Taxes are imposed on every income made from every economic activity except such is exempted by law as provided in almost all the income tax laws. Generally speaking, income is a broad term that encompasses varieties of items such as profit, gain, premium, dividend, royalty, and interest. In this piece, effort is made to consider the treatment of interest in the hands of individual or corporate persons with a view to understanding the its nature and consequence in ascertaining the tax liability of the holder or payer. Since there can only be tax liability after the ascertainment of taxable income, it is imperative to determine the nature of an interest in the hand of the tax-payer in arriving at the tax liability of such person.
In taxation and banking practice, interest is the investment income accruable from the facility granted to a borrower in addition to repayment of the principal loan or for the use of money loaned. As a matter of practice, businesses secure loans to finance investment or transactions for a fee called “interest” as may be agreed by parties. For the purpose of clarity, the banks, money lenders and other financial institutions make their income from this transaction and that constitutes income. However, the borrower who pays the interest (in addition to the principal sum loan) being the cost of using the money loaned treats the same item as an expense incurred for the purpose of its own business. What simply means is that an interest may be classified as either an income or an expense. The determining factor is whether it constitutes a cost or a gain to the taxpayer.
By Section 9(1)(c) of the Companies Income Tax Act, the tax shall, for each year of assessment, be payable at the rate specified in Act upon the profits of any company accruing in, derived from, brought into, or received in, Nigeria in respect of interests, royalties, discounts, charges or annuities. Illustrating this, Company A whose nature of business is publishing proposes to expand its business but has no wherewithal to so do and has decided to take loan facility from Bank A. The loan of N500,000,000.00 (five-hundred million naira) was granted at the rate of 18% per annum for the period of five-year tenure. The Bank receives the interest as its income of 18% of the principal loan spread over a period of term of the loan. This sum representing 18% interest accrued from the use of outstanding loan per annum is taxable in the hands of the Bank in accordance with the relevant provision of the law. In ascertaining the accessible income of the Bank, the interest accrued from the loan to Company A will be reckoned as income which the Bank generated within the year of assessment.
There are certain interests that are earned and accrued to a taxable person but not still taxable. They are exempted by law. The list is as contained in Sections 11 and 23 of the Act to wit:
Consequently, where a person though earn income in the nature of interest can show that such interest income falls within the categories identified, such interest is not taxable.
As a general rule on ascertainment of accessible income, taxpayer is allowed to deduct all expenses that are incurred in the production of those profits. The expenses amongst other include “any sum payable by way of interest on any money borrowed and employed as capital in acquiring the profits”.
It is important to state that interest would only be deductible or allowable if it passes the legal standard otherwise known as “WREN test”. That is to say, the interest must have been incurred “wholly, reasonably, exclusively and or necessarily” in the production of the accessible income or profit.
In the illustration above, it is clear that the Company A incurs the payment of 18% interest as the cost of using the principal sum loaned to it by the Bank to enable it expand its publishing business. The sum paid as interest by Company A constitutes an expense incurred for the purpose of generating whatever income accruable from such an expansion at the end of the day. In ascertaining the accessible income of Company A, the proportion of the interest paid for the year of assessment will have to be deducted as allowable expense for that year. This is permissible by law as provided in Section 24 of CITA.
Any sum of money, gain, profit earned in the nature of interest being the cost of money loaned or use of such loan is an income and it is subject to income tax either under the company income tax or personal income tax depending on the entity that receives such payment. The interest income will not crystallize until the income is earned or payment made.
This interest paid for the use of the principal or the loan is regarded as interest expense and deductible or allowable expenses by the borrower. There are however instances where interest income is earned but will not be subject to tax. For the interest expense to be allowable, it must have passed the WREN test.
Bashir Ramoni, FCTI, Partner in charge of taxation and revenue writes for SimmonsCooper Partners
 See Section 9 of the Companies Income Tax Act, Cap C21, LFN 2004 (as amended); Section 8 of Personal Income Tax Act, Cap P8, LFN, 2004 (as amended)
 Cap C21, LFN 2004 (as amended)