Tax Compliance in The Nigerian Informal Sector: Issues and Challenges

By Oyetola Muyiwa Atoyebi, SAN FCIArb. (U.K)

INTRODUCTION

Tax compliance plays a fundamental role in facilitating economic development in any modern society. It serves as a primary source of government revenue to support public services, infrastructure development, and social welfare programs.[1] Adherence to tax obligations by both individuals and businesses enables the government to allocate resources to critical sectors such as education, healthcare, transportation, and public safety, all of which are pivotal for the socio-economic advancement of a nation.

This allocation of resources creates an environment conducive to economic growth, fostering human capital development, driving productivity improvements, and generating employment opportunities. The availability of adequate government funding also allows for the implementation of effective policies and reforms aimed at stimulating innovation, attracting foreign investment, and fostering sustainable development.[2]

In Nigeria, tax compliance contributes to fiscal stability by reducing reliance on external borrowing and volatile revenue streams, such as income from natural resources. It empowers the government to prudently manage public finances, ensuring that expenditures are in line with revenues, thereby mitigating the risk of substantial budget deficits and excessive public debt levels.[3] Additionally, it cultivates a sense of civic duty and fosters trust in public institutions, as citizens and businesses witness the tangible impact of their contributions through meaningful improvements within their communities. This trust is essential for preserving social cohesion and ensuring the enduring effectiveness of the tax system, ultimately bolstering the stability and prosperity of the economy.[4]

The Nigerian informal sector plays a substantial and vibrant economic role, contributing an estimated 65% to the GDP and engaging around 80% of the workforce.[5]  It represents a dynamic and critical component of the nation’s economy, encompassing a broad range of small-scale, unregistered, and unregulated economic activities. Having a wide range of participants involved in activities that span from small-scale trading, transportation services, and agriculture to informal financial services and construction, its adaptability and responsiveness render it a pivotal economic support, particularly during periods of economic recessions or inadequacies in formal sector employment. Despite its noteworthy economic influence, the informal sector remains inadequately represented in official tax records, resulting in significant revenue deficits for the government. The sector’s heterogeneity poses unique challenges for tax authorities in terms of identification, registration, and enforcement of tax obligations.

The article will appraise the compliance level of the Nigerian informal sector with tax requirements while highlighting how this impacts the generation of revenue for the nation.

AN OVERVIEW OF THE NIGERIAN TAX SYSTEM

The legal and regulatory framework governing taxation in Nigeria is characterized by a complex web of legislations and institutions designed to ensure compliance with tax obligations within the business environment. Key tax laws delineate the payment of taxes, assessable income, assessment and remittance procedures, relevant tax authorities, available exemptions, and penalties for non-compliance. Such include:

1. The Companies Income Tax Act:[6] This serves as the primary legislation on the taxation of corporate entities or formally registered businesses with legal personality within the country. Administered by the Federal Inland Revenue Service, CITA aims to foster equitable tax contributions from corporate entities, thereby supporting Nigeria’s fiscal policies and economic development objectives.
2. The Personal Income Tax Act:[7] the Act delineates specific provisions concerning the taxation of small businesses. According to PITA, small businesses, typically categorized as enterprises or sole proprietorships, are liable to personal income tax rather than corporate tax. The income generated from these businesses is regarded as the personal income of the business owner and thus is subject to the progressive personal income tax rates outlined in the Act. Moreover, small businesses are mandated to submit annual tax returns and uphold accurate financial records to duly declare their earnings and tax responsibilities.
3. The Value Added Tax Act:[8]  The Act enforces a tax on the supply of goods and services, exempting small businesses with an annual turnover below ₦25 million from VAT registration, collection, and submission of returns. This exemption is intended to alleviate the administrative burden on small enterprises and spur their development by easing the additional tax compliance responsibilities that larger businesses face.
4. The Stamp Duties Act:[9] The Act governs the imposition, administration, and collection of stamp duties on a variety of documents and transactions, mandating that specific instruments, including agreements, contracts, bank notes, promissory notes, bills of exchange, and property transfer documents, must be stamped to achieve legal recognition. Stamp duty serves as a form of tax on these documents, thereby providing the government with a revenue stream.

Other notable legislation encompasses the Capital Gains Tax Act, the Tertiary Education Trust Fund Act, the Withholding Tax Act, and the and the Petroleum Industry Act, among others. It is important to note that not all these taxes would apply to small businesses had they been captured in the tax net. Which law will apply will depend on the nature of transactions carried out by them.

ASSESSING TAX COMPLIANCE IN THE NIGERIAN INFORMAL SECTOR

Tax compliance in Nigeria is associated with several societal advantages, notably the generation of crucial revenue for government operations and public services. This revenue plays a key role in funding vital infrastructure projects such as roads, schools, and hospitals, thereby enhancing the overall quality of life and spurring economic development. Additionally, tax compliance fosters transparency and accountability in governance by establishing a direct link between taxpayer contributions and government expenditure.[10] Moreover, a robust tax system helps alleviate reliance on external debt and unstable income sources, thus ensuring fiscal stability. Emphasizing civic responsibility, tax compliance also contributes to bolstering social cohesion and trust in public institutions, thereby fostering a more equitable and prosperous society.[11]

The Nigerian informal sector encompasses a diverse range of nano enterprises, unregistered, and carrying out economic activities outside formal legal and regulatory frameworks. This sector comprises various enterprises including artisans, small-scale manufacturers, street vendors, informal service providers, etc.[12] These businesses typically rely on cash transactions and maintain limited financial records, posing challenges for monitoring and taxation. Despite their informal nature, these enterprises significantly contribute to the economy by providing employment and income for millions of Nigerians, making substantial contributions to the GDP,[13] and supplying essential goods and services, particularly in areas with limited formal business presence. The adaptability and flexibility of this sector make it a crucial component of Nigeria’s economic resilience, especially during periods of economic instability or downturns.[14]

The peculiar benefits offered to society by the informal sector place them at a vantage point for revenue generation. What is more, these businesses operate using government facilities provided from taxpayers’ money contributions, which are not made by these informal businesses. They have thus been described as the largest category of tax defaulters and evaders, contributing significantly to leakages in government revenue.[15] Being the most challenging domain in the concept of taxation,[16] there have been several arguments on whether or not taxing the informal sector will have a significant impact on tax revenue. While some proponents have argued that, as a result of the significant contributions of the sector to employment generation and GDP, taxing them will no doubt increase government revenue, others have argued that the potential revenue yield will be meager compared to the administrative cost involved in the administration of tax to the informal sector.[17] It is, however, opined that in the current Nigerian structure, in which the informal sector accounts for a staggering percentage of employment in the nation and contributes significantly to its GDP, taxing the informal sector will be a gainful venture for the government. This, however, is not in any way disregarding the administrative costs that arise from such ventures, and it might be essential to discuss the issues attendant to it.

CHALLENGES OF TAX COMPLIANCE IN NIGERIA’S INFORMAL SECTOR

Tax compliance in Nigeria’s informal sector faces significant challenges,[18] chiefly the very nature of the sector itself. Being informal, i.e., unregistered, it is a herculean task capturing their database for administration by the government. They exist without formal measures of control or regulatory oversight and, as a result, cannot be compelled to comply with formal legal provisions. Moreover, because these businesses are often run by people with limited formal education, tax education is seldom available to them, and resultantly, they are unaware of any obligations they may have.

The apathetic attitude of the informed to tax obligations is another critical factor. As many do not perceive direct benefits from the tax revenues, such as improved infrastructure or services, they do not see value in the registration for and payment for taxes. The prevalence of deep-seated distrust in government institutions contributes significantly to this situation. Within the informal sector, there exists a prevailing perception of corruption and inefficiency of tax authorities. This notion leads participants to believe that their tax payments may either be mishandled or diverted through corrupt practices.

Furthermore, the intricate and bureaucratic tax system, characterized by layers of taxation and cumbersome registration procedures, acts as a deterrent to compliance. The dispersed and fragmented nature of the informal sector, which comprises numerous small and unstable businesses, further complicates enforcement efforts by tax authorities.

These challenges, compounded by socio-economic obstacles such as poverty and economic instability, collectively foster an environment where tax evasion is perceived as a means of survival as opposed to a criminal offense.[19]

ENHANCING TAX COMPLIANCE WITHIN NIGERIA’S INFORMAL SECTOR

In order to enhance tax compliance within Nigeria’s informal sector, a comprehensive approach is essential. Firstly, it is imperative to prioritize formalizing the informal sector, as without a mechanism of ascertaining the data of businesses in the sector, it will be difficult to regulate them or administer tax obligations. Thus, formal registration procedures should be simplified, streamlined, and made affordable for these nanoenterprises. The constant technical issues faced during business registrations on the Corporate Affairs Commission portal need to be addressed with finality, and the government can also explore discounts for the registration of businesses with meager capital.

Another important aspect to be considered is taxpayer education. Collaboration between government agencies and non-governmental organizations is crucial for conducting extensive outreach programs, workshops, and information campaigns tailored specifically for the informal sector. These initiatives should primarily focus on educating operators about their tax responsibilities, the advantages of tax compliance, and the utilization of tax revenues to enhance public services and infrastructure. [20]

Furthermore, establishing trust between the government and the informal sector holds equal importance.[21] This can be achieved by ensuring transparency and accountability in the management of tax revenues. It is essential for the government to demonstrate that tax collections are visibly reinvested in community development projects, such as infrastructure, healthcare, and education.

Additionally engaging with representatives from the informal sector in policy formulation and providing incentives for compliance, such as access to credit facilities and business support services, can serve as additional motivating factors. Moreover, reinforcing enforcement mechanisms while offering amnesty programs for past non-compliance can encourage more operators to voluntarily enter the tax net. These combined measures have the potential to establish a more inclusive and effective tax system that bolsters Nigeria’s economic development.

CONCLUSION

The challenge of tax compliance within Nigeria’s informal sector is shaped by a multitude of complexities and obstacles, encompassing factors such as an apathetic attitude to formalization, limited awareness and education, trust deficiencies in governmental institutions, and the intricate nature of the tax framework. Despite the substantial economic impact of the informal sector, its low adherence to tax regulations leads to noteworthy revenue deficits for the government, hampering the nation’s economic progress. Concerted efforts are thus needed to remold the informal sector, nurturing a more resilient, transparent, and equitable tax system in Nigeria.

SNIPPET

In Nigeria, tax compliance contributes to fiscal stability by reducing reliance on external borrowing and volatile revenue streams, such as income from natural resources. It empowers the government to prudently manage public finances, ensuring that expenditures are in line with revenues, thereby mitigating the risk of substantial budget deficits and excessive public debt levels.

KEYWORDS

Tax compliance, informal sector, challenges of tax enforcement in the Nigerian informal sector.

AUTHOR: Oyetola Muyiwa Atoyebi, SAN FCIArb. (U.K)

Mr. Oyetola Muyiwa Atoyebi, SAN, is the Managing Partner of O. M. Atoyebi, S.A.N. & Partners (OMAPLEX Law Firm). Mr. Atoyebi has expertise in and vast knowledge of Tax Law and Practice, and this has seen him advise and represent his vast clientele in a myriad of high-level transactions.  He holds the honour of being the youngest lawyer in Nigeria’s history to be conferred with the rank of Senior Advocate of Nigeria.

He can be reached at atoyebi@omaplex.com.ng  

CONTRIBUTOR: Prince Igho

Prince is a member of the Dispute Resolution Team at OMAPLEX Law Firm. He also holds commendable legal expertise in Tax Law and Practice.

He can be reached at Prince.igho@omaplex.com.ng

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[1] Emina, J. “Reducing the tax compliance gap by improving Tax Administration.” Interdisciplinary Management Research XIV (2021) is available at https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID3961055_code2020895.pdf?abstractid=3961055&mirid=1 accessed July 19, 2024

[2] Lignier, P. “Measuring the managerial benefits of tax compliance: A fresh approach.” In Australian Tax Forum, vol. 24, no. 2, pp. 117-150. 2009.

[3] Herbert, Wilson E., Innocent Augustine Nwarogu, and Caritas Chimere Nwabueze. “Tax reforms and Nigeria’s economic stability.” International Journal of Applied Economics, Finance and Accounting 3, no. 2 (2018): 74-87 available at https://www.researchgate.net/profile/Wilson-Herbert/publication/330244429_Tax_Reforms_and_Nigeria’s_Economic_Stability/links/5c35bb82299bf12be3b919f0/Tax-Reforms-and-Nigerias-Economic-Stability.pdf accessed 19th July, 2024.

[4] Adeniyi, Oluwatosin, Terver Theophilus Kumeka, and Oladimeji Alagbada. “Natural resource dependence and tax effort in sub-Saharan Africa.” Journal of Economic Development 47, no. 1 (2022): 29-64. Available at https://jed.cau.ac.kr/archives/47-1/47-1-2.pdf accessed July 19, 2024.

[5] Uko, F. O., et al. “An evaluation of the contribution of the informal sector in employment and income generation in Nigeria: Thematic approach.” Social Sciences and Management International Journal 1, no. 2 (2020): 65-97 available at https://brainspecresearch.com/publish/journal/1695720806_Journal%20of%20Management%20Science%20Vol.1%20Issue2,%20Setb.pdf#page=73 accessed July 19, 2024.

[6] Cap C21, LFN 2004

[7] Cap P8 LFN 2004

[8] Cap V1 LFN 2004.

[9] Cap S8 LFN 2004.

[10] Okafor, R. G. “Tax revenue generation and Nigerian economic development.” European journal of business and management 4, no. 19 (2012): 49-56 available at https://core.ac.uk/download/pdf/234624448.pdf accessed July, 20, 2024.

[11] Ibid.

[12] Owoeye, A. B. “Rural Micro-Entrepreneurs’ Experiences Coping with the Pandemic in Nigeria.” International Journal of Advanced Multidisciplinary Research and Studies 2024; 4(3):330-337 available at https://www.multiresearchjournal.com/admin/uploads/archives/archive-1716452123.pdf accessed July 20, 2024.

[13] Uko, F. O., et al op cit. fn. 5

[14] Owoeye, A. B. op cit. fn. 12.

[15] Udoh, Joseph E. “Taxing the informal economy in Nigeria: Issues, challenges and opportunities.” International Journal of Business and Social Science 6, no. 10 (2015): 160-175 available at https://www.academia.edu/download/106604378/14.pdf accessed July 19, 2024.

[16] Ibid.

[17] For a detailed analysis of these arguments see Udoh, Joseph E, op cit. fn. 14.

[18] Adekoya, A. et. al. “Informal sector and tax compliance in Nigeria-challenges and opportunities.” International Journal of Emerging Trends in Social Sciences 8, no. 2 (2020): 57-69 https://www.researchgate.net/profile/Adekoya-Augustine/publication/342451989_Informal_Sector_and_Tax_Compliance_in_Nigeria-Challenges_and_Opportunities/links/5ef4dee0a6fdcc4ca430f1a9/Informal-Sector-and-Tax-Compliance-in-Nigeria-Challenges-and-Opportunities.pdf accessed on July 20, 2024.

[19] See Osemeke, Nobert, David Nzekwu, and Robert O. Okere. “The challenges affecting tax collection in Nigerian informal economy: Case study of Anambra State.” Journal of Accounting and Taxation 12, no. 2 (2020): 61-74. Available at http://researchonline.ljmu.ac.uk/id/eprint/13097/ accessed on July 20, 2024.

[20] Akeju, K. F. “Informal sector and tax compliance: The role of associational membership in South West, Nigeria.” International Journal of Applied Economics, Finance and Accounting 3, no. 1 (2018): 1-9 available at https://www.academia.edu/download/98353805/16.pdf accessed on July 20, 2024.

[21]Adekoya, A. et al. “Trust relationship and tax compliance in developing countries-Informal sector perspectives.” International Journal of Economics, Commerce and Management 10, no. 6 (2022): 309-332 available at  https://www.academia.edu/download/88706490/Trust_Relationship_and_Tax_Compliance_in_developing_Countries_Informal_Sector_Perspectives.pdf accessed on July 20, 2024.