The Transfer Pricing (TP) returns filing deadline has passed for most Nigerian Taxpayers. The Federal Inland Revenue Service (FIRS) therefore has financial information about taxpayer's Related Party Transactions (RPTs) for the most recent Financial Year (FY). This information coupled with prior year TP returns and documents is very useful to the FIRS in carrying out their internal risk assessment procedures which determine whether to proceed with a full blown audit or not.

In recent months, there has been a significant drive by the FIRS to generate more tax revenues to fund government expenditure. TP audits are one of the avenues through which the FIRS can generate additional tax revenues. As such, the chances of a taxpayer being selected for TP audit has increased significantly, especially since the additional tax liabilities which may crystalize from a TP audit are typically significant. In the last few weeks, several taxpayers have received Information Document Requests (IDRs) and field audit visit requests from the FIRS, signaling the start or continuation of a TP audit.

It is therefore important for taxpayers to understand the TP audit process and how to effectively manage the audit. This article highlights the different stages of a TP audit in Nigeria, drawing from our wealth of experiences in each phase and suggests strategies taxpayers should adopt to minimize the risks associated with TP audits.

The TP Audit

A TP audit is a detailed review of a taxpayer's RPTs to determine if they have been conducted in a manner consistent with the arm's length principle. It usually involves the review of the taxpayer's business operations, documents, records, financial and economic data. The TP audit is typically in four (4) phases. We have provided below details of each phase and key points to note in managing the phases.

Phase 1: TP Risk Assessment and Desk Review

TP audits are resource-intensive, thus, the FIRS carries out risk-assessment procedures to ascertain the risk profile of taxpayers before deciding to proceed with the TP audit. The FIRS would typically send an IDR, which would cover multiple years, and sometimes companies are overwhelmed by the number of documents requested. The documents requested through the IDRs include TP documentation, financial statements, agreements, trial balance, invoices etc.

Some audit triggers the FIRS considers include; consistent loss making entities, RPTs with entities in tax-friendly jurisdictions, volume of RPTs, procurement arrangements, excessive intercompany loans, weak TP documentation etc.

Key Takeaways

  1. Taxpayers are advised to keep an audit defence file which will contain relevant information relating to the RPTs conducted. Proper record keeping as such can reduce the pressure to retrieve information when the company receives an IDR.
  2. Taxpayers are advised to prepare robust TP documentation as this is the first line of defence in a TP audit. The robustness of the TP documentation and the quality of information supplied to the tax authorities at this stage may go a long way in determining whether the tax authorities will proceed to the next stage of the audit.
  3. Taxpayers are advised to conduct internal risk assessments of their RPTs for the purpose of identifying the risk associated with the RPTs. This enables the taxpayer proactively develop strategies to manage their TP risk exposures. From this exercise, the taxpayer can also identify any supporting documents that may be required to defend their TP position and have sufficient time to collate these information.
  4. Documents to be submitted to the FIRS should be properly reviewed to ensure that it supports the company's position regarding the RPTs.

Phase 2: Field Audit

This is the fact-finding stage of the TP audit and is very crucial to the success of the audit. The objective of this phase is to get an understanding of the RPTs by ascertaining the substance of the RPTs – functions performed, assets utilized and risks borne and the pricing arrangement of each RPT. Where the substance of the transaction cannot be demonstrated, the entire transaction can be disallowed for tax purposes. The FIRS may make further requests for documents at this stage.

The taxpayer may be required to make a presentation to the FIRS on its business operations and the RPTs carried out during the years under review. The FIRS will also conduct interviews with process owners with insight into the RPTs conducted by the Company and issue interview notes for the interviewee's review and attestation. The FIRS may also conduct a factory/office/ warehouse tour. This phase ends with a close-out meeting with the FIRS.

Key Takeaways

  1. Due to the importance of this stage, the persons interviewed should be well prepared, knowledgeable about the RPTs and understand the objectives of the TP audit, as misrepresentation of facts could affect the outcome of the audit.
  2. Taxpayers should critically review the interview notes and ensure the facts surrounding the RPTs were not misinterpreted and update where necessary. This is especially important as this document will serve as evidence of the facts gathered during the audit and will be referred to throughout the audit.

Phase 3: Post-field Audit

Following the field audit phase, the FIRS will issue an audit report stating their position on the RPTs based on information gathered during the first two phases. The taxpayer is expected to rebut the FIRS' position and may provide further documents to support its position. From experience, where the FIRS has arrived at a position, it can be difficult to change their position without a superior argument supported by ample documentary evidence.

Several reconciliation meetings may be held with the aim of arriving at an agreeable position to both parties. Where both parties are able to arrive at an agreeable position, an assessment may be raised by the FIRS and thereafter settled by the taxpayer thereby concluding the audit process. However, where an agreeable position cannot be reached, the audit progresses to the fourth phase.

"Taxpayers need to proactively adopt strategies that will enable them manage the risks associated with the TP audit. The place of proactivity cannot be over-emphasised and it begins from the preparation of the TP documentation and filing of TP returns."

Key Takeaways

  1. Taxpayers should thoroughly review the FIRS' report and address any incorrect positions arrived at by the FIRS. Strong technical, economic/business and persuasive arguments should be put forward to defend the company's position, backed up by supporting documents.
  2. Taxpayers are advised to avoid closing out hastily on TP audits, especially when the issue involved is a technical matter involving TP principles and has potential adverse implications for related parties in other jurisdictions. While taxpayers may have an incentive to quickly close-out audits in order to avoid spending time and resources on the audit, it should be noted that where technical matters are not well analysed and resolved, it may lead to ambiguity in the treatment of those RPTs going forward.
  3. It is important that taxpayers evaluate their dispute resolution options at this phase in case a favourable position is not reached. Having reviewed the FIRS' report and analysed the potential additional liabilities which may arise, taxpayers should determine their preferred dispute resolution option in the event they are unable to resolve the issues during this phase.

Phase 4: Post Audit

Where the taxpayer and the FIRS are unable to reconcile their respective positions, both parties can embark upon a dispute resolution process. The dispute resolution options include negotiation, decision review panel, mutual agreement procedures and litigation.

Key Takeaways

  1. Taxpayers should measure the different litigation options considering the strength of their position on the matter under dispute. This can influence the decision of the type of dispute resolution option to adopt.
  2. At this stage adequate representation is key. Where the litigation option is taken, it is important that technical advisers work with the lawyers to properly prepare the case. This increases the chances of a favourable outcome.

Taxpayers need to proactively adopt strategies that will enable them manage the risks associated with the TP audit. The place of proactivity cannot be over-emphasised and it begins from the preparation of the TP documentation and filing of TP returns.

Also, it is paramount that taxpayers have the support of tax advisers to guide them through the audit process, especially as TP is a very technical area. Having a technically strong TP expert may make the difference during the TP audit process.

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.