A few months ago, the Nigerian government introduced plans to implement a 50% windfall tax targeting banks’ foreign exchange transaction profits for the period from June 2023 to December 2023.
This proposal was embedded in the revised 2023 Finance Bill, submitted to the National Assembly on July 17 and swiftly approved.
Every year (in the last few years at least), the government has a finance bill sent alongside its budget.
However, lawmakers increased the tax rate to 70% and extended its duration to 2025, providing banks with the option to settle the tax in installments.
This development follows an earlier directive from the Central Bank of Nigeria (CBN), which had barred banks from paying dividends from their foreign currency gains.
What is a windfall tax?
A windfall tax is a one-off tax imposed on a business or sector following economic conditions which result in a large or unexpected profit.
Many countries have, at various points, imposed windfall taxes on different industries.
- The UK has a notable history with windfall taxes. In 1997, a 23% windfall tax was levied on profits from companies privatized in the 1970s, in the late 1990s, driven by the belief that those assets were undervalued at the time of sale.
- In May 2022, Britain introduced an “Energy Profits Levy” on oil companies following record profits fueled by higher crude demand and surging prices post-COVID reopening and the Russia-Ukraine conflict. The rate was hiked from 25% to 35% in 2023.
Although the tax was originally set to expire in March 2029, there is a strong possibility it could be extended, with proposals suggesting a further rate increase to 38%.
- Germany followed suit in March 2023, introducing a windfall tax on energy companies, while Italy imposed a one-time windfall tax on banks the same year.
- The Czech Republic applied a windfall tax on companies in the energy and banking space in November 2023.
- Spain imposed a windfall tax on companies in the energy space, first in 2021 and then enacted a new one in 2022. The new tax was a 1.2% tax on domestic power utilities with an annual turnover exceeding €1 billion in 2019. The proceeds were used to alleviate the cost-of-living crisis for the vulnerable.
India in July 2022 introduced a windfall tax on crude oil production and the export of gasoline, diesel and aviation fuel exported abroad in 2022. The rates are revised every two weeks.
Also, in 2008, the Zambian government imposed a 25% windfall tax on companies that mined copper, and the proceeds were used to build infrastructure and provide health services.
The Democratic Republic of Congo did the same in 2018, when it revised its mining code and introduced a 50% tax on windfall profit. Windfall profits were defined as profits realized when the price of the mineral resource is more than 25% higher than envisaged.
The Nigerian Case
For Nigerian banks, the devaluation of the Naira following the unification of the foreign exchange markets has significantly increased the value of the dollar-denominated assets in their Balance Sheets in local currency terms. If a bank decides to sell, or there is a paydown on such assets, it will result in a substantial profit in Naira. However, it is important to note that not all assets have been sold or paid down, as such some of the expected profits remain unrealized.
Since June 14, 2023, following the unification of all exchange rate platforms, the exchange rate has surged from approximately N471.67/$ on June 13, 2023, prior to the unification to N1625.88/$ on the NAFEM exchange as of Wednesday, September 4.
The Current Economic Realities
The Nigerian government is facing significant financial challenges. According to the 2023 fiscal accounts report from the Accountant General of the Federation, the government generated N5.9 trillion in revenue but spent N19.9 trillion, resulting in a staggering deficit of 225%. Essentially, the government is spending nearly three times what it earns.
Additionally, it has yet to implement the proposed N70,000 minimum wage, which, given the current economic conditions, would likely need to increase to reflect present realities.
Another pressing issue is the petrol subsidy. Despite higher prices, the gap between the current pump price of just under N1,000 and the price of diesel, trading at over N1,200, remains significant.
The government is in a precarious position. Raising petrol prices further could trigger increased inflation, unrest through protests etc., but maintaining the current price level continues to strain its already fragile finances.
How Much is Likely to be Raised?
Between FY 2023 (the 12 months ending December 2023) and Q1 2024, Nigerian banks have reported over N3.3 trillion in foreign exchange gains.
Estimates of how much revenue can be generated from the windfall tax vary, given that not all gains have been realized—many remain as unrealized profits tied to unsold or unpaid assets.
In the coming months, more clarity is expected regarding the actual figures and the potential tax revenue as banks continue to manage their asset positions monthly based on their transaction dynamics.It is important to note that windfall taxes tend to have a short lifespan. However, there could be the need for an extension, assuming there is continued depreciation of the exchange rate over the coming years.
After Taxing,What Next?
Beyond generating revenue, a more critical discussion is needed on how these funds will be utilized. This is important as the Federal Government, through their submission, have highlighted some of their key areasof attention.
- In the UK, proceeds from the windfall tax were directed toward providing financial relief to households impacted by the post-COVID cost-of-living crisis.
- In Italy, the revenue was used to assist mortgage holders, lower taxes, and ease consumer prices in the energy sector. The same was done by the Czech Republic.
- India, the proceeds are used to finance government expenditure and cut down the cost of essential items for the poor and vulnerable.
In a letter to the Senate, the President explained that funds from this tax would be channeled toward capital infrastructure projects, education, healthcare access, and public welfare initiatives. However, there might be a need for more specific details, including cost estimates, project timelines, and the selection criteria for these initiatives. What impact will these projects have on development, and how will they address the country’s pressing needs?
