Transfer Pricing: Its Reception and Growth in Nigeria

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By Hameedah Oshodi

Transfer price can be defined as the value which is attached to the goods and services transferred between related parties. In other words, transfer price is the price that is paid for goods and services transferred from one unit of an organization to its other units situated in different countries.

Transfer pricing is the general term for the pricing of cross-border, intra-firm transactions between related parties. Transfer pricing refers to the setting of prices for transactions between associated enterprises involving the transfer of property or services.

Transfer pricing can be used in some cases as a profit allocation method to distribute multinationals net profit or loss to other countries where it does business.

THE ARM’S LENGTH PRINCIPLE

Article 9 of the OECD Model Tax Convention is dedicated to the Arm’s Length Principle. It states that the transfer prices set between the corporate entities should be in such a way as if there were two independent entities.

The arm’s length principle in relation to a controlled transaction means that “the result of the transaction are consistent with the results that would have been realized in a transaction between Independent persons dealing under the same conditions”[1]

This means that entities that are related via management, control or capital in their controlled transactions should agree the same terms and conditions which would have been agreed between non-related entities for comparable uncontrolled transactions.

TRANSFER PRICING IN NIGERIA

Transfer Pricing is regulated by the Income Tax (Transfer Pricing) Regulations, 2018 made pursuant to the Federal Inland Revenue Service (Establishment) Act, 2007. This took effect for the financial year that started from 12 March. 2018 replacing the Income Tax (Transfer Pricing) Regulations,2012.

The objective of the TP Regulations, amongst others, is to ensure that associated/related enterprises and companies pay tax on an appropriate taxable basis corresponding to the economic activities deployed by taxable persons in Nigeria. It aims to ensure that prices at which related entities exchange goods and services is in conformity with the functions performed, the asset used and the risk assumed in generating the income to be taxed.

TRANSACTIONS TO WHICH TRANSFER PRICING ADJUSTMENT APPLIES[2]

  1. Sale and purchase of goods and services;
  2. Sale, purchase or lease of intangible assets;
  3. Transfer, purchase, licence or use of intangible asset (intellectual property);
  4. Provision of services;
  5. Lending or borrowing of money;
  6. Manufacturing arrangements; and
  7. Any transaction which may affect profit and loss or any other matter incidental to, connected with or pertaining to the above listed transactions

TRANSFER PRICING METHODS

The OECD provides 5 common transfer pricing methods that are recognized and accepted by almost all tax authorities globally. These methods are also accepted in Nigeria as provided in the TP Regulations 2018. In determining whether the result of a transaction or series of transactions are consistent with the arm’s length principle, one of the following transfer pricing methods shall be applied:

THE COMPARABLE UNCONTROLLED PRICE (‘CUP’) METHOD

The CUP method compares the prices of goods and services and conditions of a controlled transaction which is between related entities with those of an uncontrolled transaction which is between unrelated entities.  That is, the price charged for a good, property or service transferred in a controlled transaction or in transaction between related entities is relative to the price charged for property or services transferred in a comparable uncontrolled transaction in analogous circumstances.

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THE RESALE PRICE METHOD

This method looks at the gross margin or the difference between the price at which a product or a service is purchased and the price at which it is sold to a third party. The method starts by looking at the resale price of a product that had been brought from a related entity and which is sold to an independent entity.

THE COST PLUS METHOD

This method evaluates the arm’s length nature of an inter-company charge by comparing the gross profit mark-up earned by a party to an uncontrolled transaction to the gross profit earned by associated companies carrying on a similar transaction. This a method that compares gross profit to cost of sales.

THE TRANSACTIONAL NET MARGIN METHOD

This method recently emerged as one of the most used method by multinationals because the transfer pricing is based on the net profit gained as opposed to comparable external marketing pricing. It involves assessing the net profit as an appropriate base such as sales or assets that results from a controlled transaction (which occurs between related entities). This method compares the net profit margin that a particular controlled entity earns to the same net profit earned by an entity in comparable uncontrolled transaction or by independent comparable companies.

THE TRANSACTIONAL PROFIT SPLIT METHOD

This method is applied when two related entities in a controlled transaction contribute significant intangible property. This method seeks to eliminate the effects of special conditions imposed in a controlled transaction by determining the division of profits which independent unrelated enterprises would have expected to realize from engaging in a similar transaction or transactions[3].

Any other method which may be prescribed by Regulations made by the Service from time to time.

As contained in the TP Regulations, a company is required to declare its relationship with all connected or related entities not later than 18 (eighteen) months from the date of incorporation or within 6 (six) months after the end of the accounting year.[4] The Regulation further stipulates that a company is to make disclosure of all controlled transactions that are subject to the Regulations without notice or demand. Failure to comply with the disclosure requirements within the prescribed period attracts payment of penalty by the defaulting company to the FIRS.[5]

Taxpayers can seek a review of transfer pricing adjustments from the Decision Review Panel (whose decision on any assessment or adjustment is final). Still, a taxpayer can seek judicial review of a decision of the panel based on a “point of law”[6]

TRANSFER PRICING RETURNS

A company must ensure that its transfer pricing return is submitted with the tax payer’s income tax return and must include the following documentation:

  • Transfer pricing declaration and disclosure forms
  • Audited financial statements
  • Copy of income tax self-assessment
  • Transfer pricing policy (with the first return)
  • Tax computation with all schedules.

While Nigerian companies have been managing the effects of the global developments, alongside the various Transfer Pricing obligations, there have been some significant TP developments in Nigeria. Some of the major developments in Transfer Pricing during the past years are as follows[7]:

  1. Materiality threshold for maintaining contemporaneous TP documentation: In a bid to reduce tax compliance costs, which is one of the indices used to measure the ease of doing business, the obligation to maintain contemporaneous TP documentation has been relaxed for companies whose controlled transactions are of total value of less than ₦300m. In essence, a company with intra-group transactions below ₦300m is not obliged to prepare documentation (record with sufficient data and analysis to verify compliance with the arm’s length principle) as the transactions are consummated. However, FIRS may still require such companies to prepare and submit their documentation within 90 days of receipt of a notice. Default in providing the documentation within the 90-day period will result to a penalty equal to 1% of the value of related party transactions in addition to ₦10,000 for each day in which the default continues[8].
  1. Scope of Application: The scope of application of TP in Nigeria under the old Regulations included Personal Income Tax, Companies Income Tax and Petroleum Profits Tax. The 2018 TP Regulations expand the scope to include Capital Gains Tax (CGT) and Value Added Tax (VAT). While the legislation on CGT and VAT have provisions for applying market value as arm’s length value of controlled transactions, it was uncertain if the recommended TP methods were applicable under the old TP regime. Furthermore, its implications on intercompany transfer/sale of assets during mergers & acquisition transactions need to be considered, as it will potentially increase compliance obligations.
  1. Ruling on the first TP case in Nigeria: The first TP judgment in Nigeria was delivered in February 2020 when the Tax Appeal Tribunal (TAT) ruled on the case between Prime Plastichem Nigeria Limited (PPNL) and the Federal Inland Revenue Service (FIRS). The case resulted in an additional tax liability of approximately N7,000,000,000 (Seven Billion Naira) for the taxpayer for the 2013 and 2014 financial years. This judgment is a landmark event in the TP space in Nigeria as it marked the first ever TP court case in the country, setting a precedence which can be referred to by the taxpayers, tax authorities and tax advisers. The resulting significant additional tax liability also buttressed the fact that TP is one of the riskiest areas in taxation. The case emphasized the importance of having a robust TP documentation capable of defending your Related Party Transactions (RPTs) during TP audits and the importance of having competent TP advisers providing technical support during a litigation process.
  1. Transfer Pricing Implications of the Finance Act 2019: The Finance Act introduced a new provision, which stipulates that for any related party expense to be tax deductible, it has to be consistent with the TP Regulations. The introduction of this section means that the provisions of the TP Regulations will trump other considerations for tax deductibility of RPTs. In addition, this provision implies that taxpayers can no longer rely on the approvals of other government regulatory agencies to demonstrate the arm’s length nature of RPTs and will be required to perform detailed TP analyses to justify the pricing of RPTs. The FA also introduced a restriction of the deductibility of foreign related party interest expense to 30% of Earnings before Interest, Tax, Depreciation and Amortization (EBITDA). This provision aims to limit erosion of the nation’s tax base via interest on intercompany loans. Any excess interest expense can be carried over to subsequent years’ subject to a maximum period of five years.
  1. Introduction of the Significant Economic Presence (SEP) Order, 2020: The SEP Order was introduced in 2020 to provide clarity on the concept of SEP, which was introduced in the Finance Act. The SEP Order describes two broad categories of companies that will be deemed to have Significant Economic Presence in Nigeria; companies involved in Digital transactions and companies providing Technical, Professional, Management or Consultancy (TPMC) services. The SEP Order creates Transfer Pricing obligations for companies with taxable presence in Nigeria. Where foreign companies with SEP in Nigeria conduct Transactions with related parties, they may be subject to the provisions of the Nigerian TP Regulations and the Country-by-Country (CbC) Reporting Regulations[9]. These companies may be required to prepare TP documentation, file TP returns, CbC notifications and CbC reports.
  1. Introduction of the e-filing platform for TP returns: The FIRS introduced an e-filing platform for filing of TP returns in 2020. The platform enables the filing of TP declaration forms, TP disclosure forms, CbC notification and CbC reports. The platform also allows taxpayers upload other relevant attachments.
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CONCLUSION

With the dynamic landscape of Transfer Pricing in Nigeria which is very broad and expansive, tax payers need to be proactive and have specific strategies in place for ensuring compliance with the transfer pricing regulations. It is very important and advisable that tax payers should ensure full compliance to transfer pricing and try to avoid any of these penalties by complying as at when due.

With more information from CbC reports and the CRS information returns available to the FIRS for risk assessment purposes, there may be an increase in TP audits and investigations. The FIRS will also continue to impose penalties on taxpayers that fail to comply with the provisions of the Regulations. Taxpayers should evaluate their dispute resolution options as part of their overall TP strategy.

Lastly, taxpayers should take proactive steps to minimize their TP risks exposures through periodic reviews and ensure continuous compliance with TP obligations.

Hameedah is an Associate with DNL Partners – hameedah.oshodi@dnlpartners.com

Footnotes

[1] Sec. 27 of Income Tax (Transfer Pricing) Regulations, 2018

[2] Sec. 3 of the Income Tax (Transfer Pricing) Regulations, 2018

[3] https://home.kpmg.com/content/dam/kpmg/ua/pdf/2016/12/UN_Manual_Transfer Pricing%20(6).pdf.

[4] Sec. 13 of the Income Tax (Transfer Pricing) Regulations, 2018

[5] Sec. 14, 15 and 16 of the Income Tax (Transfer Pricing) Regulations, 2018

[6] Sec. 21 of the Income Tax (Transfer Pricing) Regulations, 2018.

[7] Tuesday 03 November, 2020; Business Day, Page 13, Andersen Tax Digest – Transfer Pricing in Nigeria: A Review of 2020 Developments.

[8] http://blog.deloitte.com.ng/wp-content/uploads/2018/09/Deloitte-Newsletter-2018-TP-regulations.pdf

[9] The Country by Country Report provides aggregated information by tax jurisdiction, showing Multinational Enterprise (MNE)’s allocation of income, income tax paid, and certain indicators of the location of economic activity among tax jurisdictions in which MNE group operates.

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