July 19, 2024/CSL Research

President Bola Ahmed Tinubu is seeking approval to amend the Finance Act, 2023, to impose a 50% windfall tax on the realized profits from all foreign exchange transactions of banks within the 2023 financial year. The amendment will allow for the Federal Inland Revenue Service (FIRS) to enter into deferred payment agreements with assessed banks, provided these agreements are executed by 31 December 2024. Banks that fail to pay the windfall tax or do not execute a deferred payment agreement by the deadline will face penalties, including a 10% annual penalty on the withheld tax, interest at the prevailing Central Bank of Nigeria minimum rediscount rate, and potential imprisonment of principal officers for up to three years.

This measure, reflecting a broader trend of governments seeking additional revenue from sectors with unexpectedly high profits during economic distress, is not without precedent. In 2023, Spain imposed a temporary windfall tax on banks to raise funds for social spending and mitigate inflation’s impact. Italy introduced a similar tax to reduce public debt and support households and businesses facing economic hardships. The Czech Republic targeted banks and energy companies to capture extraordinary profits from rising interest rates and energy prices, using the proceeds to support vulnerable populations and mitigate inflation’s impact.

However, in the case of Nigerian banks, the situation is more complex. The proposed 50% windfall tax on realized profits from foreign exchange (forex) transactions raises questions about the nature of these gains, particularly revaluation gains. Unlike other windfall profits, which are often perceived because of economic booms or favourable market conditions, revaluation gains in forex transactions can be temporary and volatile. With currency appreciation, banks might still face potential losses, making these profits less predictable and stable. The Central Bank had advised banks to save these windfall gains as buffers against future losses rather than pay it out as dividends or use it for operating expenses. Imposing this tax, therefore, appears morally contradictory, as it takes away funds that could serve as financial safeguards.

In our view, while we believe this move is overall negative due to its potential to reduce profitability, erode buffers against future revaluation losses, increase perceived risk, and raise the cost of capital—especially when banks are seeking to raise capital, we note that this is a one-off charge, at least for now, payable only on realized gains. Given that banks can defer the payment, the impact may not significantly erode profitability within a financial year. It is also expected that banks will likely be charged for the incremental tax rate, given that there has already been a tax charge in the FY 2023 financial year. That said, we expect a lot of discussions in the coming days between the banks, the Central Bank of Nigeria, and the Ministry of Finance to clarify all grey areas.

Impact on the banks

The implied FY 2023 foreign exchange transaction gains must be realised as unrealised exchange differences are disallowed for tax purposes. However, it is worthy of note that bank’s foreign exchange transactions include FX revaluation gains and trading gains. Where, in most cases, FX revaluation gains are unrealised gains, FX trading gains are usually realised. For context, all the N441.8bn reported by GTCO in 2023 as revaluation gains were unrealised gains.

Again, if the amendment allows for the Federal Inland Revenue Service (FIRS) to enter into deferred payment agreements with assessed banks, provided these agreements are executed by 31 December 2024, this implies that banks do not necessarily have to part with cash in 2024 and the payment can be done in installments.

Reduced Profitability: A 50% windfall tax on foreign exchange profits realized in 2023 would substantially reduce the net income of many banks in whatever year or years the payments are made. Again, this will further tighten liquidity and will take away funds that should otherwise be earning interest. Moreover, several banks set aside a lot of these gains to create buffers against future asset quality issues, leading to significantly higher impairments during the 2023 financial year.

Impact on Shareholder Returns: Reduced profits could lead to lower dividends and returns on equity, further dampening investor interest.

Investor Confidence: Increased Risk Perception. Investors might perceive the new tax as a sign of an unstable regulatory environment, increasing the perceived risk of investing in Nigerian banks. This could make it harder for banks to raise needed capital, especially from foreign portfolio investors.

Strategic Shifts: Banks may decide to shift their focus away from foreign exchange transactions to other areas of business that are not subject to any potential windfall tax, potentially impacting overall revenue generation. There could be increased operational costs associated with restructuring business models to minimize tax liabilities.

Market Liquidity: Payments by banks could affect the overall liquidity of banks. There might be upward pressure on exchange rates if banks pass on the additional tax cost to customers through higher fees for forex transactions.

In conclusion, the proposed 50% windfall tax on forex transaction profits would have wide-ranging effects on Nigerian banks especially as there is a strong possibility it may not be a one-off event. We await further clarification from the Ministry of finance.

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​CSL Flash note – Banks and FG’s windfall tax.pdf​​​