Tax audit exercise: When will FIRS adopt risk-based approach in Nigeria?
With the dwindling revenue accruing to federal and state governments as a result of declining returns from sale of crude oil, tax authorities at both federal and state have embarked on a drive to increase collection through taxes. This has led to the adoption of stringent measures which would ensure that companies are up to date with their tax filings, remittances as well as pay correct amount of taxes to complete their self-assessed taxes.
Thus, tax audits remain the primary tool through which the tax and accounting records of taxpayers are reviewed by Federal and State tax authorities to ensure that the correct tax returns have been filed and correct taxes paid in the relevant year of assessment.
It is noteworthy that Federal Inland Revenue Service (FIRS) has demonstrated remarkable commitment towards improving its work processes by instituting modern-day reforms which has resulted in remarkable improvement in FIRS’ operational activities. However, tax audits remain an area in which further improvement is still required.
A very significant challenge around tax audits by FIRS has been how to ensure timely completion. In fact, very few tax audit exercises in Nigeria commence and get concluded within twelve months as most span for years before closure.
No doubt, FIRS has a duty to be thorough in its review but this duty need to be balanced with the duty to ensure timely completion of audits. Protracted tax audit exercises are not in the interest of the Federation nor in the interest of the taxpayer. They are not in the interest of the Federation because of time value of money in respect of potential additional tax liability locked up in unresolved tax audit portfolios. They are not in the interest of the taxpayers who need to commit men and materials towards closure of the tax audits as well as incur professional fees retaining tax advisors during the period.
One major factor contributing to the delay in timely completion of tax audits is the adoption of a vouching approach in the examination of a company’s accounting and financial records with the aim of ascertaining the level of compliance with the provisions of the various tax laws.
This implies that FIRS constantly need to invest substantial man-power and time in every tax audit exercise whilst in reality it may not have such man power and time at its disposal. The complexities of modern day business transactions which result in huge financial data and transactions reinforces how challenging a vouching exercise could be.
In view of the numerous hitches inherent in the traditional/vouching tax audit approach, tax authorities in other jurisdictions are adopting risk based tax audit procedures. Unlike the traditional- tax audit approach where tax officers carry out substantive audit procedure on all items in the financial records of the tax payer, the risk-based tax audit approach is more specific. It aims at identifying risk factors, assessing these factors, and conducting audit procedures on the risk variables to form a tax audit opinion.
The success of the risk based audit approach critically depends on a properly designed audit selection strategy focused on high-risk taxpayers, transactions or business arrangements, with the aim of providing the most cost-effective outcome. It is worthy of note that risk based audits thrive in the face of adequate tax data availability for analysis. The commendable introduction of Integrated Tax Administration System (ITAS) by FIRS will no doubt go a long way in ensuring availability of tax payers’ data to FIRS.
To achieve an efficient tax audit process, there is need for tax authorities to focus more on specific key audit risk based issues by profiling tax payers to establish areas in their operations which may result in material misstatements. Countries such as United Kingdom, Netherlands, Sweden, Indian, Ukraine etc. have developed various statistical techniques (such as credit scoring techniques, XENON etc.) to enable tax authorities build taxpayers’ profiles and identify tax payers who are more prone to non-compliance risk.
These statistical models help to categorize taxpayers with different business structures into high, medium, or low-risk entities. Information required to aid such risk classification would typically be obtained through certain features such as the company’s size, industry, tax compliance history, date of previous tax audit and other data acquired during previous audit campaigns among others.
Additionally, information such as late or non-filing of tax returns, delayed payment of assessed tax liability, outcome of previous tax audits, third-party sourced information (such as information obtained from customs, central bank etc.) could further aid risk profiling of tax payers. This profiling could be a reliable basis of selecting companies that are due for a tax audit exercise.
The risk based audit approach by revenue authorities is more likely to reveal incidences of tax evasion than a traditional random selection of tax payers to be audited as it gives the revenue authorities strong reasons to scrutinize selected cases in detail.
This approach also allows the tax administration to optimize its resources by focusing time and resources on its core strategic goals of promoting voluntary compliance and improving effectiveness and efficiency of tax administration.
It is worthy of note that the National Tax Policy also provides for the need of the tax authorities to promote the use of technology related systems in the tax audit process to reduce time and cost and protect the integrity of the tax audit process.
It is therefore a question of when and not if that FIRS must switch to a risk based approach. In a period where earnestness, flexibility, efficiency, timely delivery of financial goals to the Federation is required, holding on to endangered procedures would not reinforce the image of FIRS as a forward looking agency.