The transfer pricing regulations cover all transactions between 'connected taxable persons' that could impact the profit or loss position of any of the parties including transactions that entail the use of intangible assets, provision of goods or services, loans, lease or sale of assets; licensing, transfer, procurement etc. 'Connected taxable persons' can broadly be defined as companies or entities operating in Nigeria and having common control, management or ownership with other companies or who participate directly or indirectly in the management, control or capital of another company or persons otherwise connected with another person.1 Transfer pricing rules require transactions between connected taxable persons to be in accordance with the arm's-length principle and consistent with the arms-length principle stipulated under Article 9 of the United Nations (UN) and Organisation for Economic Co-operation and Development (OECD) Model Tax Conventions on Income and Capital and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2017 and the UN Practical Manual on Transfer Pricing for Developing Countries, 2017.2 In broad terms, arm's-length principles stipulate that the terms and conditions applied in transactions between connected taxable persons should be the same as those applied in transactions between independent parties.
Over time, it has become clear that the term arm's-length principle could be ambiguous and susceptible to divergent interpretations in certain circumstances. In the face of these uncertainties, there are certain legal or regulatory provisions that seem to specify with some degree of certainty the kind of pricing or compensatory arrangement that would be regarded as compliant with the arms-length principle. Such provisions are otherwise referred to as "Safe harbour rules." In this article, we provide insights on the impact of safe harbour and other similar transfer pricing rules on businesses and proffer recommendations on the most effective approach for managing the impact of such rules.
The term "safe harbour" has been defined by the Organisation for Economic Cooperation and Development (OECD) as "...a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country's general TP rules."3 Regulation 22 of the Income Tax (Transfer Pricing) Regulations, 2018 (the Transfer Pricing regulation), which essentially, is a safe harbour provision, provides that:
" A connected person may be exempted from the requirement of regulation 16 of these Regulations where the controlled transactions are priced in accordance with specific guidelines that may be published by the Service for that purpose from time to time."
Pursuant to this provision, the Federal Inland Revenue Service (FIRS or the Service) issued guidelines stating that transactions priced in accordance with statutory or regulatory provisions will be regarded as safe harbour transactions. This was a major shift from the controversy witnessed under the erstwhile Transfer Pricing Regulations 2012 where, for example, pricing arrangements for management and technical services fees approved by the National Office for Technology Acquisition and Promotion (NOTAP) were rejected by the FIRS on the grounds that such pricing arrangements were inconsistent with the arm's-length principle.
Notwithstanding all the obvious benefits of safe harbour provisions, some of which include compliance cost reduction, certainty in determining acceptable "arm's length" price and ease in administrative scrutiny or review. Safe harbour provisions are not without their setbacks, chief among which is the possibility of creating unfair and higher tax burden for taxpayers in situations where its connected counterparty is resident in a country that does not recognize such safe harbour provision and applies a different pricing structure deemed to be the "arm's-length price".
Considering the definition of safe harbour price as discussed above, of note is the regulatorily prescribed pricing for transfer of rights in intangible. Regulation 7.5 of the Transfer Pricing regulation provides that:
"Notwithstanding any other provision of these Regulations, where a person engages in any transaction with a related person that involves the transfer of rights in an intangible, other than the alienation of an intangible, the consideration payable in that transaction that is allowable for deduction for tax purposes shall not exceed 5% of the earnings before the interest, tax, depreciation, amortisation and that consideration, derived from the commercial activity conducted by the person in which the rights transferred are exploited."
This provision is renowned for its propensity to create unfair and higher tax burdens for connected taxable persons and in some situations could give rise to double taxation. For example, in a transaction between a Nigerian company and its related company based offshore involving the transfer of rights in an intangible to the Nigerian company, the above provision will not allow the Nigerian company to pay more than 5% of the earnings before the interest, tax, depreciation and amortization as consideration for the rights transferred. Considering the level of economic development in Nigeria and the fact that the Nigerian company in such a scenario will usually be an investee company of the offshore entity operating on a lower business scale, the prescribed 5% may be significantly incommensurate with the value of the rights being transferred to the Nigerian company. Such pricing arrangements may be regarded as noncompetitive or absurd by the revenue authorities in the country where the offshore-related party is based. This could give rise to pricing adjustments that could lead to double taxation. On the flip side, the offshore-related party could insist on the higher pricing scale that is acceptable to its local revenue authority. The impact of this would be that the Nigerian entity could pay the higher price proposed by its offshore related party but will only be able to claim a lesser amount that conforms with the threshold stipulated in regulation 7.5 of the Transfer Pricing Regulation as tax deduction, thus creating an unfair and higher tax burden for the Nigerian entity and even double taxation in an already unfriendly business environment.
Can This be Challenged Via Adjudicatory Process?
In our previous publication titled "Judicial Intervention In Tax Dispute Resolution"4 we emphasized that the judiciary plays a crucial role in the administration of justice but unfortunately, taxpayers hardly explore this avenue in asserting their rights and entitlements in the wake of tax-related disputes.5 The TP regulation is a subsidiary legislation issued by the FIRS pursuant to powers delegated under section 61 of the FIRS Establishment Act. It is trite law that delegated authority cannot be exercised outside the scope of the powers delegated under the enabling legislation.6 Section 61 of the FIRS Act provides that:
"The Board may with the approval of the Minister, make rules and regulations as in its opinion are necessary or expedient for giving full effect to the provisions of this Act and for the due administration of its provisions and may in particular, make regulations prescribing the – (a) forms for returns and other information required under this Act or any other enactment or law; and (b) procedure for obtaining any information required under this Act or any other enactment or law."
It is clear from the above provisions that the purpose of the Transfer Pricing Regulation is to give full effect to the provisions of applicable tax laws such as the Company Income Tax Act Cap C21, LFN 2004 (as Amended) (CITA), The Personal Income Tax Act 2011 (as amended), the Value Added Tax Act 2004, the Capital Gains Tax Act etc. Giving effect to the provisions of an act is different from creating additional requirements or otherwise adding to the provisions of that act.
Also, delegated legislation should not be inconsistent with the enabling statute. For example, the CITA clearly stipulates that expenses are deductible for companies income tax purposes if they are wholly, reasonably, exclusively, and necessarily incurred for the purpose of trade or business. Going back to the above illustration, where the Nigerian entity pays the higher price offered by its offshore related party, it should be able to claim tax deductions on the full payment following the express provisions of the CITA and not restricted to claiming deductions on the lesser amount that conforms with the threshold stipulated in regulation 7.5 of the Transfer Pricing regulation. Considering this scenario, could it be concluded that the Transfer Pricing Regulation has redefined the requirements for claiming allowable deductions under the CITA and other applicable tax laws? could it be said that the Transfer Pricing Regulations is, to this extent, inconsistent with the express provisions of the CITA and other applicable tax laws? These are questions that could be resolved by exploring tax dispute resolution mechanisms through the Tax Appeal Tribunal and the superior courts of record. The validity of the Transfer Pricing Regulations should be tested along these parameters. A similar regulation issued by the FIRS pursuant to powers delegated to the Service under the same section 61 of the Federal Inland Revenue Service (FIRS) Establishment Act 2007 was subjected to such validity test before the Tax Appeal Tribunal (TAT) sometime in August 2023 and, guess what? It failed the test! That regulation is the Income Tax (Country-by-Country Reporting) Regulations 2018 (the "CbC Regulation"). In an appeal filed by Check Point Software Technologies B. V. Nig. Ltd against the FIRS – Appeal No: TAT/LZ/CIT/121/2022, the TAT held that the CbC Regulation was ultra vires, illegal, null and void. Without delving into the issues discussed above, the TAT held that Section 61 of the Act gives powers to the Board of FIRS and that the National Assembly has delegated its powers specifically to the Board of the Federal Inland Revenue Service to make these rules, guidelines and regulations and to no other person or authority. Therefore, it is only a legally constituted and properly composed Board of the FIRS that can exercise the powers delegated by the National Assembly in Section 61 of the Act. The Appellant in the suit had presented concrete evidence before the TAT that during the period under consideration, the Boards of all federal parastatals and agencies (including that of the Federal Inland Revenue Service) were dissolved and had not been reconstituted.
The TAT also held that the Regulation imposed a penalty that is higher than what the Principal Act has imposed. The TAT emphasized that a subsidiary legislation derives its validity and authority from the substantive law and has no capacity to extend such authority. It remains to be seen if a similar interpretation and treatment will not be accorded the Transfer Pricing Regulation when subjected to an adjudicatory test.
Conclusion and Recommendation
In this article, insights on the impact of safe harbour and other similar transfer pricing rules on businesses were provided. Having considered the issues discussed, it is recommended that provisions of the TP regulations that work hardship for taxpayers should be subjected to adjudicatory tests and interpretation by the TAT and superior courts of records.
Footnotes
1. See the Income Tax (Transfer Pricing) Regulations, 2018; see also
2. See Regulation 18 of the Income Tax (Transfer Pricing) Regulations, 2018
3. the Organisation for Economic Cooperation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2017)
4. judicial-intervention-in-tax-dispute-resolution
5. Ibid
6. Shell (Nig) Exploration and Production Co LTD V NOSDRA (2021) LPELR_53068 (CA)
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.
