Tax
Tax Incentive and Private Equity Growth: The Nigerian Outlook
Stransact
Private equity is ownership or interest in entities that aren’t publicly listed or traded. A source of investment capital, private equity comes from firms that buy stakes in private companies or take control of public companies with plans to take them private and delist them from stock exchanges.
The definition of Private Equity (PE) on a well-explained background is based on two aspects, each related to the two-man characteristics of the PE fundamentals:
• PE is a source of financing, It is an alternative to other sources of liquidity, (such as a loan or an initial public offering (IPO)) for the company receiving the financing.
• PE is an investment made by a financial institution; Private Equity Investor (PEI) in the equity of a non-listed company (i.e. not a public company).
Venture Capital is a very specific case of PE. It is the investment in the very early stages of a company’s life.
Tax Incentive and Private Equity Growth
The expansion of private equity is fueled by economic policies that include tax incentives. It is critical to comprehend the effects of tax incentives in Nigeria, where private equity firms are fast emerging as significant economic actors. In sequence, the Nigeria Startup Act, 2022 was passed by the National Assembly and signed into law by the president on October 19, 2022. The legislation establishes the institutional and legal foundation for the growth and operation of startups and private businesses in Nigeria.
Furthermore, the aforementioned legislation included particular clauses designed to address recognized legal, regulatory, tax, and administrative bottlenecks that have impeded the functioning of venture-backed companies (VBC) in Nigeria. The law also provides certain tax incentives which include:
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Pioneer Status Incentive
Labelled Startups operating in eligible industries under the Pioneer Status Incentives (‘PSI’) Scheme may apply through the Secretariat to the Nigerian Investment Promotion Commission (‘NIPC’) for grant of tax reliefs and incentives under the PSI. If granted, this would entitle the Labelled Startup to a tax holiday for an initial period of three years, which may be extended for an additional two years.
The effective date for the PSI reliefs will be the date of issuance of the startup label.
A labelled startup shall enjoy full deduction of any expenses on research and development which are wholly incurred in Nigeria and the restrictions placed by the Companies Income Tax Act (CITA) shall not apply to a labelled startup.
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Exemption from Contribution to ITF
Section 25(5) of the act exempts a labelled startup from contributions to ITF in respect of in-house training provided to its employees for the duration of the startup label.
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Other Stakeholder-related Incentives
Angel investors, Private Equity funds, accelerators, and venture capitalists are entitled to an investment tax credit equivalent to 30% of their investment in a labelled startup. The credit ‘shall’ be applied on any gains on investment, which are subject to tax. Interestingly, the Act specifically amends only the Companies Income Tax Act in this regard, leading to a presumption that angel investors who invest without using a company may not be eligible to enjoy this incentive.
The Act also exempts angel investors, venture capitalists, private equity funds, accelerators or incubators from capital gains tax when they dispose of their investment in a Labelled Startup provided that the assets have been held in Nigeria for a minimum of 24 months.
Since this is a specific and a later-in-time provision, the ₦100m threshold imposed by the Finance Act, 2021 will not apply. However, where the investment is sold within 2 years, the capital gains tax payable shall be reduced by the amount of the investment tax credit.
Incentives for Venture Capital Companies
The fiscal incentives as outlined under the Capital Gains Tax Act, the Industrial Development (Income Tax Relief) Act and the Companies Income Tax Act as amended improve on those earlier prescribed by the Venture Capital (Incentives) Act, which targets venture companies and venture projects.
Venture companies that invest in venture projects must be recognized by the Federal Inland Revenue Service (FIRS) as venture companies or venture projects, and must invest a minimum of 25% of the total equity required for the venture project to be eligible for the following:
- Accelerated capital allowance for equity investment by a venture company in a venture project, with the following deductions: first year - 30%; second year - 30%; third year - 20%; fourth year - 10%; and fifth year - 10%.
- Reduction of withholding tax on dividends declared by venture projects to venture companies for the first five years, from 10% to 5%.
- Export incentives such as export expansion grants, if the venture project exports its products.
- Gains realized by venture companies from a disposal of its equity interest in the venture project will enjoy capital gains tax exemption of 25-100% where the disposal recurs between 5-15 years of the investment.
- Exemption from company income tax for three years, which can be extended for an additional final period of two years.
Read More:The Future of Nigeria's Technology Industry: A Look at the Nigeria Startups Act
Benefits of these incentives on Private Equity in Nigeria
In contrast to the US and other developed economies, where leveraged buyouts are the primary PE deal type, management buyouts and restructuring—which include launching green or brownfield investments—are the most common PE transaction types in Nigeria. A major participant in the majority of private equity transactions in Nigeria, Actis, is most known for its US$134 million investment in Diamond Bank Nigeria Plc
Private equity funds may benefit from the aforementioned tax credits and incentives by ways and means of;
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Investment Tax Credits:
For Angel Investors, Private Equity Funds, and Venture Capitalists: These investors are entitled to a tax credit equivalent to 30% of their investment in a labelled startup, which can be applied against gains on investment subject to tax. This incentive encourages more investments into startups by reducing the effective tax rate on gains, making investments more attractive and potentially increasing the available capital for startups.
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Enhanced Investment Returns
Venture companies investing in venture projects benefit from accelerated capital allowances, which provide substantial deductions in the initial years (30% in the first and second years, tapering down over five years). This accelerates the recovery of investment costs, improving cash flow and investment returns.
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Encouragement for Innovation and Growth
Private equity investments can help small and medium-sized enterprises (SMEs) grow, leading to increased employment and economic activity. Encouraging the establishment and growth of new businesses and startups can further stimulate innovation.
Conclusion
In summary, the strategic application of tax incentives is crucial for fostering the growth of private equity in Nigeria. The Nigerian government has introduced several legislative measures, such as the Nigeria Startup Act, to create a conducive environment for private equity investments. These measures include tax holidays, exemptions from certain statutory contributions, investment tax credits, and incentives specific to venture capital companies. Such incentives are designed to encourage investment, promote economic development, and support the growth of startups and private companies.
Private equity firms and investors should leverage these opportunities to maximize returns. At Stransact, we specialize in enhancing every transaction. Let us help you navigate the tax landscape and drive your business growth. Contact us to learn how we can solve your tax challenges and propel your business forward.