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The recent global economic challenges as a result of the fall in oil prices and the weak value of the Naira in the global economic market has raised many critical issues and economic questions, as to how the three tiers of government in Nigeria will finance their budgets, in the coming years. The shortfall from oil revenue accruing to government in recent years have negatively affected the economy with many implications as well as evoking the questions of whether taxing or not taxing the informal sector for revenue and for economic reasons should be undertaken. Three important issues have influenced this thinking. They are:

  • How to create additional sources for more revenue generation;
  • How to improve upon economic growth; and
  • The quality of governance.


Taxing the informal economy or informal sector in recent times have received greater economic attention and occupies an important domain in revenue generation among developing economies. Informal economy or informal sector is that part of the economic unit which is not officially registered and monitored by any form of government regulations.


The Nigerian tax authorities have renewed efforts towards increase in tax collections and revenue generated from taxation. This is spearheaded by the Federal Inland Revenue Service (FIRS) and the other State Internal Revenue Services. The authorities have initiated different schemes including several tax amnesty programs to encourage non-complaint taxpayers to come forward and declare their taxes, which will make them included in the tax net. Despite these efforts, the general level of tax compliance in Nigeria is still quite low. The recent International Monetary Fund (IMF) country report shows that only about ten (10) million people, from a labor force of about 77million people, are registered for taxes in Nigeria.

This low level of tax registration certainly creates a narrow tax base from which the government is able to collect taxes and therefore impacts government’s ability to generate revenue through taxes. It also places significant burden on the existing taxpayers who in some instances, already have a high level of compliance, as the tax authorities continue to focus on these known taxpayers for audits and tax drives.



The Informal Sector

It is not unusual to broadly classify the economy into formal and informal sectors. The informal sector is generally accepted to comprise the economic activities or interactions of individuals, enterprises or other unincorporated entities or organizations whilst the formal sector represents the economic interactions of organized individual or corporate entities.


The informal sector refers to the economic activities that function with limited government regulation and is usually unstructured. Incomes generated by the operators in the sector, in many cases, are not officially captured into the tax net of the states or nation. They typically operate at a low level of organization, with little or no division between labor and capital as factors of production. The informal sector consists of self-employed persons, micro, small and medium scale enterprises including traders and artisans and constitute a significant portion of the Nigerian economy.


There has been a lot of focus on the fact that Nigeria’s tax to GDP ratio of about 6.1% is quite low and appear to remain unchanged despite all the efforts of the tax authorities to improve collection. Given the significant size of the informal sector in the economy, it is safe to say that the tax to GDP ratio will not significantly improve until this huge and untapped sector of the economy is effectively subjected to tax.


It is clear that the formal sector alone cannot generate the required level of taxes required to fund the government and improve the tax to GDP ratio. This is because the informal sector is a significant portion of the GDP and has the potential for enormous contributions to the economy. The informal sector however forms a greater percentage of tax defaulters, thereby increasing cases of tax evasions leading to leakages in government revenue.


The informal sector is also known as the “grey economy”. The sector widely acclaimed for its wealth creation function, as well as its personal income generation capacity, through a variety of small-scale/entrepreneurial activities is a largely unstructured interface among/between unincorporated entities in any economy. To this end, the informal sector can be explained as the sum total of income generating activities outside of a government regulated contractual relationship of production.[1]


The National Tax Policy (NTP) had before now sought to set the direction for Nigeria’s tax system as well as provide the basis for tax legislation and administration in Nigeria. The NTP in recognizing the different stakeholders in the Nigerian tax system, identified taxpayers as the single most important group while reiterating the need to ensure strict compliance with the tax laws at all times. In this wise, it envisages frequent interactions and engagements between the various stakeholders to ensure seamless administration of tax regimes. One major diagnostic conclusion in the National Tax Policy is that “compliance has been a great problem in the Nigerian tax system as a result of the large scale informal sector”. The NTP admits that “the administrative burden of applying tax laws may be cumbersome for some of these entities and therefore recommended that efforts should be made to deal effectively and efficiently with them. This involves strategies to increase both compliance and revenue whilst keeping the cost of administration as low as possible”.


The NTP envisages already that tax authorities need to evolve strategies which would enable them to increase compliance and revenue from the informal sector. This reflects implicitly the limitation of any present approaches adopted so far. In evolving fresh strategies to drive increased compliance and revenue from the informal sector, it may be necessary to pose and seek answers to the following questions:

  • Is there a need to stratify the informal sector?
  • If so, along what lines in order to achieve optimum stratification?
  • Is the current tax regime optimal for the informal sector?
  • Is there a need for an alternative tax regime for the informal sector?
  • Is the informal sector eligible for incentives? If so, what type?
  • Should focus be on direct or indirect taxation of the informal sector?
  • What assurances are available in respect of voluntary disclosures of tax default?


The issue of stratification is important in that Small & Medium Enterprises (SMEs) are sometimes classified within the informal sector. This is to ensure appropriateness of strategy and focus. There is also the concern that the existing tax rates whether at personal income tax level or companies’ income tax level are still too high in relation to the margins earned from their respective businesses.[2] Players in the informal sector are generally aware that it is part of their civic duties to pay taxes due on their income to the government. It is important to stress that it is a constitutional duty for every citizen to declare his income honestly to the appropriate and lawful agencies and pay taxes promptly.


The provisions of the tax laws empower tax authorities to call for further returns and access the books and related documents of the tax payers to ensure compliance, which in the informal sector may be non-existent. A critical path forward would be an approach that either de-emphasizes documentation or makes documentation easier to arrange and present by players in this sector.

The dire straits in which the revenue position of most states of the Federation is makes counter-productive any approach which does not seek to boost revenue accruable from the informal sector. The poor employment statistics in the formal sector imply that increasing number of the working population are in the informal sector and this may mean an increase in the loss of tax revenue to government if the attitude to this sector remains unchanged. A pre-eminent objective of the NTP remains how to create, deepen and institutionalize in a sustainable manner, a culture of voluntary tax compliance amongst individuals and corporate citizens of Nigeria. There are players in the informal sector who desire to ensure voluntary registration with tax authorities; timely, correct, and complete tax returns; and payments as required by law, but are only waiting for the necessary wholistic signals from government and its tax authorities. It must be borne in mind that a law that encourages its own violation is no law (anon).


Application of Tax Policies to Businesses in the Informal Sector.


It is important to note that the informal sector emerged to absorb the shortfalls of the formal sector, unemployment as well as provide a means of livelihood for the semi-skilled and unskilled unlike. The sheer size of the informal sector makes it practically difficult to ascertain the actual membership and activities of the sector. However, a recent study by Chatham House Royal Institute of International Affairs indicated that the Nigerian informal sector constitutes as much as 64% of Gross Domestic Product (GDP). This puts Nigeria in a class of its own as the United Nations assessments suggest that for developing economies the average percentage composition of GDP by informal sector ought to be 41% and for countries in transition; 38%. The effect of this information is two-fold:

  1. It would appear that it means an increase in per-capita income as well as improved standards of living; and
  2. On the other hand, it would appear that government is losing potential income which would otherwise be revenue for it.


The Nigerian government faces two fundamental difficulties as regards the taxation of the informal sector.

  1. Government is unable to capture the existence of the businesses in the informal sector and cannot therefore include them in its tax net.
  2. Most of these businesses do not benefit directly from government support program but survive and grow solely due to the persistence and ingenuity of their owners. There is therefore little or no incentive to voluntarily remit or pay taxes to government.


The above remain germane points in the ongoing debate on government’s morality in taxing or levying businesses in the informal sector or the implementation of tax holidays for such businesses. It is however not the focus of this paper.


Challenges of Taxing the Informal Sector.


The biggest challenge is that most of the businesses operating in the informal sector do not keep proper records of their day-to-day transactions. It means that they do not maintain proper books of account which would enable them produce audited accounts and compute the appropriate tax payable for the period. The operators in that sector are usually more focused on improving and growing their businesses rather than keeping proper records. It is also common occurrence for them to mix their personal funds with that of the business. This includes using the same bank accounts for both business and personal transactions, subsidizing the business with personal loans and taking money out of the business for private use without proper documentation. This makes it difficult for an independent party to accurately evaluate the financial position of the business in order to determine the amount of tax payable.


Basically, effective tax collection is a function of accurate information. Given the operations of the informal sector, information gathering would be a herculean task. Some of the issues plaguing the proper taxation of these businesses include:


  • Most businesses are operated by liquid cash;
  • Absence or inadequate accounting/book keeping record;
  • Absence of a database in view of the non-registration of a high number of the businesses within the informal sector;
  • Difficulty in identifying the appropriate tax base;
  • Our tax operations are more suited for the formal sector, further necessitating the need for a system which makes voluntary compliance easy;
  • Taxpayers’ defiance to tax remittance in the face of what they consider to be failed government support.
  • The average business person within the informal sector does not consider himself a taxable person.


Assessment of the Informal Sector for Taxation      

In response to these challenges, government must develop smart solutions unique to this sector and the Lagos State Internal Revenue Service (LIRS) offers a good reference point because of its approach. Upon recognizing the huge revenue stream in the informal sector, the LIRS has classified the tax payers in the informal sector into:

  1. Market men/women and artisans;
  2. Micro, small and medium scale enterprises (including professionals); and
  3. Household domestic staff.


The LIRS stated not too recently that it had begun the process of overhauling its informal sector operations to ease voluntary compliance by tax payers.

Prior to this, Section 6 of the Personal Income Tax Act (PITA) provided for a new sub-section (6) to Section 36 of the principal Act which states that:


“(6) notwithstanding any of the provisions of this Act, where for all practical purposes the income of the taxpayer cannot be ascertained or records are not kept in such a manner as would enable proper assessment or income, then such a taxpayer shall be assessed on such terms and conditions as would be prescribed by the Minister in regulations by order of gazette under it or by the prescriptive tax regime”.


In essence, the above provision mandates that the income of a taxpayer from the informal sector shall be taxed in accordance with the prescriptive tax regime. While PITA relies on the prescriptive tax regime as a means of taxing the informal sector, the NTP on the other hand relies on the Presumptive Income Tax Assessment and it is apparent that these tax regimes have the same intent. According to the NTP, “the Presumptive Income Tax Assessment will require less documentation from the tax payer and also result in a quick and effective method of providing an assessment”. It would appear that the intent of both tax regimes is to develop a flexible plan to enhance voluntary compliance and minimize tax evasion. It is based on a taxpayer’s supposed income given the fact that most participants in the sector do not keep proper records of account.


Unlike the self-assessment system of tax wherein a taxpayer prepares and submits its audited account and tax computations which is subject to acceptance or rejection by the relevant tax authorities upon review, the presumptive tax regime assesses a tax payer on perceived income in view of its lack of documentation. It would appear that this assessment can be determined based on best judgment. While voluntary compliance is a benefit of this tax regime, the imprecise nature of the tax assessment could pose hardship to the business owner.

Income under this tax regime may be estimated by:

  1. A standard assessment i.e. apportioning an aggregate sum to tax payers doing the same kind of business (this is general and may not take into consideration the taxpayer’s specific condition);
  2. An estimated assessment of the taxpayers’ income based on indicators specific to a given business;
  3. Net worth and assets of the taxpayer (this does not take into consideration intangible assets)


Harnessing the Tax Potentials of the Informal Sector

It is a well-known fact that the tax authorities cannot audit every taxpayer, therefore, efforts should be concentrated on how to improve voluntary compliance. It is however advisable that a massive tax enlightenment for participants in the informal sector be embarked upon to reiterate that tax payment is part of their civic duties. The enlightenment must also seek to demystify the process leading up to taxation which is needlessly shrouded in complex financial jargons.


Given the fact that to access government support, business owners are required to undertake some form of registration with it, inter-agency collaboration would be helpful to at least identify these potential taxpayers. Although It remains incontestable that the law mandates tax payers to pay their taxes regardless of whether or not government provides infrastructure to support economic activities, it would however be a moral victory for government at all levels to fulfill their duties to the citizens, in order to make a corresponding demand on the citizens to fulfil their obligations.


A huge relief for the informal sector players would be a knowledge of the treatment that tax authorities would mete out if they make voluntary disclosure of tax defaults. If there is uncertainty, some segment of this sector may opt to sit on the fence and wallow in non-compliance, taking the chance that they may never be caught.


The need for government to capture the informal sector into the tax net has never been more urgent. Commodity prices have remained volatile globally. Diversification into other and better paying natural resources market require massive investments which government does not have readily. Taxation is a viable and long-lasting solution to government revenue shortfalls. Therefore, the efforts of all players should be targeted at developing a tax system that would work for all parties and improve the economy.



This paper examines the informal tax sector in Nigeria and the need to reform same. Before a country can successfully administer its tax system, it must possess a clear picture of the scope. The quantity and quality of resources required by tax administrators are to a large extent determined by the type of tax system which is introduced. A nation’s tax goals are not achieved by designing a tax system which is fair. Any fair system which is not administered as planned becomes inequitable. Thus, a good tax system is one capable of financing the necessary level of public spending in the most efficient and equitable way possible. It should also:


  1. Raise enough revenue to finance essential expenditures without recourse to excessive public sector borrowing;
  2. Generate revenue in ways that are equitable and minimizes disincentive effects on economic activities; and
  3. Do so in ways that do not deviate substantially from international norms.

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