Tax Incentives for Venture Capitals and Start-Ups in Nigeria

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By Olubunmi Ogunkunle, a specialist in venture capital and private capital advisory.

The grant of tax incentives is one of the most effective policy interventions employed by governments all over the world seeking to stimulate growth of the venture capital and start-up ecosystem. Such tax incentives typically range from tax incentives for persons who invest in the shares of a start-up to the tax incentives for the start-up itself. Nigeria has passed laws allowing certain exemptions from tax for venture capital companies and projects since 1993. Although not very popular, the Venture Capital (Incentives) Act (Act) is Nigeria’s primary legislation for the grant of tax incentives to venture capital companies and projects. Depending on how a start-up company is structured, start-ups and venture capitalists in Nigeria can immensely benefit from the incentives provided for under the Act

On the buy-side, tax considerations are usually a key consideration for private equity and venture capital investors. Mostly, because tax liabilities ultimately diminish the carry, which itself is really the primary motivation of a private equity firm/venture capitalist. What experience has shown is that, it is increasingly important for start-ups or companies seeking to raise venture or private equity financing to take tax issues more seriously and with no less concern than a venture capitalist would.

The objective of this alert is to set out in summary fashion, the incentives available under the Act, the eligibility and other regulatory requirements for venture capital companies /projects and also ongoing initiatives for reforms. Ultimately, we expect that companies who intend to take advantage of the incentives under this Act will be able to set up proper structures to accomplish that objective as early as possible, potentially enhancing valuation in the event of an investment decision. For venture capital /private equity investors, the intention is to ensure that they ask the right questions surrounding the tax liabilities of a potential buy.

Structure of the Act

The structure adopted by the Act is to restrict the companies that are eligible for the incentives provided under the Act to companies that meet certain threshold requirements. The Act makes provision for two separate qualifying entities, namely, a Venture Capital Company (VCC) and a Venture Project Company (VPC). Although these qualifying entities are defined in terms of the same objectives, the structure envisaged under the Act is for a VCC to invest in or take up equity in a VCP. In a typical venture capital financing scenario, the VCP will be the fund manager, whilst the VPC will typically be the start-up. The incentives under the Act are designed for both the investor and the start-up. The Act charges the Federal Inland Revenue Service (FIRS) with the responsibility of determining which company qualifies as Venture Capital Company or as a Venture Project Company under the Act for the purpose of qualifying for the incentive.

Summary of Incentives

The Act makes provisions for a number of incentives ranging from income tax to capital gains tax

  • Withholding Tax Incentives: This is a type of advance payment of income tax. Withholding taxes typically tracks the income earned by investors in a business. What the Act does is to reduce the amount payable as Withholding Tax on dividends payable to an investor in a VPC. The Act provides a 50% reduction in WHT payable by participants in a VPC over a 5-year period.

 

  • Capital Allowance Incentives: This is a type of deduction that companies can claim for the wear and tear of fixed assets (i.e. plant and machinery) used in trade or business. The Capital Allowance allowed under the Act is as follows:
  • For the first year deduct 30%
  • For the second year deduct 30%
  • For the third year deduct 20%
  • For the fourth year deduct 10%
  • For the fifth year deduct 10%

 

  • Capital Gains Incentives[1]: This is also a reduction in the amount payable as capital gains tax. Capital gains tax typically track the amount a tax on profit you make when you dispose an asset that has increased in value.
  • For the disposal of capital within five years of investment, 100 per cent
  • For the disposal of capital between six and ten of investment, 75 per cent
  • For the disposal of capital between eleven and fifteen years of investment, 25%
  • For the disposal of capital after fifteen years of investment, 0 percent

 

  • Pioneer Status Incentives: This is a type of exemption from company income tax for a period of 3 years and extendable for an additional total period of 2 years.

 

  • Export Incentives: This is a type on incentive available for start-ups engaged in export activities.Start-ups that qualify under the Act will be able to access export incentives like financial assistance from the Export Development Fund and also access the export expansion grant and the export adjustment scheme fund.

Eligibility Requirement for Incentives under the Act

(a)   The start-up must qualify as a Venture Project Company under the Act: A VPC is defined as one established for the following purposes (a) The acceleration of industrialization by nurturing innovative ideas, projects and techniques to fruition (b) The commercialization of research findings with high potentials for far-reaching forward or backward linkages (c) The promotion of self-reliance through the establishment of resource-based and strategic industries through the provision of risk guarantee and insurance (d) The encouragement of indigenous process and technologies (e) The promotion of the growth of small and medium scale enterprises with emphasis on local raw materials development and utilization. If your start-up is one established for one of the purposes you would have qualified in part for the incentives provided for under the Act. A VCC must also be established for the foregoing purposes to be entitled to the incentives provided for under the Act.

(b)   Share Capital Threshold: The VCC must have at least 25% of the total capital required for the project.

(c)   FIRS Certification: The Federal Inland Revenue Service is the agency responsible for administering the incentives under the Act and generally has the powers to determine whether a company is capable of fulfilling one or more of the incentives. Companies who intend to take advantage of the incentives under the Act must obtain the accreditation of the Federal Inland Revenue Service.

Conclusion

The incentives provided for under the Act are in addition to the existing incentive available to business operating in Nigeria. Clearly, Tax incentive considerations must form part of the investment and business strategy for both venture capitalists and start-ups especially at the point of setting up a venture capital fund/company or a start-up. It is also possible to re-structure existing venture capital funds/companies and start-ups in such a way as to enable them to be able to take advantage of the incentives under the Act.

Read: How To Launch Your Startup In Africa With Little Capital

[1]There is a doubt that CGT incentives are useful in view of Section 30 of the Capital Gains Act which exempts gains accruing to a person from a disposal of stocks and shares is applicable

[2] A venture project means a project in the commercialization of an innovative idea and process and includes capital expenditure in the development of a local resource base

[3] A sworn undertaken by promoters of venture capital funds is a registration requirement under the Rules and Regulations made pursuant to the Investment and Securities Act

 

 

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