Tinubu’s sneaky FX windfall tax unsettles Nigerian banks

ONOME AMUGE IN LAGOS, NIGERIA

Faced with a persistent fiscal shortfall, the Nigerian government has devised a daring strategy to shore up revenue by imposing a windfall tax on the nation’s banking sector, seeking to capture an estimated N1.35 trillion in revenue from some banks if all their foreign exchange (FX) profits are realised.

However, this audacious plan has ignited vehement opposition from bank shareholders and investors, who are digging in their heels to safeguard the immense profits secured by their institutions. With these hard-earned gains teetering on the brink of being swept away, the government’s ambitious revenue-raising endeavours is encountering a stubborn resistance.

A windfall tax is a special tax imposed on specific industries when economic conditions result in unusually high profits. Typically used as a one-time measure, windfall taxes are designed to capture a portion of these unexpected gains, often driven by factors such as natural disasters, commodity price spikes, or other favourable market conditions. Governments often introduce windfall taxes as a way to generate additional revenue and mitigate the impact of volatile economic conditions on the general population.

In what can only be described as a financial boon for the Nigerian banking sector, the year 2023 and the first quarter of 2024 witnessed an unprecedented surge in profits, with four Tier-1 banks, including Access Holdings, GTCO, UBA, and Zenith Bank, reaping massive gains. According to industry reports, the cumulative gross earnings of these banks exploded by an astounding 114.40 percent, topping N7.98 trillion. In addition, their cumulative pre-tax profits experienced a 233 percent surge to hit an estimated N2.89 trillion.

Seizing upon the financial gains made by the Nigerian banks in the wake of the naira’s devaluation, President Bola Tinubu shrewdly orchestrated a daring fiscal manoeuvre. Realising the immense potential of this financial windfall, he crafted a one-time 50 percent windfall tax, a move calculated to tap into the banks’ immense profits derived from foreign exchange transactions. This policy, poised to redirect the banks’ remarkable currency gains to the nation’s coffers, aims to enrich the government treasury with the newfound treasure and shore up the country’s fiscal position.

Taking decisive action to tap into the sizeable profits generated by the banks due to their successful foreign exchange dealings, President Tinubu reached out to the National Assembly, urging them to amend the 2023 Finance Act. The president’s request, clearly outlined in a letter addressed to  Senate President Godswill Akpabio, was read on the floor of the upper legislative chamber.

The letter titled, “Transmission of Appropriation Amendment Bill 2024 And Finance Act Amendment Bill 2024 for Consideration”, read in part, “Furthermore, the proposed amendments to the Finance Acts 2023 are required to (sic) a one-time windfall tax on the foreign exchange gains realised by banks in their 2023 financial statements to fund capital infrastructure development, education, and healthcare as well as welfare initiatives all which are components of the Renewed Hope Agenda.”

Emboldened by a need to assert fiscal control and compliance, the federal government announced that, should the proposed windfall tax on banks’ foreign exchange gains be passed into law, bank executives risk imprisonment of up to three years over non-compliance.

Professional services firm KPMG, in an analysis of the consequences of the windfall tax, identified a potential legal minefield arising from the federal government’s controversial plan to impose a retroactive tax on banks’ foreign exchange gains.

KPMG noted that such a policy is completely at odds with Nigeria’s tax system, which has never before practised retroactive taxation.

“Nigeria’s tax policy frowns at retroactive application of tax laws. It is, therefore, surprising, that the government has chosen to implement these windfall taxes retroactively. Moreover, many of these banks have submitted their tax returns for the 2023 financial years and have settled the resultant liability,” it observed.

According to the tax advisory firm, applying a tax retroactively could raise constitutional concerns, given that such a measure could violate the principle of legitimate expectations, whereby businesses are entitled to rely on established tax policies and regulations. The firm cautioned that implementing such a tax could invite litigation, stifling economic growth.

In addition, KPMG expressed concern that this retroactive tax could deter foreign investors, casting a shadow over Nigeria’s international reputation as a business-friendly country.

KPMG’s analysis of the windfall tax also highlighted the potentially shady nature of the tax, noting that banks had already paid a 30 percent Company Income Tax (CIT) on their overall profits, which would have included their foreign exchange earnings. The firm pointed out the ambiguity surrounding the government’s proposed approach, as it was unclear whether the 50 percent windfall tax would be added to the CIT already paid or if it would be treated as an entirely separate levy.

KPMG also raised a crucial point regarding the selective nature of the proposed windfall tax. The firm questioned the justification for targeting banks exclusively when other businesses had also made forex gains in 2023.

Banks’ shareholders rally against windfall tax

Amidst the brewing fiscal storm, bank shareholders under the New Dimension Shareholders Association (NDSA), have risen in an uncompromising protest against the proposed 50 percent windfall tax on banks’ foreign exchange gains.

Patrick Ajudua, the NDSA president, argued that the proposed windfall tax would unjustly erode the financial performance of banks in an already challenging operating environment and seriously compromise the amount of funds available to shareholders.

Ajudua insisted that the banks’ gains from foreign exchange were a result of the naira’s devaluation and were not the result of actual cash movements, calling attention to previous CBN circulars instructing banks not to pay dividends from these gains.

“As shareholders of the banks, we outrightly condemn this unholy move and ask that such thought and move be halted.

“Why would the government attempt to impose a tax on such gains? It is both unfair and immoral,” he stated.

Ajudua threatened that shareholders would not hesitate to initiate legal proceedings should the government proceed with the proposed windfall tax on banks.

The NDSA president dismissed the notion that the tax revenue could be used to finance infrastructure development as a flimsy justification, drawing comparisons to the government’s past attempt to tap into the pension fund for a similar purpose. He therefore advised the government to seek alternative revenue streams to shore up their expenditure.

Boniface Okezie, national chairman of The Progressive Shareholders Association of Nigeria (PSAN), also opposed the federal government’s decision to consider a windfall tax on banks’ foreign exchange gains. Okezie castigated the government for initiating a policy that could have significant adverse effects on the banking sector and the wider economy.

“Why on earth will the government rely on the private entity to make all the money they are hoping to make from N6.2 trillion from a windfall of forex exchange deal, which almighty CBN has given them?

“It is ill-human to contemplate doing such a thing. Don’t forget that the banks are private companies that are paying heavy taxes to the government from the profits they make and you want to levy them again on forex transactions,” he stated.

Further intensifying his criticism of the windfall tax proposal, Okezie directed the government’s attention to its own parastatals, urging the administration to focus on fiscal reforms and seek alternative revenue sources within its own institutions.

The PSAN national chairman  insisted that the banks should not be subjected to what he called “clueless policies,” suggesting that the move was an indication of the government’s failure to effectively manage the country’s affairs and a signal that it was running out of viable ideas to sustain governance.

Meanwhile, in a recent analysis, Renaissance Capital revealed that the implementation of the proposed windfall tax could potentially net the federal government N1.35 trillion in revenue from some of the banks, if their foreign exchange (FX) profits were to be fully realised. However, the investment company cautioned that this taxation measure could give rise to double taxation or over-taxation, as these profits, under the Companies Income Tax Act (CITA), would already have been taxed at a rate of 30 percent in 2023.

“Therefore, an additional 50% tax on the same line item, which was taxed at 30%, leads to double taxation and would increase the effective tax rate on FX profits to 80%,” it stated.

The emerging and frontier markets investment bank also brought to light a potential snag in the proposed windfall tax. Despite the CBN mandating that banks close out their Net Open Position (NOP) to zero percent long shareholders fund, the company pointed out that a significant portion of these banks’ FX profits remain unrealised as the banks could meet this directive without actually realising their long FCY NOP. As a result, Renaissance Capital noted that this could undermine the government’s ability to raise its targeted revenue from the tax, despite its lofty ambition.

With an eye for fiscal implications, Renaissance Capital warned that the proposed windfall tax on banks’ foreign exchange gains could prove detrimental to foreign investment flows, which are currently crucial for the Nigerian economy.

The investment bank argued that the timing and nature of the bill could undermine the tax principle of certainty, as the government would be retroactively taxing profits generated in the previous year. This move, it cautioned, could deter foreign investors from committing their capital to the country, as they might view such a tax policy as unpredictable and untrustworthy.

“Furthermore, the long process the bill must typically undergo before it becomes law significantly increases market uncertainty and perceived systemic risk,” it added.

Expanding upon its analysis, Renaissance Capital also warned that the introduction of a windfall tax could potentially tarnish investors’ perceptions of the Nigerian economy, crippling the ability of the nation’s banks to attract much-needed foreign portfolio investment (FPI), particularly from the diaspora.

According to Renaissance Capital, the potential imposition of this tax could sour investor sentiment, hindering banks’ ability to secure capital via FPI when they need to meet the minimum capital requirements set by the CBN.

PricewaterhouseCoopers (PwC), in a recent publication titled “The Windfall Tax Conundrum,” elucidated the difficulties that governments encounter when considering a tax on foreign exchange gains.

The financial services firm analysed the complex interplay between the taxation of such gains and its fiscal impact on Nigerian banks, revealing that such a taxation measure, while seemingly straightforward, can prove challenging for governments to navigate due to its potential wide-ranging implications for tax revenue, financial stability, and the overall economy.

PwC asserted that should the final legislation only apply to realised profits earned in 2023, the generated revenue would be marginal, thereby failing to fulfil the government’s revenue objectives.

It also posited that, since most banks had not realised their foreign exchange gains until 2024, when the CBN mandated banks to adjust their net open positions in February 2024, taxing only realised profits in 2023 would yield negligible gains. This, in turn, would render the proposed windfall tax largely ineffective at achieving the government’s fiscal targets.

In its recommendation, the multinational professional services firm stated: “While the tax aims to ensure that banks contribute their fair share to the national coffers, it must be implemented in a manner that upholds legal principles and maintains investor confidence. As Nigeria treads into this uncharted territory, the outcomes of this policy will have far reaching implications for the country’s financial stability and economic growth.”

Analysts at Afrinvest, a leading investment management holding company, also added their perspective on the controversial windfall tax.

While acknowledging the government’s constitutional right to impose such taxes for fiscal purposes, Afrinvest expressed concern about the timing of the announcement, stating that its suddenness would naturally sow seeds of uncertainty and unpredictability among investors and industry players.

Illustrating their point, the Afrinvest analysts brought attention to Italy’s own experience with a similar windfall tax on banks’ net interest margin in 2023. While noting that the Italian policy was eventually amended, they highlighted the crucial difference between the timing of the two tax proposals. While Italy announced its plan during the year in question, Nigeria’s proposal is considered a bolt from the blue, catching the banking sector off guard.

“Furthermore, there is need for clarification on the wind-fall tax adjustments to be made for banks that [have] already remitted income tax for 2023. Given the five-month window for compliance, the FG should provide a clearer template that would take into consideration some of the nuances around implementing the tax,” the analysts advised.

The Afrinvest analysts also dwelled on the issue of fairness, considering the perspective of capital owners whose access to foreign currency (FCY) earnings had already been curtailed by the CBN. They observed that while shareholders were effectively blocked from utilising these gains via dividend payments, the government was now attempting to claim 50 percent of these same profits. Highlighting the apparent contradiction in the treatment of the foreign exchange gains, Afrinvest underscored the pressing question of whether it was fair to levy a windfall tax on profits that had already been earmarked for regulatory purposes and could not be shared with shareholders.

“In light of the ongoing recapitalisation, the broad steps by the regulator and the FG to tighten the noose around FX income for banks might disincentivise new capital inflow into the sector, thereby prolonging the current episode of lacklustre foreign capital inflows into the country,” they cautioned.