by by Prof. M.T. AbdulRazaq, Professor of Taxation, Faculty of Law, Lagos State University
Introduction
The problems which arise when a document, or an oral agreement, contains words in relation to some future money payment, which require that payment is to be made “free of tax,” forms the basis of this paper.[1] The first problem is to construe the words which have been used and to ascertain exactly what they mean. The second problem is the extent to which the words, according to their proper construction, are affected by various statutory provisions. Having thus ascertained the legal effect of the words in question, the final problem is to discover the tax consequences which ensue both to the payer and the recipient of the money. When words such as “free of tax” or “without any deduction” are used(,) two questions of construction may arise.
The first is whether or the words used actually do refer to tax at all; clear words are necessary to have any effect for tax purposes; “without any deduction,” by themselves, will not usually be taken as referring to tax. Assuming that the words refer to tax, then the problem arises, when the recipient is an individual, whether the words refer to personal income tax. Both of these problems require consideration. The first problem of construction usually arises in relation to annuities payable under the terms of a will or codicil.[2] In such cases, it is well established that an annuity is not payable free of tax unless there is a clear direction to that effect.[3] The fact that it is payable out of income which has already borne tax at source does not justify the annuity being paid without deduction[4] ; the trustees or personal representatives are under a duty to the other beneficiaries to deduct tax.[5] Words such as a “clear annuity” [6] or an annuity “free of all duties” [7] or “free from legacy duty and other deductions” [8] or “free from all deductions and abatements whatsoever” [9] or a “net income”[10] have all been held to have no effect so far as income tax is concerned. In Re Wells, where the words used were “free of all deductions,”
Simonds J. said: There is no case among all those which have been cited to me where an annuity had been stated to be free of income tax unless there was clearly expressed on the face of the will and intention of the testator that, when he referred to freedom from deductions, he was including income tax. [11]
General words can only relate to tax if they are qualified in some way to show an intention that the tax is not to be borne by the annuitant.[12] This intention may be gathered from the other parts of the relevant document [13]; if the words used include “taxes” this will generally indicate that the annuity is to be free of income tax.[14] Where the words free of all deductions whatsoever” could, in their context, only apply to income tax, they were held to imply a sufficient intention[15] but this decision is of doubtful authority.[16]
Where a testator directed that an annuity should be paid as in his lifetime (when he had paid it without deduction of tax) and there were other words indicating an intention that it should be free of tax, this construction was adopted.17 Even if “free of tax” is used, the question may arise whether Nigerian tax is intended if the testator is domiciled abroad.[18]
The Statutory Provisions
Where the free of tax types of clause occurs, the sum payable is usually one which is subjected to deduction of tax at source under the general law of income tax, also, the statutory provisions as to deduction may be mandatory as in the following provisions:
Section 1 PITA states that: “There is hereby imposed a tax, on the income”
(a) of individuals, communities and families and
(b) arising to any trustee or executor under any settlement, trust or estate, which shall be determined under and be subject to all the provisions of this Act.
Also, Section 2 (1)(a) of PITA states the persons from whom tax is to be collected as: “every individual other than persons covered under paragraph (b) of this subsection or corporation sole or body of individuals deemed to be resident for that year in the relevant State under the provisions of this Act” Furthermore, Section 3(1)
(a) and (b) of PITA in defining the limits of income chargeable provides that: “Tax shall be payable for each year of assessment on the aggregate amounts each of which is the income of every taxable person, for the year, from a source inside or outside Nigeria, including, without restricting the generality of the foregoing:
(a) gain or profit from any trade, business, profession or vocation for whatever period of time such trade, business, profession or vocation may have been carried out or exercised;
(b) Any salary, wage, fee, allowance or gain or profit from employment including compensation, bonuses, premiums, benefits or other perquisites allowed, given or granted by any person to any temporary or permanent employee other than so much of any sums as or expenses incurred by him in the performance of his duties, and from which it is not intended that the employee should make any profit or gain.
The clause “free of Tax” would be ineffective, also, where it is not under section 19 of PITA as an income exempt as specified in the Third Schedule to the Act. Neither would the clause be effective if it is not within the deductions allowed under section 20 (1) (a-d) PITA which provides that:
a) A sum payable by way of interest on money borrowed and employed as capital in
acquiring the income;
b) Interest on loan for developing an owner-occupier house;
c) Rent for that period, and premiums on liability for which was incurred during that period, payable in respect of land and building occupied for the purpose of acquiring the income; and
d) Expenses for repairs of premises, plant, machinery or fixtures employed in
acquiring the income, or for the renewal, repair, or alteration of any implement,
utensil or article so employed;”
In addition, the income must satisfy the test of “wholly, exclusively, necessarily and reasonably incurred”. The test is as follows:
(a)Wholly and Exclusively Incurred:
The word “wholly” refers to the quantum of the money expended while the word “exclusively” refers to the motive or object accompanying it. The question where the expenditure was incurred exclusively for business purposes is one of fact and purpose. However, if the sole purpose is business promotion the expenditure is not disqualified because the nature of the activity necessarily involves some other result or the attainment or furtherance of some other objective since the latter is necessarily inherent in the act.
(b) Necessarily Obliged To Incur
The test of necessity is objective[19] and the fact that the trader or employer, requires the particular expenditure is not decisive[20] . Hence, the test is not whether the trader or employer imposes the expense but whether the business or duties do, in the sense that irrespective of what the trader may require or what the employer may prescribe, the business or duties cannot be performed without incurring the particular outlay.[21]
(c) Reasonably Incurred
In the context of the statutory provision in section 20 PITA 2004 the meaning of “reasonably incurred” is unclear as its usage here tends to connote the existence of a situation where expenses could be incurred “wholly and exclusively”, and “necessarily” without it being “reasonably” incurred.
Taken on its own this would appear to be the real test of deductibility of expenses in Nigeria in the sense that once it is shown that the expenses were reasonably incurred for the purpose of ascertaining the income in the opinion of the relevant tax authority other requirements are really subsidiary, so that, on the other hand, where there is a claim that an expense has been incurred in accordance with the rules of deductibility and the tax authority is of the opinion that it was not reasonably incurred it then becomes irrelevant that it was incurred, wholly and exclusively, and necessarily. The test of deductibility in the real sense in Nigeria would appear to depend on the discretion of the relevant tax authority which is expected to be exercised “reasonably”.
The clause “free of tax” would certainly be effective if the taxation falls within section 33 PITA as amended which makes provisions for a consolidated relief allowance.
Agreements not to Deduct Tax
Agreements not to deduct tax is void by the provision of section 73(1) PITA which states: “Income tax assessable on a person whether or not an assessment has been made, shall, if the relevant tax authority so direct, be recoverable from any payment made by any person to that person.” and section 73(5) provides that “A person required under any provision of the Act to make a deduction from payments made to a person shall account to the relevant tax authority in such a manner as the relevant tax authority may prescribe for the deduction so made”
Also Section 73(6) states that: “The Minister on the advice of the Board may, from time to time, make regulations for carrying out the provisions of this section.” The directions of the relevant tax authority or the advice of the Board to the Minister must be based on reasonable grounds and in any case the relevant tax authority must make a direction or the Joint Tax Board ( JTB) must advise the Minister charged with responsibility for taxation if the income is specifically provided for by the statute.
The PITA 2004 has specifically provided for the deduction of tax in the following situations:
(a) Rent
Under Section 69 (1) “where a rent becomes due or payable to a person, the payer of the rent shall, at the date when the rent is paid or credited whichever first occurs shall deduct therefrom tax at the rate prescribed in subsection (2) of this section and shall forthwith pay over to the relevant tax authority the amount so deducted.”
(b) Interest or Royalty:
Section 70 (1) provides that “where a payment, such as interest or royalty, becomes due or payable to a person, the payer at the date when the payment is made or credited whichever first occurs, there deduct therefrom tax at the rate prescribed in subsection (21) and shall forthwith pay over to the relevant tax authority the amount so deducted.”
(c) Director’s Fees
Section 72 (1) states that “where any payment of director’s fees becomes due from or payable by a Nigerian company to a person, the payer at the date when the payment is made or credited whichever comes first occurs, deduct thereof tax at the rate prescribed under subsection (2) of this section and shall forthwith pay over to the relevant tax authority the amount so deducted.”
(d) Tax Clearance Certificate
Under section 85 whenever the relevant tax authority is of opinion that tax assessed on the income of a person for the three years immediately preceding the current year of assessment has been fully paid or that no tax is due on the income or that the person is not liable to tax for any of those three years, it shall issue a tax clearance certificate to the person within two weeks of demand for the certificate by that person or give reason for the denial, so however that the payment of current year tax shall not be made a condition for the issuance of the certificate unless the applicant is leaving the country finally.
A tax clearance certificate shall disclose in respect of the last three years of assessments:
a) Chargeable income;
b) Tax payable
c) Tax paid; and
d) Tax outstanding or alternatively a statement to the effect that no tax is due.
These taxes must be deducted at source under sections 69,70,71,72 of PITA 2004 and Section 74 PITA 2004 provides a criminal penalty for failure to deduct tax.
It was held in I.R.C. v. Ferguson[22] that an agreement “free of tax” meant that the payer was bound to pay the recipient such a sum as after deduction of income tax at the basic rate would leave the figure specified in the agreement.
Occasionally a problem arises whether a payment arises under a document to which this provision does apply or under one to which it does not. Thus when a dispute as to the validity of a will was compromised by an annuitant agreeing to take smaller annuity than the will gave him, it was held that the direction in the will not to deduct tax remained effective so long as the agreement did not provide further security for the annuity.
The Tax Consequences
The final problem now has to be considered, namely, the tax consequences to the payer and recipient of a valid “free of tax” clause. Where the clause uses words such as “free of tax” or a formula which depends on the tax liability of the recipient[23] then what is known as the rule in Re Pettit is brought into play.
The Rule in Re Petit
Where the clause is valid and, on its true construction, implies that the payment is to be free of the tax which the recipient has to bear upon it[24], it is now well established that the payer is liable to pay the stipulated sum in full and that this payment is treated for tax purposes as if it had been a gross sum from which tax at basic rates has been deducted.[25]
The recipient, however, is under a duty[26] to reclaim from the Revenue the tax to which he is entitled in respect of the income in question by virtue of his personal relief or allowances[27] and to account and pay the tax so recovered to the payer, under the rule in Re Pettit[28]
This rule is based on the English Law of Trusts. When it applies, the liability to repay the tax recovered does not reduce the total income of the recipient, nor his right to the reliefs [29]; there is no decision as to its effect on the original payer, but the practice is to treat him as entitled to additional income equivalent to the grossed-up amount of the sum he is repaid. It has been held in Total Nigeria PLC v Akinpelu decided by the Court of Appeal that the rule in Re Pettit would apply in Nigeria to a provision in a contract requiring payment to be made free of tax.[30]
This, however, would seem not to be in agreement with the Supreme Court of Nigeria in the case of Marina Nominees v. Federal Board of Inland Revenue where it was held that an incorporated company is a separate legal entity and must fulfill its tax liabilities on its own and not through an agency relationship.
When the clause provides for payment free of tax up to a stated rate of tax and the rate is higher, the recipient must account for a proportion of the tax recovered in respect of his reliefs.[31]
When an estate is insufficient to meet annuities given by will [32] and an abated capital sum is payable[33] the effect of the rule in Re Pettit, where it applies, is taken into account in calculating the capital sum.[34]
The effect and the consequences of the above rule and the free of tax clauses in agreements is still an open question in Nigeria.
Footnotes
1 Whiteman &Wheatcroft (1976) Income Tax (Sweet & Maxwell) pp. 160-166
2 See Harvey, B.W. (1968) The Law and Practice of Nigerian Wills, Probate and Succession (Sweet
and Maxwell) p. 56
3See Re Skinner (1942) 1 ch. 82 (where Morton J. explained the rules applicable to these cases);
Re Sharp (1906) 1 ch.793
4Re. Skinner (supra): Re Cain’s Settlement (1919) 2 ch. 364
5Re Sharp (1906) 1ch. 793
6 Re Loveless (1918) 2ch. 1
7Re Saillard (1917) 2 ch. 401
8Sadler v. Rickards (1858) 4.K & J 302
9Gleadow v. Leatham(1882) 22 Ch. D. 269. See also Well v. Wall (1817) 15 Sim. 513 (“ clear of all
taxes and deductions”: held subject to property tax): Lethbridge v. Thurlow (18510 15 Beav. 334
(“clear of legacy duty and every other deduction whatsoever”; same result); and Abadam v. Abadam
(1884) 33 Beav 475 (“ payable without any deduction whatsoever”: held subject to income tax)
10Re Wright (1952) 2 All E.R. 698.
11 (1910) ch. 411, at p. 413, followed in Re Skinner (supra) where the words were “such a sum … as will
bring his income up to £1,000 per annum.”
12Festing v. Taylor (1863) 32 L.J.Q.B. 41 Lovat v, Leeds(1862) 31 L.J., Ch. 503; Re Bannerman
(1882) 21 Ch.D 106; Re Williams (1936) 1 Ch.509; Re Hirst (1941) 3 All E.R. 466.
13Turner v. Mullineux (1861) 1 J.&H. 334; or from a will where the clause in question is in a codicil;
Re Buckle(1894) 1 Ch.286
14 Re Shrewsbury Estate Acts (1924) 1Ch.315 where the words were “clear of all deductions
whatsoever whether for taxes or otherwise” of Wall v. Wall (supra) see also Ferguson v. I.R.C. (1970)
A.C.442
15Re Cowlishaw 1939) 1 Ch. 654
16 See Re Wells (1940) Ch. 411 (supra): Re Hooper (1944) Ch.171
17Re Balley (1951) Ch. 558
18 See Havelock v. Grant (1946) 27 T.C. 363 See also Re Bishop Bertram Lasbrey 5 WACA 142
19Ricketts v. Colquhoun (19260, AC 1 at 10. See Abdulrazaq, M.T. (1989) Deductibility of Legal and
Accounting Expenses to Contest Tax Liabilities in Nigeria, Gravitas Review of Business & Property law
Ibi 2.No.12 p.69.
20Roskams v. Bennett (19500 32 TC 129; Owen v. Burden (1972) 1 All ER 655; Maclean v. Trembath
(1956) 36 TC 653 at 666
21Brown v. Bullock (1961) 40 TC 1 at 10; Blackwell v. Mills (1945) 2 All ER 356 at 358; Lomax v.
Newton (1953) 2 All ER 805; Ellwood v. Utitz (1965) 42 TC 482 22 (1969) 46 T.C.1
23Re Maclennan(1939) Ch. 750 24 Where a tax-free annuity is qualified by a provision depending on the basic rate of tax and the
qualification comes into operations, the rule in Re Pettit does not apply; Re Batley, (No.2)
(1952) Ch. 781.
25I.R.C. Cook (1946) A.C. 1: 26 T.C. 480
26Re Kingcome (1936) 1 Ch. 566. A married woman is bound to claim separate assessment so as to
obtain the relief herself: Re Batley (No.2) at first instance (1952) W.N.225; in the C.A. (supra)
the point was not decided as it was held that the Re Pettit rule did not apply, but, if it had, Jenkins
L.J. (at p.790) agreed on this point.
27 For personal reliefs generally, see Section 33 PITA 2004 as amended.
28 (1922) 2 Ch. 765, Re Eves (1939) ch. 969; Re Williams (1945) Ch. 320
29 See I.R.C. v. Cooker (Supra) For total income see Section 36 PITA 2004. It also appears from Re:
Cameron, Kingsley v. IRC (1996) 42 T.C.539 that a husband receiving repayment of tax receivable by him because his wife’s income is deemed to be his does so as trustee for his wife and the “deeming” is for purposes of collection only and extends only to the income eventually found liable to tax.
30See Total Nigeria PLC v.Akinpelu (1960-2010)1 NTLR 214.
31Re Bates (1946) 1 Ch.83; Re Arno (1947) Ch.198 See Section 30 PITA 2004.
32 See also generally Harvey B. W. (1968) op. cit.
33 Under the rule in Re Cottrell (1910) 1 Ch. 402
34Re Twiss (1941) ch. 141; Re Dunsille (1946) N.I. 90 and Re Rothermere(1945) Ch. 72
