LIRS Issues Public Notice on “Taxation of Employee Loans”

As government remains resolute on the achievement of its Economic Recovery and Growth Plan (ERGP) through tax drive, tax authorities have increasingly begun to identify areas of ambiguity in the tax laws and those areas where there are loopholes. Just on the heel of the release of Public Notices cautioning taxpayers on the abuse of the Voluntary Pension Contribution Scheme last month, the Lagos State Internal Revenue Service (LIRS) has issued more public notices on:

  1. Taxation of Employee Loan”, and 
  2. “Allowable Interest Deduction on Owner Occupied Residential Houses”(published in today’s papers)

The Public Notice on Taxation of Employee Loan” seeks to address a loophole in the Personal Income Tax Act (PITA) by providing guidance on the tax implication of employee loans.

According to the Notice, “Employee Loans are loans given by an employer to an employee for specific reasons, with the expectation that such loan will be repaid in full to the employer through a pre-agreed deduction from the employee’s net salary, with or without any interest”. 

In most circumstances, employee loans are not granted at arm’s length, that is, the applicable interest on loans (as applies for normal third party loans) is usually absent or do not reflect current market conditions [i.e. lower than the prevailing third party or bank lending rate/ Monetary Policy Rate(MPR)]. This latest LIRS Public Notice calls the attention of the general public to the fact that such benefit-in-kind (that is, the interest cost thus waived for the employee) is a taxable income in the hands of the employee. 

The assessment of such benefit to tax is in line with the provision of Section 3 (1)(b) of PITA which imposes tax on “any salary, wage, fee, allowance or other gain or profit from employment including compensations, bonuses, premiums, benefits or other perquisitesallowed, given or granted by any person to any temporary or permanent employee”. In fact, following the International Financial Reporting Standards (IFRS) adoption in Nigeria, we had always advised our clients to fair value the benefit-in-kind accruing from low interest or interest free loans to employees and include the fair values derived as part of staff cost and taxable benefits in the hands of the employees. 

LIRS now also posits that this benefit-in-kind is to be included in the gross emolument of the employee and taxed accordingly at the applicable tax rate on the tax table. 

The Notice goes ahead to provide guidance on compliance procedures as follows:

  1. Computation: The benefit arising from employee loan is to be computed as the difference between the rate on such employee loan and the adjusted MPR. The adjusted MPR is the prevailing MPR (which is currently 14%) minus 3%. An employee loan granted at the rate of 5%, for example, has an accruing benefit of 6% [(14% – 3%) – 5%] on the amount of the loan granted.
  2. Assessment: The amount of benefit derived is assessed to tax under PAYE, that is, by applying the Personal Income Tax Table.
  3. Deduction and Remittance: It is the responsibility of employers to deduct the appropriate amount of tax on benefit accruing from employee loans and remit same to the relevant tax authority(ies). The statutory timing of the tax deduction on the benefit will be determined by the pre-agreed (with the employee) deduction terms of the loan, either on a monthly or annual basis. i.e. where the loans are repayable on a monthly basis, the tax on the benefit-in-kind will also be payable on a monthly basis, the same goes for annual loan repayments.
  4. Filing: Employers are required to file a schedule showing details of their employee loans and the payment terms, alongside employers’ annual returns (Form H1) latest by 31 January every year.
  5. Applicability: The guidance provided in the Notice apply strictly to the loans a company extends to its employees, directors, and significant shareholders. Even upon termination of relationship with a company, the provision will continue to apply as long as the loan has not been settled in full by the employee, director, or shareholder.
  6. No taxable benefit will arise on employee loans granted at an interest rate above the adjusted MPR or at the commercial rate. 

We will discuss LIRS’ position on the “Allowable Interest Deduction on Owner occupied residential Houses”in details in our subsequent newsletter.