Transfer Pricing (TP) as a discipline in taxation seeks to analyze whether Related Party Transactions (RPT) are conducted in a fair manner to ensure that entities involved in the transactions declare their fair amount of profits for tax purposes. The transactions analysed can be categorized into four main groups – tangible goods, services, intangibles and financial transactions. All four groups of transactions are Profit & Loss (P&L) items that impact the profitability of an entity.

Of the four groups of transactions, intangibles are generally more complex in nature and are therefore more difficult to analyze. As a result, a few African countries such as Nigeria have adopted a form of "General Anti-Avoidance Rule (GAAR)". Nigeria has capped the tax deductibility of royalty payments to related parties to 5% of EBITDAC (Earnings before Interest, Tax, Depreciation, Ammortisation and the intangible Consideration), which is clearly inconsistent with the Arm's Length Principle (ALP) upon which TP analyses are predicated. This has created significant confusion for taxpayers, creates significant potential double taxation risks for Multinational Enterprises (MNEs), and has material impact on the ease of doing business in Nigeria.

Considering the post-AfCTA (African Continental Free Trade Agreement) era where African economies are competing for Foreign Direct Investments (FDIs), with Nigeria losing its competitive advantage of market size, factors that are unattractive to FDIs may have much bigger adverse impact on the economy than before.

This article reviews the key provisions in the 2018 Nigeria TP Regulations (the Regulations) relating to intangible transactions, the challenges posed to taxpayers due to inconsistency with the ALP, and proffers recommendations that may help the Federal Inland Revenue Service (FIRS) achieve its objective of protecting the nation's tax base without creating confusion in its application, reduce the incidence of double taxation, and contribute positively to the ease of doing business in Nigeria.

Guidance on Analyzing Intangibles

The Regulations and the 2021 OECD TP Guidelines provide guidance on how to identify intangible transactions, the relevant functional factors that contribute to the value of intangibles, and TP methods to be used to analyze such RPTs based on the ALP. The ALP tests the reasonableness of the outcome of RPTs by comparing them with outcomes of comparable transactions between independent parties under similar facts and circumstances.

With such detailed guidance in both the Regulations and the OECD TP Guidelines, it is baffling that the Regulations will introduce a cap for tax deductibility purposes that is inconsistent with the globally accepted ALP.


To better appreciate the issue at hand, let us make use of a simple hypothetical example. Let us assume that a Fast Moving Consumer Goods (FMCG) company that is a member of an MNE Group (SubCo) licenses unique and valuable technology and process know-how from its Parent Company (ParentCo) to help make its manufacturing process more efficient. This efficiency is a critical success factor for the SubCo because it enables it price competitively and increase demand for a High Volume and Low Margin (HVLM) business.

Let us further assume that ParentCo does not license the unique and valuable intangible to third parties, so we do not have internal third party data to compare with the royalty charged to SubCo (an Internal Comparable Uncontrolled Price Method). However, there exist license arrangements of similar types of technology and process know-how between independent parties that show that the licensors charge the respective licensees royalty rates as a percentage of the revenues that the valuable technology and process know-how drive.

In this example, clearly in an arm's length dealing, the compensation for the use of the intangibles is a percentage of revenue and ParentCo will be expected to charge a royalty rate on this basis. However, the Regulations provides that the amount of tax deductible for such royalty payments to related parties be capped at 5% of EBITDAC, even though the arm's length range of royalty rates that independent licensors charge is from say 2% to 6% of revenue.

This scenario causes a number of challenges for affected taxpayers:

First, the provision is clearly inconsistent with the ALP upon which the Regulations is based on, creating confusion for taxpayers that have similar intangible transactions that are treated differently in other jurisdictions where they have businesses.

Second, if SubCo chooses to only pay a royalty amount limited to the 5% of EBITDAC to avoid having the excess amount disallowed for tax purposes, ParentCo during a TP audit by its tax authorities will be expected to have received a royalty payment commensurate with the armslength outcome. As such the tax authorities will make an upward adjustment to the royalty payment from SubCo to for example, 4% of the revenue of SubCo and tax the additional profit resulting from the adjustment. This clearly results in the MNE Group (including SubCo) suffering double taxation, which is in variance with one of the key objectives of the Regulations of seeking to minimize double taxation risks for taxpayers.

Third, because Nigeria has a relatively smaller tax treaty network, depending on the jurisdiction of ParentCo, the MNE Group may not be able to seek double tax relief via a potential corresponding adjustment on SubCo's end. Even where Nigeria has a tax treaty with the country, the reconciliation process is highly inefficient and historically ineffective in practice.

"In a period where the Nigerian economy needs revenues for developmental purposes and at the same time needs FDIs to help stimulate a sluggish economy, the Government has to ensure that achieving one objective does not come at the detriment of the other. As such, having a balanced approach to achieve both objectives cannot be overemphasized."

Finally, the confusion in the application of the Regulations relating to intangibles and the associated double taxation risks adversely impacts the ease of doing business in Nigeria for businesses that rely on intangibles such as technology, process know how, trade names and trademarks, as a source of differentiation in their industries. Examples of such industries include the Consumer, Industrial, Technology, and Pharmaceutical industries. As such, this may be a deterrent for some MNEs in these industries seeking to enter the Nigerian market, especially in a post-AfCTA era where such businesses can set up in other African countries and still access Nigeria's large market size.


Considering the above challenges, it is imperative that the Federal Government through the FIRS reviews the highly controversial GAAR provision in the Regulations relating to royalty payments for use of valuable intangibles.

With the detailed guidance on the analysis of intangibles in both the Regulations and the OECD TP Guidelines, a rigorous review by the FIRS of the valuable functions performed by each entity involved in the intangible transaction such as the Development, Enhancement, Maintenance, Protection and Exploitation (DEMPE) of the intangible over time should help mitigate excessive outflows through royalty payments. This approach will be consistent with the internationally accepted ALP while protecting the Nigerian tax base. It will also help mitigate the challenges of confusion, double taxation risks and potential loss of FDI that will adversely impact the Nigerian economy.

Concluding Remarks

In a period where the Nigerian economy needs revenues for developmental purposes and at the same time needs FDIs to help stimulate a sluggish economy, the Government has to ensure that achieving one objective does not come at the detriment of the other. As such, having a balanced approach to achieve both objectives cannot be overemphasized. Thus, the FIRS should takes steps to revise the guidance on intangibles in the Regulations to make it consistent with the internationally accepted ALP, while applying a rigorous review of the DEMPE functions of entities involved in the intangible transactions to ensure that the local entities do not pay excess royalties to their foreign affiliates.

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.