRC). IAS 1 – Presentation of Financial Statements outlines the general requirements for the presentation of financial statements. This provision recognises that retained earnings are typically presented on the statement of financial position under equity through the statement of changes in equity. 

Further, Share Premium, which constitutes gains from issuing shares at a price exceeding the nominal value after deducting issuance costs, is considered a reserve, much like undistributed profits accumulated over the years, now referred to as retained earnings.

It is therefore a considered opinion and suggested that the apex bank should reconsider its stance and allow retained earnings to be considered as part of banks’ capital for capitalization purposes. 

To ensure accuracy, unrealized gains that form part of retained earnings, such as foreign exchange gains on transaction conversions and restatements of receivables and payables denominated in foreign currency at closing rates by the end of each reporting period, should be excluded. 

Similarly, gains on the fair value adjustment of financial assets classified as Fair value through profit or loss should be excluded, unless these financial assets no longer exist due to sale, in which case the gains can be considered realized.

Reasons Why Retained Earnings Should Be Considered for Capitalization:

1. Stability and Solvency: Retained earnings represent a bank’s accumulated profits that have not been distributed to shareholders but retained for reinvestment. Utilizing these earnings can strengthen a bank’s capital base, enhancing its stability and solvency.

2. Enhanced Market Confidence: Using retained earnings for recapitalization signals to investors that the bank has generated enough profits to support growth plans, bolstering market confidence in its ability to operate profitably.

3. Reduced External Funding Dependency: Recapitalizing with retained earnings reduces reliance on external funding sources like debt or equity financing, lowering financial risk and reducing interest payments or dilution of existing shareholders’ stakes.

4. Preservation of Shareholder Value: Utilizing retained earnings for recapitalization preserves existing shareholders’ ownership stakes, maintaining confidence and protecting their interests during the process.

Overall, including retained earnings in Nigerian banks’ recapitalization efforts is deemed justified, providing a stable source of internally generated capital that enhances financial strength, market confidence, and shareholder value preservation.

In conclusion, the CBN is urged to reconsider its exclusion of retained earnings in bank capitalization by carefully analyzing the composition of each bank’s profit for the period and excluding all forms of unrealized gains from its constituents.

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After 9 years of Emefiele who conjured different ways and means to traumatize an entire generation, nous and prudence have been restored to the Apex bank at ​​Plot 33, Abubakar Tafawa Balewa Way, Central Business District, Abuja.

Nigeria’s new Central Banker, Dr Olayemi Cardoso seems to be righting the wrongs of the embattled ex-Central Bank Governor of Nigeria, who oversaw an FX backlog of $7 billion, a 14.02 percent rise on inflation from 8.2% to 22.41% during his reign, reckless abuse of Ways and Means that contravened the CBN Act coupled with shoddy intervention financing, all of which made a mess of CBN’s balance sheet.

In December 2023, the CBN issued a circular which was a thinly veiled dig at the previous management. “In furtherance of the Central Bank of Nigeria’s new policy thrust focusing on its core mandate of ensuring price and monetary stability, the Bank has commenced its pullback from direct development financing interventions – accordingly, the CBN would be moving into more limited policy advisory roles that support economic growth”.

With a series of policy changes in the past quarter, communicated via Friday-released circulars, Nigeria is beginning to witness different reforms that seek to steady the nation’s ship.

So far, remittances have been flowing in through the proper channels, portfolio investors have their interests piqued and market theorists seem to align with his methods in combating inflation with the monetary tools at the bank’s disposal.

So do we still need an economist as CBN governor or do we just need someone who has common sense?  Do we need someone who would just focus on the apex bank’s objectives or someone who would gaslight Nigerians to queue under canopies to collect limited redesigned naira notes?

Let’s examine what is the objective of the CBN. The CBN Act of 2007 of the Federal Republic of Nigeria charges the Bank with the overall control and administration of the monetary and financial sector policies of the Federal Government.

The objectives of the CBN are as follows:

●Ensure monetary and price stability;

●Issue legal tender currency in Nigeria;

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●Maintain external reserves to safeguard the international value of the legal tender currency;

●Promote a sound financial system in Nigeria; and

●Act as a banker and provide economic and financial advice to the Federal Government.

Now, there were question marks on Dr Yemi Cardoso when he was appointed CBN governor. There were legitimate concerns over how his friendship with the current Nigerian president might affect the independence of the Central Bank. Their friendship began when he first met Tinubu, a Treasurer at Mobil while being a bank officer handling Oil accounts.

There was also worry around Cardoso’s suitability for the role, with preference in some quarters for someone with a strong macroeconomic background, perhaps a Professor in economics who would have the gravitas to turn the tide. However, people largely forget that the CBN has a large army of Ph.D. economists that they can deploy to help guide policy decisions.

“There had been a dislocation of monetary transmission mechanism, for quite some time, which rendered the MPC meetings largely ineffective” – Cardoso said in one of his speeches, as he said the Bank has reviewed the effectiveness of the Central Bank’s monetary policy tools and had spent time fixing the transmission mechanism to ensure the decisions of Monetary Policy Committee (MPC) meetings resulted in desired objectives.

Now he is doing the conventional work needed to battle against inflation which is his prerogative. He has tightened and aggressively hiked rates to an accumulated 600 basis points this quarter.  Yields on one-year Treasury Bills now flirt within the 19%-27% range. NAFEM has recorded its highest FX turnover since the beginning of this administration as Naira assets are beginning to look more attractive than holding dollars.

The FX backlog has been cleared and Cardoso contracting Deloitte to work out the invalid claims of about $2.3 billion has proven shrewdness which his predecessor struggled to fathom.

Two interesting things can be observed with his FX management. One, the approach to liberating the FX market with liquidity, and two, the attempt to achieve convergence of the official and parallel market exchange rates. In some developed and stable countries, black market premiums rarely exceed 5%. Black market premiums measure differences between NAFEM rates and the spot rates. At some point in Nigeria, black market premiums exceeded over 20%.

Cynics argue that applauding Cardoso for the recent naira rally after taking the dollar at N700/$1 to the four-digit territory is a bit ironic. However, they forget that at the other end of a lower exchange rate was an ever-growing backlog which in the long run reduces investors’ confidence and stifles liquidity.

Since March 2020, liquidity challenges in the Nigerian foreign exchange (FX) market have consistently affected the accessibility of its equity market, leading to capital repatriation concerns and a significant gap between the official and parallel exchange rates for the Nigerian Naira. This caused global institutional investors to face recurring challenges with index replicability and investability of the MSCI Nigeria Indexes and other indexes they are part of.

Whatever it is, the unorthodoxy of using depleted reserves to heavily defend the currency while dishonoring FX commitments which saw Nigeria relegated to standalone markets with the likes of Argentina seems to be coming to an end.

Cardoso has a lot to do going forward, but market participants see a man who knows what he is doing. He needs some help from the “fiscal side” in the fight against inflation and FX inflows as carry trade from portfolio investors could be evanescent. Crude oil receipts and non-oil export earnings need to come in to support the rates or build the FX reserves.

Cardoso’s onerous task is to tame inflation, however month-on-month inflation has followed an upward trajectory and there’s no assurance it may peak in H1 of 2024. His deployment of monetary tools and FX management would be tested in the long run as without support from his bosom colleague Wale Edun, the Minister of Finance, he may not have enough wriggle room to emerge victorious.

One thing we are encouraged by is that he would not encourage the excesses of the FG and has said CBN will no longer grant loans to FG until the outstanding is paid. By also hiking rates, he has ignored the wishes of the President who prefers a low-interest rate environment to boost economic growth.

For now, it appears there is an end to the days when the Central Bank failed to strictly adhere to the law. They would now limit advances under ways and means to 5 percent of the previous year’s revenue. FG now has to be creative in looking for alternative sources of financing.

But there are a few concerns the CBN governor must begin to consider. How would the CBN resolve its monetary policy conundrums where high MPR is affecting Nigeria’s high growth and employment costs on the economy? 

Can interest rates keep following inflation to where it is not known as food inflation and arbitrary price gouging as a result of FX volatility means there’s still some upside for inflation? How long will he hold on to the liquidity ratio with CRR going higher? What are the opportunity costs of liquidity management with yields at 27%?

How does he reform the bank in a way that functionally separates its responsibilities for monetary policy and micro/macro-prudential policies? How does he disprove the Economist’s theory that the CBN is inexperienced in handling a managed float exchange rate system?

When you open the website of the Bank of England, the first thing you see is the tagline “Promoting the good of the people of the United Kingdom by maintaining monetary and financial stability”, it is safe to say that Cardoso and the new Central Bank team is determined to promote the good of the people of Nigeria the same way.

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The legal proceedings between the Abuja Electricity Distribution Company (AEDC) and the Federal Inland Revenue Service (FIRS) have hit a standstill following AEDC’s non-compliance with a Federal High Court order in Abuja.

The court order, issued amidst the backdrop of a December 14, 2023, judgment by the Tax Appeal Tribunal, directs AEDC to settle N5,314,665,952 in Value Added Tax (VAT) and Withholding Tax (WHT) liabilities dating back to 2013.

The motion was scheduled to be heard and moved today. 

• AEDC in suit no: FHC/ABJ/TA/01/24 had approached the court seeking “an order staying the execution and or enforcement, by whatever means (including garnishee proceedings), of the judgment of the Tax Appeal Tribunal, Abuja Zone (“Tribunal”) delivered on 14 December 2023 in  Abuja Electricity Distribution Plc v Federal Inland Revenue Service (Appeal No: TAT/ABJ/APP/330/2022) (“Judgment”‘) pending the hearing and determination of the appeal filed against the Judgment by the Applicant (“Appeal”).” 
• The electricity billing company had argued that compelling the applicant to pay the money will “jeopardize the supply of electricity to millions of consumers in Kogi State, Nasarawa State, Niger State and the Federal Capital Territory, Abuja.” 

What transpired in court? 

At the resumed sitting on Tuesday, the AEDC lawyer, Josephine Titi told Justice Inyang Ekwo that she has four pending applications and was ready to move the one dated March 8, 2024. 

But the judge said the motion was not before him. The lawyer insisted that her motion was in the court’s file but later opted to give the court her copy of the motion, but the judge refused the oral application. 

Ekwo said he had ordered “parties to conduct a search on their file in court and ensure that the process they will be moving on the next date is in their file” but the AEDC lawyer did not comply with it order. 

• “That was my order, but it appears you did not do that. 
• “I refuse your application, you should do what the court said you should do,” Ekwo said and shifted the matter to April 13, 2024, for motion. 

Backstory 

AEDC had approached the court after a five-man Tax Appeal Commissioners led by its presiding judge, Hon. Iriogbe Alice, entered a judgment against the electricity billing company in suit No: TAT/ABJ/APP/330/2022. 

The AEDC’s legal team argued that sometime in 2018, the FIRS, in conjunction with the Economic and Financial Crimes Commission (EFCC) conducted a tax investigation on the company for the 2013-2017 years of assessment period (YOA), and claimed it was owing in billions. 

The AEDC disagreed with the findings of the tax collection agency, adding the FIRS did not provide any lawful basis for such liability. 

However, the FIRS legal team objected to the appellant’s claims that its assessment was invalid. 

The Tribunal subsequently declared its judgment against AEDC. 

It declared, 

• “This Honourable Tribunal therefore, compels the Appellant to pay N4,534,358,874.00 (Four Billion, Five Hundred and Thirty -Four Million, Three Hundred and fifty -eight thousand, eight hundred and seventy-four naira) only as VAT liability for 2013 – 2017 as contained in the Notice of Refusal to Amend (NORA) to the Respondent forthwith.  
• “This Honourable Tribunal compels the Appellant to pay the sum N780,307,078.00 (Seven Hundred and eighty million, Three Hundred and Seventy-Eight Naira) only as WHT liability for 2013 and 2016 as established by its consultant KPMG. 
• ” This Honourable Tribunal compels the Appellant to pay the sum of N100,000 (One Hundred thousand naira Only) pending cost awarded in favour of the Respondent in the course of the proceeding, “ 

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Deloitte has embarked on its most extensive revamp of global operations in ten years, driven by the imperative to trim expenses and simplify organizational structure amidst projections of a market downturn.

Under the plan, Deloitte’s main business units will be cut to four — audit and assurance; strategy, risk, and transactions; technology and transformation; and tax and legal — from the five the firm has had since 2014.

According to a Financial Times report, the reorganization will reduce costs across the firm, said one person familiar with the plan, but added that a figure had not yet been put on the savings.

Deloitte’s global chief executive Joe Ucuzoglu is spearheading the shake-up that will take a year to implement across the more than 150 countries the firm operates.

Plans to reduce the firm’s complexity

In an email sent to Deloitte’s partners on Monday, Ucuzoglu said the plan would reduce the firm’s “complexity” and “free up” more of them to work with clients rather than manage staff internally. Deloitte employs about 455,000 people globally.

Deloitte’s global revenues increased 15% to $65 billion in its last financial year, cementing its position as the largest of the Big Four.

But after several years of rapid growth, Deloitte, EY, PwC, and KPMG are braced for a tougher 12 months as a difficult economic backdrop in key markets prompts companies to cut spending.

The UK consulting market will fail to grow this year for the first time since 2020, according to a new report, which includes input from the Big Four.

According to the report, the move by Ucuzoglu comes after last year rejected the possibility of separating its audit and consulting businesses and publicly dismissed the logic of doing so.

Rival EY spent more than a year trying to engineer a break-up of the firm before abandoning the attempt in April last year.

Reorganization 

In contrast to a typical multinational company, the Big Four are run as a worldwide network of partnerships linked through a global entity that sets the strategy. The global business is funded by fees paid by the local member firms.

The complex structure can make reorganizations fraught with difficulty as partners compete for influence. The reorganization was “a fairly divisive topic internally”, said one former Deloitte partner.

The report noted that as part of the changes, Deloitte’s advisory businesses, which advise companies on everything from technology to dealmaking and also include its tax and legal unit, will be cut to three divisions from four. Its audit and assurance arm will remain as a standalone unit.

Deloitte’s consulting, financial advisory, and risk advisory divisions will be brought into two newly created business units: strategy, risk, and transactions; and technology and transformation.

The former will house Deloitte’s mergers and acquisitions advisory services that have struggled amid a drought in dealmaking.

The technology and transformation unit will bring together its “digital transformation” services, including engineering, artificial intelligence, data, and cyber, according to the email to partners, a copy of which was seen by the Financial Times.

In an attempt to eliminate silos, some staff will be transferred to an expanded audit and assurance arm, including those working on environmental, social, and governance.

Tax and legal will remain a standalone business within the new structure as Deloitte tries to wring benefits from the decision to keep its audit and consulting businesses together.

EY’s break-up plan collapsed because its leaders could not agree on how the tax practice should be divided between the two halves of the business. PwC, meanwhile, has split tax between its advisory and assurance businesses in the US.

• “While some others in the market are looking to break this function apart,” Ucuzoglu wrote to partners, “we believe that our fully integrated suite of tax and legal capabilities is a significant source of strength and differentiation and aligns with the needs of our clients.”

The new structure is expected to be in place by June 2025, with member firms starting to implement it as soon as June, according to the email to partners.

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The Federal Inland Revenue Service (FIRS) has announced the service’s transition from the e-TPPLAT used in filing transfer pricing returns and country-by-country reporting notification to a new platform called TAXPRO-MAX platform.  

This was disclosed in a public statement signed by the Executive Chairman of the service, Zaach Adedeji PhD.  

The announcement further specifies that taxpayers have been allocated a grace period extending up to July 30, 2024, to address any outstanding filing requirements related to transfer pricing returns and country-by-country reports.  

FIRS has also pledged to absolve compliant taxpayers from penalties within this timeframe. However, it issued a warning stating that failure to adhere to the stipulated deadline will result in legal penalties, emphasizing its commitment to enforcing compliance.  

What the FIRS is saying  

• “The annual filing of Transfer Pricing Returns and Country-by-Country Reporting (CbCR) notification have been migrated from the e-TP plat to the Tax Pro Max platform. Taxpayers are now required to file their Transfer Pricing Returns and CbCR notification on Tax-Pro Max using their regular login credentials.
• “The Service, by this notice, grants both existing and prospective taxpayers up to 30th June 2024 to fulfil all pending filing obligations of their Transfer Pricing Returns, and submission of CbCR notification on Tax-Pro Max. 
• “The administrative penalties previously imposed or to be imposed by the service or in accordance with the Income tax (Transfer Pricing) Regulation 2018 and Income Tax (Country-by-Country) Regulation 2018 shall be waived by virtue of compliance with paragraph 2 above. 
• “However, penalties shall be imposed on any taxpayer who fails to comply accordingly” 

The FIRS further noted that taxpayers who decide to refile that tax returns under the new platform are free to do so and used the medium to advise owners and representatives of companies, and other stakeholders to be guided by the new notice.  

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Base erosion, profit shifting, a global minimum corporate tax rate and Singapore’s new Refundable Investment Credit – CNA’s Tang See Kit tries to make sense of it all.

A view of the Singapore skyline on Jan 27, 2023. (File photo: Reuters/Caroline Chia)

SINGAPORE: Singapore on Friday (Feb 16) announced a sprucing up of its economic policy toolkit, with a new Refundable Investment Credit aimed at ensuring the country retains its appeal as a top investment destination.

Deputy Prime Minister and Finance Minister Lawrence Wong in his annual Budget speech said this was necessary amid tougher competition for investments around the world, and as Singapore makes major changes to its corporate tax system to be in line with a global minimum tax rate of 15 per cent.

This new tax floor is part of what’s called the BEPS 2.0 framework – Base Erosion and Profit Shifting – an overhaul of international rules aiming to tackle tax avoidance by multinational firms.

What exactly is BEPS?

Base erosion: When companies use deductible business expenses – costs of keeping a firm running, such as wages, rental and utilities – to reduce their taxable income.

Profit shifting: When firms move their profits from high-tax jurisdictions to low- or no-tax locations.

Together, BEPS refers to tax planning strategies deployed by multinational firms, to exploit gaps in tax systems and avoid paying a fairer share of tax.

How some companies have done this

For example, Nike was identified in the 2017 Paradise Papers, a leaked trove of financial documents showing offshore investments of wealthy individuals and institutions, as having moved large chunks of its profits from other markets to Bermuda.

It did this by registering its intellectual property rights, such as its logo and product designs, with a subsidiary located in Bermuda.

The subsidiary, which did not appear to have any staff or offices, would then charge Nike subsidiaries in other markets large trademark royalty fees.

These fees helped to lessen Nike’s taxable income in these other markets, while allowing the company to legally shift profits to a tax haven.

Other large firms such as Shell and tech giants Facebook, Google and Amazon have also been singled out by tax authorities and industry groups for creative accounting.

According to Britain-based advocacy group Tax Justice Network, nearly US$1.4 trillion (S$1.9 trillion) worth of profits are shifted into tax havens by multinational companies every year.

This means US$245 billion in lost corporate tax for governments annually – funds which could have been used to build schools, hospitals and other key infrastructure projects.

To be sure, it is not just companies which are under pressure to reduce their taxes.

Jurisdictions themselves compete with one another to attract foreign investments, in turn creating a downward spiral in corporate tax rates globally.

These rates have fallen from an average of 40 per cent in 1980 to 23 per cent now – what United States Treasury Secretary Janet Yellen has called a race to the bottom.

Jurisdictions also sweeten the deal by doling out additional reliefs and subsidies, meaning that businesses end up paying even lower corporate taxes.

And what’s BEPS 2.0?

Discussions to revise global tax rules and make large businesses pay more taxes have been underway since 2013.

But it was in 2021 when a decisive, significant step was finally taken.

Led by the Organisation for Economic Cooperation and Development (OECD), nearly 140 countries agreed to a two-pillar solution known as BEPS 2.0. 

The first pillar looks to reallocate certain taxing rights from the multinational enterprises’ (MNEs) home countries, to the markets where their consumers are based and products sold.

The implementation date for this pillar remains unclear.

The second pillar prescribes a global minimum corporate tax rate of 15 per cent for MNE groups with annual global revenues of 750 million euros (S$1.09 billion) or more.

Under this second pillar, there are several interlocking measures such as an Income Inclusion Rule, Domestic Minimum Tax and Undertaxed Profits Rule – more on these later.

How other countries are adopting BEPS 2.0

The UK has enacted the Income Inclusion Rule and a Domestic Top-up Tax – also known as the Domestic Minimum Tax – for business accounting periods beginning on or after Dec 31, 2023.

Likewise, Australia has implemented both initiatives from January.

Switzerland has rolled out the Domestic Top-up Tax from January this year and said it will revisit other components under pillar two “at a later point in time”.

Japan will enact the Income Inclusion Rule from April this year.

Elsewhere, others like Hong Kong and Malaysia have announced plans to adjust their corporate tax rules from 2025.

What’s Singapore’s approach?

Singapore has, since 2022, signalled that it was mulling a top-up tax for large MNEs. A year later, Mr Wong confirmed that it will kick in from 2025, though details were scant.

On Friday, in his Budget speech, Mr Wong announced that from Jan 1, 2025, Singapore’s corporate income tax regime will move ahead with two components under the second pillar of BEPS 2.0.

The first is the Income Inclusion Rule.

Under this, an MNE parented in a jurisdiction will pay 15 per cent corporate tax for all overseas profits. The rule kicks in when an MNE’s overseas subsidiary is taxed below the new tax floor – a move to ensure that the parent entity consistently pays a 15 per cent tax rate regardless of where it operates, experts said.

In summary, this means MNE groups with parent companies in Singapore will have to pay a minimum effective tax rate of 15 per cent on profits made by their overseas subsidiaries.

The second is the Domestic Top-up Tax or Domestic Minimum Tax, which applies to local profits made by MNE groups.

This allows a jurisdiction to retain taxing rights and collect any top-up taxes which kick in when the effective corporate tax rate of an MNE’s local profit is below 15 per cent. If uncollected, these will flow overseas, such as to an MNE’s parent jurisdiction, under the Income Inclusion Rule mentioned earlier.

Although Singapore’s headline corporate tax rate is at 17 per cent, many businesses pay a lower effective tax rate due to various reliefs aimed at encouraging activities beneficial to economic development.

Authorities here have previously pointed to about 1,800 MNE groups in Singapore that would meet the revenue threshold of 750 million euros (to be taxed the global minimum corporate tax rate). “A majority” of these have effective tax rates below 15 per cent, and thus qualify to pay top-up tax.

“Without this tax, these MNE groups would have had to pay their parent jurisdictions the effective tax rate of 15 per cent on their Singapore profits,” Mr Wong said on Friday.

Hence, it’s in Singapore’s interest to implement this top-up tax, so that the country collects the tax “rather than have it go somewhere else”.

Another component, the Undertaxed Profits Rule, will be considered at a later stage.

This rule largely functions as a backstop to instances where the Income Inclusion Rule or Domestic Top-up Tax is not enforced, said the Grant Thornton advisory’s Singapore head of tax David Sandison. So the delay is “not surprising”, he added.

“The best example is the low-taxed Singapore income of a Singapore parented group or the low-taxed profit of a Singapore subsidiary being held directly by a non-BEPS country. There is no rush to tax either of these if no other country is getting the top-up tax,” he explained.

Altogether, the latest corporate tax announcements provide “welcome certainty” for affected MNEs to plan their overall business strategies, said Mr James Choo, international tax and transaction services partner at professional services firm EY.

What are the bigger implications for Singapore?

The new regime of a global minimum corporate tax rate essentially means reduced scope for Singapore to use traditional tax incentives to attract new investments.

And this inevitably raises concerns about whether Singapore could lose its shine as a prime location for global businesses, whose investments are crucial for growing the economy.

Local businesses will not be spared the consequences either.

“The global tax rule doesn’t directly impact the local SMEs, but I think the concern is … if there’s a shift in how the global companies are domiciling then that will have knock-on effects on our businesses,” said Mr Ang Yuit, president of the Association of Small and Medium Enterprises (ASME).

Singapore has repeatedly warned that multinational firms are “mobile and … have options” for their next investment projects. Governments around the world are also rolling out vast subsidies to attract investments to build up their own strategic industries.

Still, Singapore “really has no choice” but to implement these corporate tax changes, Mr Sandison told CNA.

“Otherwise, it would be giving tax revenues away to the parent company tax authorities, where in some cases BEPS legislation is already operating.” 

In his Budget 2024 speech, Mr Wong said the implementation of BEPS pillar two initiatives will provide additional revenues to the government in the short term, but it’s “uncertain how much this will be or how long it will last”.

He warned that Singapore may even see a reduction in its tax base, should MNEs shift some of their activities to other jurisdictions in response to the new business environment.

Enter the new Refundable Investment Credit. How will it work?

The Refundable Investment Credit (RIC) works as a tax credit with a refundable cash feature. It will be awarded based on qualifying expenditures incurred by a company, for a qualifying project over a period of up to 10 years.

Such expenditures may include capital expenditure, manpower and training costs. Companies can receive up to 50 per cent of support on each category.

If awarded, companies will be able to use the credits to offset their payable corporate income tax.

Any unutilised credits will be refunded to the company in cash within four years from when the company satisfies the conditions for receiving the credits.

Singapore’s Finance Ministry said this new scheme is consistent with Global Anti-Base Erosion Rules for Qualified Refundable Tax Credits (QRTCs).

QRTCs have long been touted as a viable alternative to traditional tax incentives, in a post-BEPS 2.0 world. This is because such credits are treated as income, rather than a tax relief that reduces an MNE’s effective tax rate.

Several experts said the RIC will help Singapore remain top-of-mind among global investors.

“Given that BEPS is likely to affect all jurisdictions that currently give away incentives in equal measure, it would be a case of ‘out of the frying pan, into the fire’ if businesses moved,” said Grant Thornton’s Sandison.

“The Refundable Investment Credit is clearly aimed at staunching any outflow and keeping the playing field level.”

Mr Ajay Kumar Sanganeria, partner and head of tax at KPMG Singapore, said the scheme’s support for a wide range of project activities was “a compelling proposition” for MNEs to invest in Singapore.

These include the setting up or expansion of manufacturing facilities, new innovation and research and development (R&D) activities, as well as activities supporting the green transition. 

For the RIC to have an even greater effect, it could expand beyond being expenditure-based to include output-based features, such as the volume of products manufactured in Singapore, Ms Yvaine Gan, global investment and innovation incentives leader at Deloitte Singapore, suggested.

“This greater flexibility of having a combination of expenditure-based and output-based credits will address the needs of a broader range of businesses, making the RIC an even more impactful incentive in supporting companies in the changing investment landscape,” she said.

What else is Singapore doing to stay competitive?

Mr Wong on Friday also announced a S$2 billion top-up to the National Productivity Fund to support the RIC and other investment promotion efforts.

He also said Singapore will further inject S$3 billion into its Research, Innovation and Enterprise 2025 plan; invest more than S$1 billion in artificial intelligence development over the next five years; and boost the SkillsFuture scheme among other plans.

The slew of initiatives is “set to inspire confidence among companies to anchor and expand their high-value economic activities in Singapore, particularly in light of the rapidly evolving and dynamic macroeconomic landscape”, said Mr Lee Bo Han, partner for R&D and incentives advisory at KPMG Singapore.

But beyond the policy toolkit, other considerations – such as a business-friendly and stable political environment as well as a competitive workforce – still matter for global investors. And these remain Singapore’s strengths, experts said.

“It’s not just about taxes, but also about the others (like) manpower, our transparency or our efficiencies, our law and order; all these still have to pay a very, very important role,” said OCBC’s head of treasury research and strategy Selena Ling. “It still comes down to the overall investment climate (of) Singapore.”

Mr Victor Mills, chief executive of the Singapore International Chamber of Commerce, pointed to attributes such as fair and progressive tax regime, pleasant living conditions, as well as a strategic location that provided easy access to the region.

“MNEs will always do what is most advantageous for them,” he said. “Singapore remains advantageous because of its brand.”

Excerpt from CNA/sk(jo)

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