The Nigerian Transfer Pricing (TP) Regime has witnessed significant developments in the last few years, which have resulted in TP finally becoming one of the high-risk tax areas facing Group Companies in Nigeria.
First, there was the introduction and implementation of the Country-by-Country Reporting (CbCR) Regulations with significant administrative penalties for non-compliance. The CbCR Regulations ushered the Regime into an era of unprecedented transparency that requires qualified Multinational Enterprises (MNEs) to disclose their key financial information and economic activities in the jurisdictions where they have footprints to tax authorities.
Second, the revised Nigeria TP Regulations (Revised Regulations) released in 2018 also introduced steep administrative penalties for non-compliance as well as some contentious provisions.
Third, there has been some contentious implementation of aspects of the Revised Regulations such as the retrospective application of administrative penalties for non-filing of TP returns for accounting years prior to the commencement of the Revised Regulations.
Finally, there has been increased number of TP disputes in recent years.
All the above developments, among others, have contributed to making TP one of the highest tax risk areas, thereby making it necessary for taxpayers to have a clear TP strategy to navigate this risky terrain full of pitfalls.
This article analyses how best taxpayers can navigate their TP risks to enable them focus on their respective core businesses.
Ensuring full compliance with TP requirements
2019 witnessed a significant number of taxpayers being penalized for non-compliance with either the CbCR Regulations, the Revised Regulations or both. Some of the penalties, especially the retrospective penalties for late filing of TP Returns ran into hundreds of millions for some Group Companies. Thus, being fully compliant with both sets of Regulations has become more of a necessity.
Being fully compliant means that a taxpayer should have:
- filed all TP Returns (TP Declaration and TP Disclosure Forms) for all relevant years timely;
- prepared annual TP Documentation contemporaneously (i.e. prepared prior to the due date of filing the income tax returns for the year of interest) and ready to be submitted within 21 days of receiving a request;
- if applicable, notified the Federal Inland Revenue Service (FIRS) of which Group entity will be responsible for preparing and submitting the CbC Report to the relevant tax authority; and
- if applicable, prepared the CbC Report and submitted to the FIRS on time.
For taxpayers that are fully compliant, the only concern will be how best to demonstrate that their related party transactions were conducted in a manner consistent with the arm's length principle when audited.
However, for taxpayers that are yet to regularize their TP compliance, they face a more difficult dilemma: either regularize by filing all outstanding TP returns and CbCR notifications/reports, which may potentially trigger penalties or remain non-compliant and leave the onus of establishing non-compliance to the FIRS. Considering that remaining non-compliant increases the potential amount of penalties; we are of the view that the former is the preferred option if the company seeks to mitigate its TP risk exposure on a going forward basis.
Performing periodic reviews to ensure adherence with TP policy
In addition to the risk of taxpayers being assessed administrative penalties for non-compliance with TP requirements, there is the risk of being assessed additional tax liabilities because their related party transactions were not conducted in a manner consistent with the arm's length principle. To mitigate this risk, first, a taxpayer with related party transactions should have a TP Policy that guides the pricing of all its related party transactions. The TP Policy is an internal guidance which includes details of arm's length prices/benchmark ranges.
Second, the taxpayer has to operationalize the TP Policy by implementing a process or mechanism to ensure that the pricing of the related party transactions are in line with the TP Policy. For large MNEs with significant related party transactions, this can be achieved by incorporating the arm's length prices in their IT systems to ensure the appropriate prices are charged contemporaneously as the transactions occur. However, considering that such an approach is costly, most taxpayers may consider periodic reviews of the pricing or margins from related party transactions to ensure that they are in line with the TP Policy. These review can be performed quarterly, semi-annually, or at year-end and necessary true-ups made before the financial books are closed.
Such proactive measures are necessary to ensure that the intended prices of related party transactions are consistent with actual prices. This requires that in addition to the Finance Department, the Operations Department(s) should also be conversant with the TP policy of the Group or company.
Adopting a proactive approach to TP controversy
Finally, no matter how compliant a taxpayer is with the TP requirements or how often the taxpayer performs periodic reviews to ensure that its TP Policy is actually being applied, there is bound to be dispute with the FIRS during a TP audit. This is partly because TP as a tax discipline is highly contentious. Unlike core tax, it goes beyond the appropriate interpretation of the tax laws and focuses more on an appropriate application of the theoretically sound arm's length principle that faces some practical application challenges. Coupled with the fact that the objectives of the taxpayer and the tax administrator differ, it is virtually inevitable to have a dispute during a TP audit.
As such, it is important that taxpayers be proactive by considering their TP dispute resolution alternatives when complying with the TP requirements. This enables the taxpayer to be aware of all available options in case of unavoidable TP dispute and make informed decisions on the preferred options.
The key TP dispute resolution options available to the taxpayer are negotiations and litigation, given that the Decision Review Panel headed by the Head of the FIRS' International Tax Division is not an independent arbitration body as is the case in other jurisdictions such as the United States of America. Where the TP function is outsourced, having a firm with strong TP and legal capabilities is becoming increasingly important because of the increasing possibility of ending up with litigation as a last resort.
TP has increasingly become a high risk area of taxation, as such, taxpayers cannot afford to have a passive or reactive approach to dealing with it. Ensuring that you are fully compliant with TP filing and documentation requirements is a must to avoid steep administrative penalties. Further, having robust TP documentation and periodic reviews to ensure that your TP policy is being implemented will help mitigate the risk of TP adjustments and assessment of additional tax liabilities for multiple years. Finally, TP dispute resolutions options, including litigation at the tax tribunal, should be proactively reviewed to ensure that you have a comprehensive TP strategy that covers each phase of the TP cycle.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.