Taxation of Companies and Transactions in the Free Zone: Clarifying the Position of the Law

The Nigerian free zone scheme overseen by the Nigeria Export Processing Zones Authority (NEPZA) was established by the Federal Military Government in 1992 pursuant to the Nigeria Export Processing Zones Authority Act No. 67 of 1992 (NEPZA Act), to drive economic growth by attracting foreign direct investment (FDI) and domestic direct investment (DDI), promoting industrialization, facilitating infrastructure development, employment generation, skill and technology transfer, and diversifying the economy away from oil dependency.

There are currently 44 private and 2 public free zones in Nigeria, hosting over 600 registered enterprises operating in various sectors and industries including logistics, manufacturing, aviation, shipping, tourism, industrial parks, amongst others. These free zones include the Lekki Free Zone, Snake Island Integrated Free Zone, Ladol Free Trade Zone, and the Ogun Guangdong Free Trade Zone. The Nigerian free zone scheme is estimated to have created over 150,000 direct and 250,000 indirect jobs, and attracted FDI of over USD66 billion and DDI of over NGN620 billion, as reported by NEPZA.

Investors in Nigeria's free zones enjoy a range of incentives, including exemption from all federal, state, and local taxes. They also enjoy duty-free importation of goods, machinery, and equipment, unrestricted repatriation of profits, and exemption from customs duties on export-oriented activities and foreign exchange regulations.

The tax regime applicable in the free zone is governed by the NEPZA Act and the Investment Procedures, Regulations and Operational Guidelines for Free Zones in Nigeria, 2004 (NEPZA Regulations) issued pursuant to the NEPZA Act. The body of tax legislations and sub-legislations applicable in the free zone is supplemented by finance acts passed by the National Assembly, circulars and notices issued by the Federal Inland Revenue Service (FIRS) and various case laws, litigated from the Tax Appeal Tribunal to the Supreme Court.

General Exemption from all Taxes, Levies and Rates

Free zone entities enjoy full exemption from all federal, state and government taxes, levies and rates pursuant to Section 8 of the NEPZA Act. This exemption covers companies’ income tax (30% of chargeable profit), value-added tax (7.5% of taxable purchases), capital gains tax (10% of chargeable gains), stamp duty (fixed/ad valorem), education tax (3% of assessable profits), and withholding tax (2.5% to 10% of transactions), amongst others.

Prior to the enactment of the Finance Act 2020, Section 18(1)(a) of the NEPZA Act provided that “Legislative provisions pertaining to taxes, levies, duties and foreign exchange regulations shall not apply within the Zones”. This provision created enforcement difficulties, as it inadvertently extended the tax exemptions reserved for free zone enterprises to all entities and persons transacting within the free zone.

To ensure that the true intent of the tax exemption provisions in the NEPZA Act is maintained, Section 58 of the Finance Act 2020 amended Section 18(1)(a) of the NEPZA Act by deleting the original sub-paragraph and replacing with a new paragraph (a) which clarifies that approved enterprises will enjoy as an incentive, “exemption from taxes, levies, duties and foreign exchange regulations in accordance with section 8 of this Act…”. This amendment re-aligned the provision with the Federal Government’s original intent for the provision of tax incentives to approved enterprises in the free zone, and answered the lingering question of whether non-free zone entities who do business or provide services in the free zone can enjoy tax incentives in the free zone.

VAT Treatment

Free zone entities are exempt from VAT on their purchase of goods and services, whether from vendors or service providers within or outside the free zone, pursuant to Sections 8 and 18(1)(a) of the NEPZA Act. Accordingly, invoices for goods or services provided to free zone entities should not include a VAT component. ?However, this VAT exemption does not apply to transactions where free zone entities supply goods or services to entities or persons operating outside the free zone, or to unapproved entities (free zone entities without valid operating licences). In such cases, as clarified in Sections 2, 3, and 7 of Paragraph 3 of Part 6 of the NEPZA Regulations, VAT must be applied, and free zone entities are required to include VAT on their invoices for customers located outside the free zone.

It is important to note that in transactions where a free zone enterprise supplies goods to a wholesaler in the customs territory, with the free zone entity acting as the exporter and the wholesaler as the importer, VAT is not charged at the point of this transaction. Instead, VAT will be applied when the wholesaler sells the goods to end users within the customs territory, ensuring that VAT is applied at the retail stage of the sale.

Withholding Tax (WHT) Obligations

Free zone entities are exempt from WHT when they receive services, as they enjoy income tax exemptions under the NEPZA Act. However, when a free zone entity provides services to a customer outside the free zone, the free zone entity is required to withhold and remit WHT on the transaction, as specified in Section 7 of Part 6 of the NEPZA Regulations.

Unapproved enterprises (those without valid operating licences) are subject to WHT as they do not qualify for the tax exemptions available to licensed free zone entities.

Taxation of Dividends

Dividends paid by free zone entities are not subject to WHT, by virtue of Section 19(2) of the CITA, as amended by Section 7(a) of the Finance Act 2019. The amendments to the CITA by the Finance Act 2019 exempt all dividends paid out of tax exempt income from WHT.

Stamp Duty Exemption

Free zone entities are exempt from paying stamp duties on instruments that would ordinarily be subject to duties under the Stamp Duties Act Cap. S8 LFN 2004. This exemption extends to stamp duties on electronic transactions, such as the Electronic Money Transfer Levy introduced by the Finance Act 2020, which applies to cash deposits of NGN10,000 and above. However, where a transaction document is executed between a free zone entity and a non-free zone entity and the party responsible for stamping the dutiable instrument in this case is the non-free zone entity, the stamp duty exemption will not apply.

Personal Income Tax

While free zone entities enjoy significant exemptions from federal, state, and local taxes, this exemption does not extend to their obligations under personal income tax laws. The Finance Act 2020 clarified that although free zone entities are exempt from payment of taxes, they are not exempt from tax laws. As such, free zone enterprises are required to deduct and remit Pay-As-You-Earn (PAYE) tax from their employees' salaries, in line with the Personal Income Tax (Amendment) Act 2011 (PITA). PAYE is a statutory requirement for all employers in Nigeria, including those operating in free zones, and must be calculated using the progressive tax rates applicable under PITA.

Import Duty Relief

Goods consigned to the free zone enjoy full exemption from import duties, which range from 5% to 70% of the CIF value of dutiable imports, as provided under Section 1 of the Customs Tariff (Exemption) Order 2001.

When goods manufactured, processed, or assembled within the free zone are subsequently exported into the Nigerian customs territory, import duties are levied only on the raw material component of the finished goods, as stipulated in Section 3(i) of Part 2 of the NEPZA Regulations.

Filing of Tax Returns

Section 18(1)(a) of the NEPZA Act (as amended by Section 58 of the Finance Act 2020) introduces an obligation on free zone companies to comply with the provisions of Section 55(1) of the Companies Income Tax Act CAP C21 LFN 2004 and submit returns to the FIRS.

Chidi routinely advises on the tax implications of transactions in the Free Trade Zone.

*Please note that the views expressed in this article are those of the author only, and do not necessarily reflect the position of?Rendeavour, Alaro City, or any other institution with which the author is associated.