Withholding Tax; What Constitutes a Sale in the Ordinary Course of Business?

The Withholding Tax (WHT) is not another form of tax, rather, an advance payment of income tax on specific transactions. Generally, when such transactions are executed, the person or company making payment is required by law to deduct WHT at the specified rate depending on the type of transaction and the party involved. The tax withheld is then remitted to the relevant tax authority. The objective of withholding tax is basically to minimize tax evasion, ensure that more taxpayers are captured into the tax net and provide revenue to the government to meet up with its budget.

The Companies Income Tax (Rates, etc., of Tax Deducted at Source (withholding Tax)) Regulations (WHT Regulations) specified the payments from which WHT should be deducted and the applicable rate of tax. The payments include all aspect of building, construction and related activities, all types of contracts and agency arrangements, other than sales in the ordinary course of business, consulting and professional services, management services, technical services, and commissions.

Over time, the definition of sales in the ordinary course of business has continued to be a basis for arguments between taxpayers and the tax authorities. Consequently, this has forced so many taxpayers to suffer WHT deduction on income received from sales in the ordinary course of business.

Definition of Ordinary Course of Business

The Blacks Law dictionary defines “Ordinary Course of Business” as the normal routine in managing a trade or business; that which is customary and practiced within business in the usual manner.

A company’s ordinary course of business literally means the recurring activities carried out by the company which is usually stated in its memorandum of association. According to the Companies and Allied Matters Act 2020 (CAMA 2020), the memorandum of association of a company is the document that states “the nature of the business or businesses which the company is authorized to carry on, or, if the company is not formed for the purpose of carrying on business, the nature of the object or objects for which it is established”.

The memorandum of association enables members, creditors, tax authorities, and anyone who deals with the company to know the company’s area of expertise. The most important clause is the object of the company. This clause states the nature of business of the company. All the businesses the company intends to engage in must be stated in the object clause because a company cannot engage in any activity that is completely different from what has been stated in the object clause.

The company’s object clause in the memorandum of association can therefore be the most relevant indicator to guide what constitutes contracts and agency arrangements that would form sales in the ordinary course of business. These transactions are therefore those referred to in the WHT Regulations as exempt from withholding tax deduction.

Sale or Supply in the Ordinary Course of Business

A contract of sale or supply simply means an agreement between a supplier and a customer for the sale or supply of goods and/or services. Based on the WHT Regulations , WHT deduction should not apply where a sale is done directly between two parties or in an agency arrangement provided that the goods or services are supplied by a company (the manufacturer or supplier) in pursuant to its business object as stated in its memorandum of association.

However, a contract agreement can be executed directly between two parties for the supply of goods and services where the goods or service to be delivered does not form part of the supplier’s business objectives. Such contracts are those referred to in the WHT Regulations as all types of contracts and agency arrangements and would be liable to WHT deduction.

Many companies have over time deducted WHT from payments to their suppliers on all types of contracts and agency agreements not taking into consideration the ordinary course of business of the supplying company. Majorly, this is because the Federal Inland Revenue Service (FIRS) had mandated companies to deduct and remit withholding tax on all forms of contracts and failure to do so was usually penalized. The FIRS standpoint has created several controversies which has also led to tax disputes between taxpayers and the FIRS. The most recent tax dispute is the case between Tetra Pak West Africa Limited (Tetra Pak) and the FIRS, where the Tax Appeal Tribunal (TAT) ruled that sales in the ordinary course of business are exempt from withholding tax in pursuance to the WHT Regulations.

Recent TAT Ruling on Supply in the Ordinary Course of Business

Tetra Pak’s customer deducted WHT on its fee for sales provided in the ordinary course of business. These deductions significantly impacted on Tetra Pak’s cash flow especially as the company did not make any profit during the year. Hence, the company wrote to the FIRS to obtain a confirmation that its business activities qualified as sales in the ordinary course of business and thus exempt from WHT deduction. The FIRS in its response wrote that the specified company’s transactions should be liable to WHT deduction. This disagreement prompted Tetra Pak to appeal to the TAT.

The TAT ruled that sales in the ordinary course of business are not liable to WHT; stressing further that the WHT Regulations seek to ensure that taxpayers are captured into the tax net to avoid evasion which is not the position in this case.

While delivering the judgement on the case between Tetra Pak and the FIRS, the TAT provided guidelines to be considered when determining a sale or supply in the ordinary course of business. The TAT stated that the following must be considered:

• history of the taxpayer in relation to the activity;
• frequency of the transaction;
• nature of transactions/activities listed in the memorandum of association; and
• practice in the taxpayer’s industry

The TAT also mentioned that sales in the ordinary course of business was a question of fact and that the tax authority has the obligation of determining whether a business activity can be regarded as a sales in the ordinary course of business based on the conditions stated by the TAT.

Conclusion

The taxpayer besides having the problem of high interest rates, scarcity of foreign currencies, high inflation rates, etc. to contend with, is also crippled by the burden of undue WHT deduction considering time value of money. This is so because WHT deduction is made in advance and the profit margin for most taxpayers is lower than the WHT rates applied on the turnover. Also, WHT rates at 5% or 10% when applied on turnover would most often than not result in a higher tax remittance than the income tax rate of 30% on profit at the end of the year. This puts taxpayers in a situation where the WHT deduction taken in advance is perpetually higher than the income tax payable at the end of the year. Worse more is the fact that the refund mechanism has not been seen to be effective over the years.

Hence, the recent TAT ruling is laudable as it will provide succor to the taxpayers in line with the ease of doing business initiative of the federal government. Hopefully, the tax authority will embrace the TAT ruling and adopt same for tax administration purposes going forward.