In the past year, the Nigerian government has declared and demonstrated its interest in increasing tax revenue in the country. This is founded on the need to grow government revenue to meet rising government expenditure and public debt servicing. While the focus of the tax authorities in Nigeria spans all tax segments, there has been particular interest in multinational enterprises (MNEs) and other companies with intercompany transactions, with the tax searchlight beamed not only on the collection of current tax liabilities but also on the recovery of prior tax liabilities.
MNEs in Nigeria may therefore expect an increase in tax audits, especially in relation to transfer pricing (TP) compliance. This is due to:
The new opportunities afforded tax authorities by enhanced information sharing and cooperation among various tax authorities through multilateral and bilateral arrangements; and
The complex nature of TP compliance requirements.
It is therefore crucial that MNEs review their TP compliance systems to ensure they protect against, or minimise, the risk of default or non-compliance with existing TP regulations as they brace for an increase in tax audits by the tax authorities.
TP issues and regulation
TP generally deals with the setting of prices for transactions between related parties, with the goal of preventing the mispricing of such transactions through underpricing or overpricing of transactions by related parties.
TP regulation in Nigeria is based on the provisions in the various taxing statutes, commonly referred to as general anti-avoidance rules (GAAR). These provide for the power of the relevant tax authority to treat a transaction as artificial or fictitious and therefore disregard or make adjustments to the terms of such transaction as it considers appropriate where:
The transaction is between connected or related parties; and
The tax authority considers that the transaction has not been made at terms that might fairly be expected to have been set by persons engaged in the same or similar activities dealing with one another at arm’s length.
The relevant legislation is set forth in Section 20 of the Capital Gains Tax Act, Section 22 of the Companies Income Tax Act, Section 17 of the Personal Income Tax Act, Section 15 of the Petroleum Profits Tax Act, and Section 269 of the Petroleum Industry Act.
These GAAR provisions do not, however, establish a clear mechanism for the determination of when related-party transactions will be considered to have been made at arm’s length, thereby giving wide discretion to the relevant tax authorities and creating uncertainty as to the application of the provisions. The Income Tax (Transfer Pricing) Regulations (the TP Regulations) were therefore enacted in 2012 and reviewed in 2018 in line with, and incorporating, the United Nations Practical Manual on Transfer Pricing for Developing Countries (the UN Manual) and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines) to provide an empirical framework for determining whether transactions between related parties are made on an arm’s-length basis.
Managing tax audit risks
The measures necessary to manage the risk arising from increased tax audits, especially TP tax audits, are based on the phases relevant to tax audits; namely:
The compliance phase;
The pre-audit/field audit phase; and
The post-audit/resolution phase.
The compliance phase
Proactive compliance is the first step towards managing the risk of increased TP audits. The taxpayer must understand the scope of the compliance requirements under the TP Regulations and ensure compliance with them. Generally, the TP Regulations apply to controlled transactions (i.e., commercial or financial transactions between connected parties), which could include:
The sale and purchase of goods and services;
The sale, purchase, or lease of tangible assets;
The transfer, purchase, license, or use of intangible assets, the provision of services, lending, or borrowing of money;
Manufacturing arrangements; and
Any transaction that may affect profit or loss or any other matter incidental to, connected with, or pertaining to these transactions.
The taxpayer will need to identify and adopt the appropriate TP method that is applicable to the controlled transaction. Under Regulation 5(2) of the TP Regulations, this selection process should involve:
A consideration of the respective strengths and weaknesses of the various TP methods; i.e., the comparable uncontrolled price method, the resale price method, the cost plus method, the transactional net margin method, and the transactional profit split method, or such other method as may be prescribed by the Federal Inland Revenue Service (FIRS);
Detailed function, asset, and risk (FAR) analysis of the controlled transaction as between related parties; and
The availability of information required to apply the TP method and the degree of comparability between the controlled and uncontrolled transactions.
A TP method chosen by a taxpayer will therefore be disallowed if it does not apply to the controlled transaction based on the process above (Plastichem Nigeria Limited v FIRS (2020) 51 TLRN 1). Where more than one TP method may appropriately analyse a controlled transaction in line with the selection procedure above, the OECD Guidelines and the UN Manual recommend the selection of the most appropriate method (MAM) based on the information obtained from the selection procedure.
Where the MAM results in several financial indicators for which the degree of comparability of each of the controlled transactions, and to each other, is uncertain, a statistical approach shall be used. And where such an approach is used, the interquartile range shall be considered to be the arm’s-length range.
The TP Regulations also contain a special rule for the determination of arm’s length in transactions relating to intangibles, intra-group services, and capital-rich, low-income companies.
Furthermore, the taxpayer must ensure that:
It makes (i) a declaration (and updated declarations) of its relationship with all connected persons, whether such persons are in Nigeria or elsewhere, and (ii) a disclosure of all controlled transactions that are subject to the TP Regulations in the form prescribed by the FIRS within 18 months of incorporation or six months after the end of the taxpayer’s accounting year, subject to the power of the FIRS to extend the time for good cause; and
It maintains contemporaneous documentation consistent with the provisions of the schedule to the TP Regulations, except for a connected person whose total value of controlled transactions is less than NGN 300 million, in which case the connected person may choose not to maintain contemporaneous documentation. But the FIRS may, where it deems such documentation necessary, direct the taxpayer to maintain such record.
TP documentation is a very important part of the TP process because it provides the FIRS with the taxpayer’s basis or justification that the controlled transactions were conducted and priced on an arm’s-length basis. They are sufficient records of information or data, with analysis of such information or data maintained by connected persons as proof that the arm’s-length principle was followed in the pricing of transactions between related parties.
The schedule to the TP Regulations provides for two levels of TP documentation: the master file and the local file.
The master file is required to show an overview of the global business operations of the MNE group to which the ultimate holding company belongs and the information to be included therein, such as organisational structure and a description of the MNE’s business.
The local file is required to disclose detailed information on the enterprise’s related-party transactions.
The categories of information to be provided in the local or master file are also required to be supported with authentic documents relevant to establish the information provided. Furthermore, given the scale of TP documentation as set out under the schedule to the TP Regulations, taxpayers may practically require more than just their regular spreadsheet applications and should consider adopting appropriate software solutions/TP automation systems that enhance TP documentation.
Lastly, taxpayers may explore the advance pricing agreement (APA) mechanism provided for under the TP Regulations as a means of ensuring compliance and reducing the risk that may arise from tax audits.
An APA is meant to establish an appropriate set of criteria for determining whether a taxpayer has complied with the arm’s-length principle for certain future controlled transactions undertaken by that taxpayer over a fixed period (an APA shall apply for a period not exceeding three years). And upon entering the APA, the FIRS may provide confirmation to the connected person that no TP adjustment will be made to a controlled transaction covered by the APA where the transactions are consistent with the terms of the APA.
A request for an APA from the FIRS shall be accompanied with, among others:
A description of the activities of the taxpayer to be addressed in the APA, including a description of the controlled transaction, a FAR analysis, and the proposed duration of the APA;
A proposal for the determination of the transfer prices for the transactions to be covered by the APA, including an analysis of the comparability factors, selection of the MAM, and the critical assumptions as to future events under which the determination is proposed; and
Identification of any other country(ies) that may wish to participate in the APA.
The pre-audit/field audit phase
This phase begins when the tax authority notifies the taxpayer of an intention to conduct a tax audit and requests copies of relevant documents. Under the TP Regulations, the taxpayer is required to make TP documentation available to the FIRS upon request and such documentation must be prepared taking into account the complexity and volume of the transactions. The documentation is also required to be in place prior to the date for the filing of income tax returns for the year in which the documented transaction occurred.
The submission of TP documentation is to be made within 21 days of receiving a request from the FIRS (subject to an extension by the FIRS); failing which, the reporting entity shall be liable to an administrative penalty.
Upon receipt of the request for information and documentation, the taxpayer should review its earlier TP documentation to ensure that the documents collated are in order and support the connected transactions. During a TP audit, the burden of establishing that the conditions of the controlled transactions are consistent with the arm’s-length principle lies with the taxpayer, and the taxpayer will be deemed to have discharged that burden only if it provides documentation consistent with the TP Regulations to support that it complied with the arm’s-length principle in its controlled transactions (Regulation 16(10), the TP Regulations).
The taxpayer must therefore engage with the tax authorities during the field audit phase through appropriate personnel who are able to provide sufficient clarification on the TP documentation. The taxpayer should also rely on the support of TP experts/relevant professionals who can shed light on its TP position before the relevant tax authority. For instance, a legal practitioner and relevant member of the commercial team should be available to provide clarification on the relevant provisions of an intercompany agreement.
It is noteworthy that, by law, tax authorities are generally allowed to conduct tax audits only within six years of filing tax returns, and may go beyond this period only in the case of fraud, wilful default, or neglect (Gulf Oil Company (Nigeria) Limited v Federal Board of Inland Revenue, 3All NTC 1).
The post-audit phase
Upon conclusion of the tax audit, reconciliation meetings should be held with the tax authority to clarify any outstanding matters before the issuance of an additional assessment by the tax authority arising from any adjustment it may make to the income of the taxpayer based on its determination of the taxpayer’s compliance with the arm’s-length principle in line with the TP Regulations.
Given that a dispute may arise between the taxpayer and the tax authorities in this regard, the TP Regulations provide for the FIRS to set up a decision review panel (DRP) for the resolution of disputes or controversies that may arise from the application of the TP Regulations, where a taxpayer objects to an assessment within 30 days of the receipt of the assessment.
The DRP is made up of officers of the FIRS. In rendering its decisions, which represent the FIRS’s final position on the dispute, the DRP will consider:
The adjustment or assessment issued;
The basis on which the adjustment or assessment was issued;
The taxpayer’s objection; and
The evidence presented by the parties.
A taxpayer that is not satisfied with the decision of the DRP may appeal to the Tax Appeal Tribunal (TAT) in line with paragraph 11 of the fifth schedule to the Federal Inland Revenue Service (Establishment) Act. A further appeal may be made from the TAT to the Federal High Court, and up to the Supreme Court of Nigeria.
Final words
Taxpayers must be proactive in dealing with the risk of additional tax liability that may arise from non-compliance with TP requirements. One of the ways to avoid or manage the risk is for taxpayers to adopt the appropriate TP method to ensure that their transactions follow the arm’s-length principle.
A taxpayer is also required to be consistent in the adoption of the appropriate TP method and the reason for variance (if any) in the adopted TP method must be well documented.
Should an audit arise, the taxpayer should be ready to engage proactively with the FIRS, with the support of the right combination of professionals to avoid or minimise the risk of additional tax liability arising from the audit.
