The Chairman of the Federal Inland Revenue Service (FIRS), Zacch Adedeji, has pointed out the significant inequities in Nigeria’s current Value Added Tax (VAT) distribution system, revealing that the current structure disproportionately benefits a few states, particularly Lagos, Rivers, and the Federal Capital Territory (FCT). According to Adedeji, these states together receive over 70% of VAT collections, leaving other states with little to no benefit.
Current VAT Allocation Imbalance
During a public hearing on the proposed tax reform bills held at the House of Representatives in Abuja, Adedeji shared data from the latest VAT distribution in October 2024, which showed a skewed allocation:
- Lagos: 42% of the VAT
- Rivers: 16%
- Oyo: 5.2%
- FCT: 9%
Adedeji highlighted that these four states alone were receiving over 70% of the VAT collected, largely because they host the head offices of most major corporations. However, he pointed out that these states do not represent the majority of the country’s consumption, with 70% of total consumption taking place in other regions.
For instance, while MTN (a major contributor to VAT) generates substantial revenue, the head office in Lagos means all VAT from MTN is allocated to Lagos, even though consumption of its services occurs across the entire country. This unequal distribution, Adedeji argued, is not aligned with the intent of the tax system, which should fairly allocate resources based on consumption rather than the location of corporate headquarters.
Proposed Reform: Derivation Principle for VAT
The FIRS Chairman proposed a derivation principle model for VAT allocation, which would be based on where goods and services are consumed rather than where corporate offices are located. This is different from the derivation principle applied to oil-producing states, which is based on production locations.
For example, under the new model:
- VAT revenue would be allocated to the states where products and services are consumed. This means that, if people in a particular state are consuming goods or services, that state will receive the VAT revenue, regardless of where the company producing the goods is based.
- This approach would address the current imbalance, where Lagos, Rivers, and the FCT disproportionately benefit from VAT collections because they host the majority of corporate headquarters, even though the actual consumption is spread across the entire country.
Adedeji clarified that consumption tax (like VAT) should follow the principle of where it is consumed, not where it is produced or where companies are headquartered. This would ensure a more equitable distribution of VAT, benefitting a broader range of states, particularly those that do not host the headquarters of large companies but contribute significantly to the national consumption.
Tax Reform Bills Under Consideration
The Nigerian National Assembly is currently considering several tax reform bills that propose the adoption of the derivation principle in the allocation of VAT between the Federal Government and the states. However, these proposed reforms have generated significant controversy, especially among northern elites, who have raised concerns that the changes may not be favorable to their regions.
Under the current VAT Act, revenue is distributed as follows:
- 15% to the Federal Government
- 50% to the States and Federal Capital Territory (FCT)
- 35% to Local Governments
The distribution to states and local governments includes a derivation principle (at least 20%), but the remaining funds are allocated based on a combination of equality (50%) and population (30%). Additionally, a portion of the collected VAT is allocated to the Federal Inland Revenue Service (FIRS) and the Nigeria Customs Service (NCS) for administrative fees (4% and 2%, respectively).
The Implications of the VAT Reform
Adedeji’s proposal for a more equitable distribution of VAT could have significant implications for Nigeria’s federal structure and intergovernmental relations. The goal is to address disparities in revenue distribution and ensure that all states benefit from VAT in proportion to their consumption levels.
While the reforms are likely to face opposition from states that currently receive the lion’s share of VAT (particularly Lagos and Rivers), they could offer a fairer system for northern and rural states, where consumption patterns differ from corporate hubs. This could also help to reduce the growing regional economic disparities in the country.
In conclusion, while the proposed VAT reforms aim to address historical imbalances in Nigeria’s tax system, they will require significant political negotiation and careful consideration of the federal system and regional equity. The final outcome of the reforms will shape the future of Nigeria’s tax structure and how wealth is distributed across the country.
