Retroactive income tax (Taxation) explained

Income tax is retroactive if they are paid now and are for a previous year of assessment. In Nigeria, a case of retroactive taxation occurred recently. When this occurs it affects the company's current fund. In this article, we discussed it in detail.

1. What's retroactive income tax?

A retroactive income tax is a tax policy that requires taxpayers to pay taxes retrospectively. This implies that the taxpayer will pay additional taxes for a previously paid taxation. The payment made is not as a result of underpayment of taxes in the assessment year, but as a result of a change in tax policy by the government requesting that the taxpayer(s) must make such payment.

An example is the Windfall tax that the government of Nigeria wants banks to pay on their gains on foreign exchange gain. The tax law became active in 2024. Therefore it is expected that the taxes will be paid by the bank at the end of their 2024 assessment year. However, the government wants the banks to pay windfall tax on their 2023 gains on foreign exchange. This is a retroactive taxation.

In order to achieve this, the Federal Government will adjust the tax policy for 2023 so that it can be enforced on the banks. This tax policy is referred to as the finance act 2023 in Nigeria.

2. Benefit of retroactive taxation

Retroactive taxation has no benefit to the taxpayer except if the policy intends to reduce the taxes paid by them. Therefore, the tax authority will have to make a refund to the taxpayers. However, retroactive taxes benefit the government. In the case of the windfall taxes, if it is applied, it will be additional revenue to the government that is not part of their annual budget. 

3. Disadvantages of retroactive income taxes

3.1 Income of taxpayers

Retroactive income tax will have a negative impact on the taxpayers. They will be required to pay additional tax to what was earlier paid. This will affect the current income of the taxpayers and reduce their standard of living.

3.2 Impact on budget

Retroactive taxes will have an impact on the budget of the companies paying them. In the case of windfall taxes, the companies already have a budget which is already implemented. Requesting for more taxes will thereby impact on their cash flow budget and disrupt their operations.

3.3 Investors confidence

The laws made by the government form part of the external environment of every business person including investors. When a retroactive taxation is implemented, it will send a bad signal to investors locally and internationally and they may withdraw their investment or adjust their current plans to invest in the country.