Introduction

The prevalent use of tax avoidance strategies such as Transfer Pricing (TP) by multinational enterprises (MNEs) has become a major international taxation issue in recent years. By making use of several tax shifting accounting manipulations, MNEs attempt to exploit differences in marginal statutory tax rates across countries where they have subsidiaries and associate enterprises for the purpose of adjusting their profits based on their cross-border transactions. Since MNEs may try to divert their profits from high tax jurisdictions where they operate into low tax jurisdictions or tax havens through TP tactics, national tax authorities have initiated tax audits on MNEs for the purpose of verifying whether the pricing of controlled transactions are in line with the arm's length principle and other tax and regulatory provisions of the country. TP audits are therefore used by tax authorities to review the TP returns, documents, financial and economic records of MNEs and to assess the arm's length nature of related party transactions.

In Nigeria, the Federal Inland Revenue Service (FIRS) functions as the TP auditor who carries out an independent review  of the taxpayer's TP documentations and financial records, after which it prepares an audit report to show whether the taxpayer has complied with the arm's length principle. In line with its powers contained in the 2018 TP Regulations and the Federal Inland Revenue Service (Establishment) Act, the FIRS is empowered to make necessary adjustments to the pricing of related party transactions in the event that the taxpayer fails to comply with the arm's length principle, the result of which may lead to additional tax liability and penalties for affected taxpayers. This approach of addressing TP issues (would) undoubtedly created several TP controversies and lead to increased litigations and disputes between tax authorities and MNEs. Most multinationals are now contesting the demands raised by tax authorities for the alleged contravention of TP legislative provisions.

TP regulations in Nigeria provide for several dispute resolution mechanisms with varying implications. As seen in Regulations 14, the administrative mechanism for resolving disputes or controversies arising from TP adjustments made by the FIRS to a taxpayer's taxable profit is the Decision Review Panel (DRP). This option is however rarely used by taxpayers to resolve disputes due to the presumed bias that may arise because of the panel being composed of only officials of FIRS. Also, under the Regulations, taxpayers have the opportunity to present their disputes in courts from the Tax Appeal Tribunal up to the Supreme Court. This option is however long drawn and costly and is often used as the last resort. It's also worth noting that under the 2012 TP regulations, both the taxpayer and FIRS can refer to DRP but under the 2018 regulations, only FIRS can refer a case to the DRP. Since regulating TP is relatively new in Nigeria, judges may not be able to have an appreciable understanding of the issues of the case and therefore may fail to effectively resolve the disputes and controversies that may arise between the taxpayer and the tax authority. In light of the costly and lengthy nature of TP audit cases in Nigerian courts, it is necessary for the FIRS and taxpayers alike, to take advantage of other techniques such as advance pricing arrangements (APAs) in order to prevent the disputes and controversies from arising in the first place.

This article therefore examines the prospects of APAs in TP and the need for the FIRS and other tax authorities to issue guidelines geared towards entertaining any taxpayer's requests for APAs.

What are APAs?

APAs are key dispute avoidance mechanisms which play a key role in preventing disputes between taxpayers and tax authorities from occurring. An APA is defined in the 2017 OECD TP Guidelines for Multinational Enterprises and Tax Administrations as "an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events) for the determination of the TP for those transactions over a fixed period of time." In other words, APAs are formal arrangements between taxpayers and tax authorities in respect of certain controlled cross border activities which aim to avoid TP disputes by setting in advance a set of criteria for pricing of these transactions for future years. The arrangements are therefore made for the purpose of determining the TP methodology which will be used to price international transactions of taxpayers for future years. By definition, the scope of APAs is limited to issues relating to TP and the arm's length principle which arise in connection with Articles 7 and 9 of the OECD Model Tax Convention. The rationale behind APAs is to promote tax certainty and transparency for taxpayers, as well as preventing possible exposure to the risks of double taxation. It therefore serves as a mechanism for improving the efficiency of tax administration by encouraging collaboration between taxpayers and tax authorities on proper TP analysis while working towards a mutual agreement.

APAs are of different types and may be unilateral, bilateral or multilateral depending on the number of tax administrations involved in the arrangement. Unilateral APAs involve only the taxpayer and the tax authority of the country where the taxpayer is domiciled. Bilateral APAs on the other hand involve four parties including the taxpayer, tax authority of the country where the taxpayer is domiciled, associated enterprise of the tax payer in the foreign country, and the tax authority of the country where the associated enterprise is domiciled. Multilateral APAs however involve multiple parties including the taxpayer, the tax authority of the country where the taxpayer is domiciled, two or more associated enterprises of the taxpayer in different foreign countries, and the respective tax authorities of the associated enterprises.  A bilateral or multilateral APA is usually in the nature of a mutual agreement procedure APA which is regulated by Article 25 of the OECD Model Tax Convention. According to the OECD guidelines, asides the fact that some countries refuse to grant unilateral APAs to taxpayers within their jurisdiction, concerns over double taxation have led most MNEs to prefer bilateral and multilateral APAs. It has been noted that bilateral and multilateral APAs are more likely to alleviate the risk of profit shifting and double taxation, promote greater certainty for taxpayers and to be equitable to all tax administrations and taxpayers involved. This has led the OECD guidelines to recommend that APAs should be concluded on a bilateral and multilateral basis between tax authorities through the mutual agreement procedure of the relevant tax treaty.

Prospects of adopting APAs in Nigeria

APAs have become a commonly used TP dispute prevention mechanism which promotes certainty with respect to tax outcome of the taxpayer's international transactions; ensures the fair application of the arm's length principle; saves time and costs of TP audits; avoids double taxation; and reduces the burden of record keeping and documentation.

Certainty for taxpayer's transactions

One important benefit of APAs is the certainty it provides in the country's tax regime both for taxpayers and tax administrations. Multinational taxpayers may use APA to achieve certainty on the tax treatment of their cross-border transactions for future years covered by the arrangement. Provided the conditions of an APA are fulfilled, a taxpayer enjoys some form of certainty including the freedom from penalty exposure, certainty as to tax position for financial and tax reporting, as well as the freedom from being subjected to costly TP audits which may arise in the future with respect to relevant transactions covered under the arrangement. After the expiration of an APA, tax administrations and MNEs may decide to renegotiate the agreement. In light of the certainty provided by an APA, MNEs are placed in a better position to predict their tax liabilities, with the tax administration creating a tax environment that increases the ease of doing business and is therefore favourable for investment.

Fair application of the arm's length principle

An APA system also seeks to ensure the fair application of the arm's length principle through the mutual agreement made in advance between tax authorities and multinational taxpayers as to the arm's length pricing or TP methodology to be applicable to the latter's international transactions covered by the arrangement.

Saves time and costs of TP audits

There is no doubt that APAs provide a win-win situation for all relevant parties involved. For tax administrators, an APA system reduces heavy reliance on scarce resources, alleviates the cost of conducting TP audits and appeals over the period of the APA, as well as prevents lengthy and time-consuming litigations. APA avoids all the drawbacks of litigation, particularly in relation to drawn out litigation, and the uncertainty of the result of litigation. Also, it has been observed that APAs concluded on a bilateral and multilateral basis help to enhance the mutual agreement procedure by significantly reducing the time needed to reach an agreement. This is because under the arrangement, tax administrators deal with current data as opposed to prior year data which may be difficult and time-consuming to produce. For taxpayers, it reduces the threats of TP audits for transactions covered by the APA and eliminates penalties for potential TP adjustments. The futuristic nature of APA allows for quick identification of potential disputes and prompt resolution during negotiation process.

Avoids double taxation

Where a tax authority within a jurisdiction carries out tax audits in order to verify whether the prices invoiced by MNEs are in compliance with tax laws provisions and therefore subject the MNEs to TP adjustments, this may result in double taxation for the company. Instead of preparing a TP documentation and recording file, bilateral and multinational APAs in particular help to substantially mitigate this risk for multinational taxpayers.

Alleviates the burden of documentation

Due to the nature of APAs, taxpayers are aware in advance of the required documents that are to be maintained in order to substantiate the agreed terms and conditions of the arrangement. In the event where an APA is agreed and finalised, all the taxpayer needs do, as required in many jurisdictions is to file a compliance report which is usually in a prescribed form. This reduces the burden of documentation and record keeping for both tax administrators and taxpayers.

Challenges of adopting APAs in Nigeria

Notwithstanding the benefits and prospects of APA as a dispute prevention technique in TP, there are several problems it may present for both the taxpayer and tax authority. Firstly, it may be difficult for all taxpayers to secure an APA since the procedure can be very costly and time consuming and only big taxpayers may be able to afford it particularly in situations where independent TP specialists are involved in the arrangement. The APA system is therefore used mainly in large TP cases involving big multinationals. Secondly, as opposed to bilateral or multilateral APAs, unilateral APAs provide certainty only for the taxpayer in one jurisdiction and may not in all cases prevent MNEs from being doubly taxed. By providing only a partial resolution to international TP issues, unilateral APAs do not determine how the issues are to be resolved in the other country involved. This arrangement therefore does not eliminate the risk of double taxation in relation to TP. Thirdly, APA allows tax authorities to make a closer study of cross border transactions of MNEs with respect to TP, while requiring detailed disclosure of information which can pose a huge challenge for multinational taxpayers that are concerned about protecting corporate secrets. Since taxpayers are expected to apply previous years' data and future year's projections, as well as disclose extensive and sensitive information about their operations, they face the risk of suffering irreparable loss. Thus, the fear that confidential information may be revealed under the arrangement has hindered taxpayers from concluding APAs with tax authorities.

In addition, APAs do not exclude MNEs from examination of its TP activities, as it may still have to show that it has complied in good faith with the terms and conditions of the APA, that the critical assumptions underlying the APA are still valid and that the TP methodology is applied on a regular basis. Another challenge is the difficulty in implementing APA system by tax authorities which may lead to the ineffectiveness of the arrangement. Tax authorities must therefore perform critical supervision to ensure the taxpayer acts in compliance with the terms and conditions of the APA. This requires a high level of administrative methods and standards in the tax administration which may be difficult for a developing country like Nigeria to sustain.

Lessons to be learnt by Nigeria from other countries and jurisdictions with an APA system

Developed and developing countries like China, India, Canada, Australia, United States and the United Kingdom have already implemented an APA system for the purpose of addressing the proliferation of TP controversies. In China, the State Taxation Administration (STA) published the 2019 APA annual report which summarises the circumstances under which the tax authorities in the country signed APA and introduced the current APA regulations, while providing data on signed APAs between taxpayers and STA covering the period from 1 January 2005 until 31 December 2019. The report shows that tax authorities in China concluded 21 APAs in 2019, including 12 unilateral APAs and 9 bilateral APAs, both of which are considered a record high since 2009. As observed in the 2019 statistics, MNEs are applying for APAs in China as a mechanism for ensuring tax certainty and avoiding double taxation. The United States is known to establish the world's first formal APA program in 1991 as an alternative to the regular TP enforcement process. The program is geared towards negotiating prospective agreements with taxpayers and other tax authorities on complex TP issues. In 2012, the APA program was renamed as the Advance Pricing and Mutual Agreement (APMA) program and has received more than 2,549 APA requests and signed over 1,820 APAs. The Internal Revenue Service's APMA issued its annual report as regards the operations of the United States' APA program in 2020. This report, as in the case of China's annual report, underlines the importance of APAs as tax planning tools for MNEs operating in China and the United States. Tax authorities in both countries meet on a regular basis to discuss APA and to develop a productive working relationship, as well as handle an increasing number of cases in TP.

The Indian government also introduced the APA system in 2012 after it witnessed many TP cases held up in dispute. APA was therefore adopted with the aim of providing "much needed tax certainty to MNEs operating in India, particularly on their intra-group transactions, and in the process, adopt global best practices." Over the years, APA system in India has received considerable popularity amongst taxpayers and tax administrations globally for being able to address complex TP issues in a fair and transparent way. This is evidenced by the fact that over 1,150 APA applications have been filed and close to 271 APAs (unilateral and bilateral) signed. With respect to the United Kingdom, its APA program has been in operation since 1999. While every APA request is considered, there exists the likelihood for Her Majesty Revenue and Customs (HMRC) to accept APA requests only in situations involving complex TP issues or circumstances where without an APA, there will be high possibility of double taxation or where the HMRC considers it to be a good use of government and taxpayer's resources.

There is no doubt that Nigeria can gain substantial lessons from the experience of other countries and jurisdictions that have successfully embarked on APA programs to promote certainty in international transactions and reduce the scope for litigation. In light of the cumbersome and costly nature of resolving TP disputes by traditional TP audits and examination techniques, it is imperative for the FIRS to implement the APA program in Nigeria in order to provide the opportunity for negotiations with taxpayers on transfer prices of related party transactions before they are conducted. APA therefore has the potential of increasing the level of certainty in respect of complex TP transactions, and general compliance level, while reducing the rate at which TP disputes and litigations occur between FIRS and taxpayers.

Conclusion

There is no doubt that APA has the potential of being used as a mechanism for risk management, promoting tax certainty and transparency, as well as serving as an efficient alternative for TP dispute resolution. Notwithstanding the fact that Nigeria's TP Regulations contain provisions for APAs, the FIRS is yet to begin the APA program. Considering the recent advancement in TP, most multinational taxpayers in the country are now conscious of the need to comply with the arm's length principle in the planning phase of potential related party transactions. The FIRS is therefore encouraged to issue a circular or guideline to enlighten taxpayers on APAs, and then put teams and processes in place to accommodate APA applications from taxpayers. There is not a better time for the FIRS to pay closer attention to adopting dispute prevention mechanisms as an alternative to dispute resolution, while also adopting strategies to address the challenges attendant with the implementation of APAs.

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