Nigeria currently operates a self-assessment tax regime. What this means is that taxpayers are given the right to assess themselves to tax according to the applicable tax laws, then pay the tax as assessed and file the necessary returns with the relevant tax authorities. After filing, the tax authorities occasionally review the returns to determine consistency with the provisions of the law and the taxpayer's operations. If any discrepancy is observed, the authorities would then seek to probe into possible causes by way of a tax verification exercise. Typically this includes, desk queries, audits or investigation.
Tax verification is therefore a veritable exercise embarked upon by tax authorities in view of the self-assessment system. It therefore behoves Micro, Small and Medium Enterprises (MSMEs) to ensure that income declared, deductions made and tax paid are correctly stated and free from misstatements to avoid potential exposure to additional taxes. In this first part of the series, we would examine the impact of accounting errors on an MSME's tax position.
One reason for increased tax exposure by businesses particularly MSMEs in Nigeria include misstatements or avoidable inaccuracies and this may arise from accounting errors. Accounting errors are simply unintentional or non-fraudulent misstatements that may have occurred in the process of recording business transactions. Examples include error of omission, commission, original entry, principle, and duplication.
While it must be emphasized that these errors are not deliberate or fraudulent and in most cases, can be detected and corrected with little or no consequence during a financial audit, it may have severe consequences during a tax verification exercise. We would be looking at these common errors in detail and how they can impact your tax position.
- Error of omission - When transactions are omitted from the account, it is called an error of omission. In reality the transaction occurred but no record of it was entered in the books. For example, ABC Enterprise whose business activity is the sale of tailor-made fashion wear, purchased a box-set of tailoring needles from a supplier on credit. For accounting purposes, a particular transaction must be recorded in at least 2 accounts. By omitting this transaction in its books, ABC Enterprise has understated the purchases for the period and understated creditors balance. ABC Enterprise therefore stands the risk of paying more taxes as a result of higher profits.
- Error of commission - This occurs when a transaction is recorded in a different customer's account. From the example above, if the supplier's name is XYZ Enterprise and the transaction was incorrectly recorded in the account of XYZ Limited, this results in an error of commission. For tax purposes, this has the effect of distorting ABC Enterprise's treatment of the transaction especially for withholding tax (WHT). Say the rate for an enterprise is 5% and the rate for a limited company is 10%, if the error is not corrected the tax authority would require ABC to deduct WHT at 10% instead of 5%.
- Error of original entry - This is when an incorrect amount is posted to an account. For instance, the total amount of the tailoring needles of ABC Enterprise is NGN28,500 but it was recorded as NGN25,800 in the purchases account. This error could lead to ABC Enterprise reporting a higher profit and higher taxes if not corrected.
- Error of principle - This error usually occurs due to ignorance of accounting concepts and conventions. For example, ABC Enterprise purchased motor vehicle for office use and this transaction was recorded in the purchases account instead of the motor vehicle account. Aside the fact that the profits for the period would be unfairly represented, this creates tax issues with ripple effects on capital allowances, exposure to minimum taxes and the likes.
- Error of duplication - Error of duplication occurs where a transaction is recorded twice in the accounts. Going back to the first example, in recording the purchase of tailoring needles in the accounts of ABC Enterprise, the accountant entered the same record on two different days. This can lead to double taxation as all applicable taxes on the transaction (income tax, WHT, etc.) would be paid twice.
From the foregoing, we have highlighted some of the ways errors in the accounts can create tax exposures for an MSME. Not only do errors cause misrepresentation and distort the truthfulness and fairness of the financial statements, they can lead to a business expending more money than is required.
Always bear in mind that every accounting entry has a tax implication. It is therefore pertinent to take extra care and diligence when transactions are presented and recorded in the accounts.