Parallel foreign exchange markets or "black market" as it is popularly called, has been in existence for a while now and has become a common phenomenon in most developing countries. In Nigeria, the market has grown in length and girth to become a major and ready source of foreign exchange to most individuals, corporate bodies and to some other participants in the economy. The implication of this is that as the parallel market for foreign exchange expands and the majority depend more on it for their transactions, the government loses control over the foreign exchange market as more of the official transactions are diverted to the parallel market. To curtail this overbearing reach of the activities of the parallel market and its impact on the Nigerian economy, the Presidential Committee on Fiscal Policy and Tax Reforms (the Committee) proposed imposing excise taxes on foreign exchange transactions conducted outside the official exchange market. It should be recalled that the Committee was set up in July 2023 by President Bola Ahmed Tinubu, to review and proffer advice that would help reform Nigeria's fiscal policy and tax systems, with its major responsibility being on tax law reforms, fiscal policy design, coordination, harmonization of taxes, and revenue administration.
This article seeks to examine the proposed taxation of foreign exchange transactions in the parallel market and its implications on the economy and taxpayers.
Overview of the Proposed Initiative
The term "parallel market" is used to refer to any form of unregulated and unofficial foreign exchange market where foreign currencies are purchased or sold. Parallel markets are often created inadvertently due to the restrictions placed by the government on free trading of foreign currency within the country. According to the World Bank, parallel markets can also arise due to explicit exchange rate regulations introduced by governments, or due to economic or policy conditions impacting international transactions leading to a significant unofficial market.
In Nigeria, several factors such as the increasing pressure on the Naira, unfavorable economic policy and limited supply of foreign currency in the official market (due to decreasing oil revenue in the international market), have necessitated individuals and companies in need of foreign currency to turn to the parallel market to meet their foreign exchange obligations.
Given the high volume of trading conducted in the parallel market, imposing taxes on the trading activities in the parallel market should ordinarily serve as a source of revenue generation to the government. However, this may not necessarily be achieved due to the lack of regulation within the market, making it challenging to effectively enforce compliance. More so, the cost of tax administration may equally be very high as enforcing and collecting excise tax in the parallel market poses administrative difficulties due to its highly decentralized and elusive nature. Therefore, to ensure compliance, regulators and policymakers may have to incur huge administrative costs at least in the short term, to ensure compliance.
There also exists the possibility of encouraging more unofficial channels due to the volatility of the exchange market as speculators may be pushed into other unofficial markets such as bonds, stocks and shares to mention a few, in order to evade the excise tax set by regulators, thereby defeating the purpose of the excise tax and creating a volatility in the trading of these classes of assets too.
Furthermore, regularizing the activities of the parallel market would silently mean approving the "illegality" of the market as it is impossible for the government to tax transactions arising from the market widely construed by the regulators as illegal.
Potential Tax Implications of the Initiative
Apart from controlling exchange rate fluctuations, one of the major reasons why policymakers seek to impose an excise tax on foreign exchange transactions in the parallel market is the additional revenue the initiative would generate for the government if implemented. Particularly as the transactions carried out daily in the market are voluminous. Imposing an excise tax on these transactions could open a new stream of income for the government to fund its increasing costs. However, the forecast of generating a significant amount of revenue from the excise tax remains an assumption as the huge volume of transactions in the Market may not necessarily translate to huge revenue due to the difficulty perceived to be experienced with compliance and tax evasion.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
