Transfer Pricing (TP) audits are a key part of the activities of the tax authorities as audits afford them the opportunity to assess the level of taxpayers' compliance to extant TP laws and the arm's length principle.
A TP audit is a detailed review of a taxpayer's Related Party Transactions (RPTs) by the tax authorities to ensure that they have been conducted in a manner consistent with the arm's length principle. It involves the review of the taxpayer's business operations, documents, records, financials and economic data. In Nigeria, the Federal Inland Revenue Service (FIRS or the Service) is empowered to conduct TP audits on taxpayers. Due to the lengthy and time-consuming nature of TP audits, the FIRS usually conducts the audits for multiple years (usually six years) to enable the Service maximize its resources.
The TP audit exercise in Nigeria is typically carried out in four (4) phases. Phase one, the TP Risk Assessment and Desk Review often begins with the issuance of an Information and Documentation Request (IDR), which covers multiple years and requests for various documents such as TP documentation, financial statements, agreements, trial balance, and invoices. The second phase, the field audit stage, involves a comprehensive fact-finding exercise in which the FIRS conducts interviews, site visits, and documentation gathering to verify the functions performed, assets utilized and risks borne by entities involved in each of the RPTs under review.
In the third phase, the post field audit stage, the FIRS issues an audit report that outlines its position on the RPTs, based on findings at the field audit stage. The taxpayer is expected to accept or rebut the FIRS' position and may be required to provide further documents to support its position. Where the FIRS and the taxpayer fail to reach a consensus on their differing positions, the audit extends to the fourth phase, being the post audit stage, which involves exploring several dispute resolution options such as negotiation, decision review panel, and litigation to enable both parties resolve their disagreements effectively.
The number of TP audits initiated by the FIRS has been on the increase. This article reviews the recent trends observed during TP audits and potential implications for taxpayers.
Review of TP Audit Trends
- Focus on Transaction Taxes: A TP audit is conducted to ascertain that the RPTs entered into by a taxpayer have been conducted in a manner consistent with the arm's length principle. Where there are deviations, the FIRS would pass adjustments to the taxpayers' profits, resulting in additional tax liabilities. The audit is usually conducted by the International Tax Department (ITD) of the FIRS.
On the other hand, a tax audit exercise is conducted to review the financial information and transactions of a taxpayer with both third parties and related parties, to ensure compliance with tax laws and ascertain whether the accurate amount of corporate income taxes (Companies Income tax, Tertiary Education Tax etc.) and transaction taxes (Withholding Tax (WHT), Value Added Tax (VAT) etc.) have been paid. Tax audits take place frequently (often yearly) and are usually conducted by the tax office where the taxpayer's file is domiciled.
In recent times, in addition to the focus of TP audits on reviewing the compliance of RPTs with the arm's length principle, there has been increased focus on assessing whether appropriate transaction taxes have been paid on transactions with related parties. The ITD requests for evidence of payment of transaction taxes and supporting documents to ascertain that the appropriate amount has been remitted to the FIRS. Based on practice, transaction taxes is not expected to be under the purview of the ITD, but with the FIRS' corporate tax team.
This potential conflict is particularly obvious where a taxpayer has already undergone a full-blown tax audit, which typically cover both related and third party transactions and all attendant issues regarding transaction taxes have been reviewed, positions agreed and finalized, and relevant taxes paid, prior to the initiation of a TP audit by the ITD. Where this is the case, a review of the taxpayer's RPTs for the assessment of transaction taxes can be viewed as a duplication of effort by the FIRS. This review by the ITD also raises the question of whether already concluded audits can be revisited by another department. It should be noted that such duplication of effort puts a strain on the taxpayer's limited resources as its finance team will be required to furnish required information that have been previously provided to another office to prove a case that has been concluded.
The Finance Act 2023 (the Act) introduced an additional provision to the VAT Act (Section 7(3)), which empowers the FIRS to review artificial or fictitious transactions between related parties that should ordinarily be subject to VAT and make necessary adjustments for the imposition of VAT. The recent increased focus by the ITD on reviewing these transaction taxes may have been spurred by this new provision. However, given that current TP audits cover years prior to the enactment of the Act, it can be argued that the FIRS' efforts may be an attempt to apply the Act retroactively, which does not align with the intention of the law.
The above notwithstanding, the Act does not specify the department of the FIRS responsible for administering the provision. However, since VAT issues are under the purview of the corporate tax team, it can be argued that this team should be responsible for its administration.
Given the ambiguity around the administration of this provision of the Act and until the FIRS is able to resolve the duplication issue and resulting strain on taxpayers, it is imperative for taxpayers to consider a thorough review of their transaction taxes pertaining to RPTs and how they can be impacted should there be adjustments to prices relating to those RPTs.
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.