Transfer Pricing And Arm's Length Principle In International Taxation: The Nigerian Perspective

Introduction

Multinational Enterprises (MNEs) now operate beyond their countries of residence. In doing so, they often have economic interests in companies located in other jurisdictions and enter into commercial transactions with their subsidiaries, affiliates, or related entities in those countries. These transactions fall within the scope of international taxation. Due to these close ties within a group, the prices of goods, services, and other transactions between an MNE and its subsidiary are sometimes set with preferential terms. These arrangements are often part of strategic tax planning to create tax advantages.¹ As a result, transfer pricing has become a key concern in international taxation.

In many cases, the prices of international transactions are no longer driven entirely by market forces, but by the shared interests of related entities. It is therefore necessary to determine the appropriate price—known as the "transfer price"—for intra-group, cross-border transfers of goods, services, or intangibles. MNEs may use transfer pricing to reduce their tax liabilities by shifting profits to low-tax or tax haven jurisdictions. Governments, on the other hand, rely on the principle of fiscal sovereignty, which allows each country to exercise its right to tax income from activities and assets—both tangible and intangible—that occur within its borders, and to tax the income of its residents irrespective of its source. When assessing deductions, expenses, and transaction pricing in related-party international dealings, tax authorities examine whether the prices reflect what would have been charged between unrelated parties in the same sector. This comparison is essential in determining the taxable income from such transactions.

What is Transfer Pricing (TP)?

Transfer Pricing (TP) refers to the pricing of goods, services, or intangible assets exchanged between associated or related enterprises. It applies when two entities under common control—such as a parent company and its subsidiary—carry out transactions with each other. It may also arise during cost sharing where two or more companies collaborate to produce, develop or obtain products, services or rights. While transfer pricing itself is not illegal, problems arise when the prices set do not reflect economic reality or established legal standards. In such cases, tax mispricing may occur, leading to risks of double taxation, tax evasion, or double non-taxation.

Illustration 1

• A watch manufacturing company in Country A distributes its watches through a subsidiary in Country B at a cost of $1,400. The subsidiary incurs an additional $100 in distribution costs. The parent company sets a transfer price of $1,500, and the subsidiary sells the watch for $1,600 in Country B. The group earns a total profit of $100, on which tax is expected to be paid.
• During an audit, Country B's tax authority observes that the subsidiary records no profit: the $1,500 transfer price and $100 distribution cost exactly match the $1,600 retail price.
• As a result, the tax authority in Country B challenges the transfer price, arguing it should have been $1,400, so that the $100 profit is reported by the subsidiary and taxed locally. To determine this, the tax authority must assess whether an independent distributor would have paid the same price under open market conditions.

Illustration 2

• A U.S.-based oil and gas company owns two subsidiaries: one in Ghana that grows pongamia seeds and another in France that provides logistics services. The U.S. company's shareholders also own the Ghanaian farmland and receive rent annually. Both subsidiaries (Ghana & France) co-own a Nigerian company that produces hydraulic oil. The U.S. parent company funded the research formula through a shareholder loan and licensed it to the Nigerian company, which pays royalties.
• The Ghanaian subsidiary sells pongamia seeds to the Nigerian company, while the French subsidiary handles transportation of the finished products and oversees sales in the U.S., Ghana, and other countries.
• The Nigerian company earns profit and, in determining its taxable income, must account for the farmland lease payments to the Ghanaian entity, the price of raw materials, and the cost of marketing services from France. These transactions trigger transfer pricing reviews by tax authorities in Ghana, France, and Nigeria.

It is important to note that the value of services or intangibles contributed by related parties must be determined as if the entities were independent. This reflects the arm's length principle, affirmed in Spain v. Nutreco España S.A.²

Transfer Pricing Laws in Nigeria

Globally, domestic tax laws often include general or specific transfer pricing provisions, such as rules governing controlled foreign companies (CFCs) or thin capitalization. These rules are further supported by tax treaties, which complement local tax legislation. In Nigeria, the governing framework is the Income Tax (Transfer Pricing) Regulations, 2018, ("TP Regulations") which replaced the 2012 Regulations. The TP Regulations apply to financial years beginning after 12 March 2018 and incorporate several key developments in international tax standards. These include selected updates from the OECD Transfer Pricing Guidelines (OECD TPG) and relevant provisions from the African Tax Administration Forum's Suggested Approach to Drafting Transfer Pricing Legislation (ATAFSA).

Scope of Controlled Transactions for TP Purposes

A key concept in transfer pricing is the idea of a "controlled transaction". This refers to any commercial or financial transaction between connected persons³. Courts have been interpreted it to mean: "any transaction or transfer between two or more members of the same group of controlled taxpayers"⁴. The emphasis is on transactions between connected persons, which could be domestic or cross-border transactions. Under the OECD Model Convention, transfer pricing also applies to dealings between a head office and its permanent establishment.⁵ It is important to note that treaty benefits may be denied on interest or royalty payments that exceed arm's length amounts.⁶ Globally, TP rules apply to a wide range of transactions between related or associated persons, including:⁷

• Sale and purchase of goods and services ·
• Sales, purchase or lease of tangible assets ·
• Transfer, purchase, licensing or use of intangible assets,
• Provision of services;
• Lending or borrowing of money;
• Manufacturing arrangement;
• Transactions between head office and permanent establishments ("PEs"); and
• Any transaction which affects the profits of a company whether domestic or cross-border.

Importantly, since TP rules cover "transfer, purchase, licensing or use of intangible assets", it may also extend to the sale or acquisition of equity interests in related companies.

Illustration 3

In 2020, Company Burger LLC, based in Copenhagen (Denmark), had two subsidiaries in Nigeria—Loggin Ltd and Copping Ltd. In 2022, Company Burger acquired a 35% shareholding in Loggin Ltd, becoming a substantial shareholder. To fund the acquisition, it obtained a loan at an interest rate of 18.5% from Bartax Bank Ltd, a Nigerian bank. During a 2024 audit, the Nigerian tax authority discovered that Company Burger also holds a 10% interest in Bartax Bank Ltd.

Given this relationship, the tax authority is likely to question both the loan interest rate and the share transfer pricing between the parties. Specifically, it must assess whether the 18.5% loan rate and the price paid for the 35% equity stake reflect arm's length terms, as required under Nigeria's transfer pricing rules.

Conditions for Invocation of Arm's Length Principle

The term "arm's length" is not a tax term, but a commercial standard used to assess pricing arrangements between parties within the same corporate group. However, it does not apply automatically to all transactions—it can only be invoked when certain conditions are met. These conditions are twofold:

1. There must be a transaction between parties involving some form of consideration. Without a transaction that results in a financial gain, transfer pricing rules do not apply.
2. The parties involved must be related, connected, or associated with each other.

In some jurisdictions like India, the existence of a parent–subsidiary relationship is sufficient evidence of association, requiring compliance with the arm's length principle. Courts in those jurisdictions have often made a distinction between the activities of local subsidiaries and their parent companies when interpreting international tax treaties.

In Nigeria, both permanent establishments and their head offices are treated as separate taxable entities. As a result, transactions between them are considered controlled transactions and fall within the scope of transfer pricing rules.⁸ Determining whether a party is "related" or "connected" is a central question in transfer pricing assessments. Article 9 of the OECD Model Tax Convention provides that an associated enterprise includes: "An enterprise of one state that participates either directly or indirectly in the management, control and or capital of an enterprise of another state; or the same persons participate in the management, control and capital of an enterprise of a state and an enterprise of another state."

In Nigeria, the term "connected person⁹" is used instead of "associated enterprise." A person is considered connected or related where one party controls or influences the other in making financial, commercial, or operational decisions—or where a third party exercises such control or influence over both.¹⁰

Given the global structure of MNEs, cross-border tax matters often raise complex issues involving jurisdiction, profit allocation, valuation of transactions, cost sharing, and functional analysis.

An instructive case is Poland vs A Pharma S.A,¹¹ a pharmaceutical wholesaler, sold its assets to another company and later leased back those assets under a tenancy agreement. The tax authority, following an audit, assessed the transaction as one that should comply with the arm's length standard and raised an additional tax liability. The key issue was whether the buyer and seller were related parties. The Administrative Court ruled in favour of Pharma S.A., and this decision was upheld by the Supreme Administrative Court, which found that the parties were not related and therefore the transaction did not qualify as a controlled transaction.

Determination of the Transfer Price

Arriving at an appropriate transfer price under the arm's length principle requires a detailed comparability analysis and a functional analysis.

Comparability Analysis

Comparability analysis is central to applying the arm's length principle. It involves examining the relationship between the parties to the controlled transaction, the nature of the transaction itself, and comparing it with similar dealings between independent enterprises engaged in comparable industry (uncontrolled transactions). This requires a careful review of the specific characteristics of the transaction, including the nature of the goods, services, or intangibles transferred, the contractual terms, the functions performed, assets used, and risks assumed by each party.

Only where these key elements align reasonably well between controlled and uncontrolled transactions can they be considered comparable for transfer pricing purposes.

Functional Analysis

Functional analysis—commonly referred to as a FAR analysis—focuses on the 'functions performed', 'assets employed' and 'risks assumed' by the parties involved in the transaction. This assessment helps to establish each party's relative contribution and economic role, which influences the appropriate pricing. Functions commonly examined in a FAR analysis may include:¹²

• Research and development
• Product design and engineering;
• Manufacturing, production and process engineering;
• Product fabrication, extraction and assembly;
• Marketing and distribution functions, including inventory management and advertising activities;
• Transportation and warehousing;
• Managerial, legal, accounting and finance, credit and collection, training and personnel management services.
• Outsourcing nature of work
• Business process management

Methods of Transfer Pricing Adjustment

Regulation 5 of the TP Regulations prescribes specific methods for determining or adjusting transfer prices in controlled transactions. These methods are available to both taxpayers and the Federal Inland Revenue Service (FIRS). However, as affirmed in Prime Plastichem Nigeria Limited v. FIRS,¹³ the FIRS retains the discretion to apply any of these methods when adjusting a taxpayer's profits to reflect arm's length terms.

The prescribed methods include:

• Comparable Uncontrolled Price (CUP): This method compares the price charged in a controlled transaction with the price charged for the same or a similar property or service in an uncontrolled transaction between unrelated parties under similar conditions.
• Resale Price Method (RPM): The resale price method is used to determine the price to be paid by a reseller for a product purchased from an associated enterprise and resold to an independent enterprise. The purchase price is set in a manner that allows the reseller to earn a margin sufficient to cover its selling and operating expenses and to make an appropriate profit.
• Cost Plus (C+, CP) Method: This method calculates the arm's length price by adding a reasonable markup to the costs incurred by a supplier in producing goods or services sold to a related party. The markup reflects the supplier's functions, risks, and assets employed, as well as prevailing market conditions.
• Comparable Profit Method (CPM): This method also known as the "Transactional Net Margin Method" (TNMM), examines the net profit margin earned by a taxpayer from a controlled transaction and compares it to margins earned by independent companies engaged in similar activities under similar circumstances.
• Profit-Split Method ("PSM"): The profit-split method combines the profits earned by two related parties from one or a series of transactions and divides the total using a defined basis. The goal is to replicate the profit division that would have been expected if the parties had dealt with each other at arm's length. Arm's length pricing is thus derived by working backwards—from shared profit to individual prices.

Alternative to TP Adjustment Methodology

Disputes may arise over the choice of method used in determining transfer prices for controlled transactions. To reduce such controversies under Nigeria's transfer pricing regime, taxpayers may enter into an Advance Pricing Agreement (APA) with the FIRS.¹⁴

An APA sets out agreed terms in advance for determining the transfer pricing of specified controlled transactions. These terms typically include: a description of the transactions covered; the functions to be performed; assets to be used; and risks to be assumed. The agreement also addresses comparability factors, the chosen transfer pricing method, any other tax jurisdiction the taxpayer wishes to involve, and the taxpayer's proposed pricing for each transaction. It also outlines critical assumptions regarding future events. An APA may not exceed a duration of three years,¹⁵ and FIRS may terminate it in writing if there is a material breach or a change in the law.¹⁶

Steps Involved in Transfer Pricing Documentations

A transfer pricing exercise typically involves several structured steps, including:

• Gathering background information;
• Conducting an industry analysis;
• Carrying out a comparability analysis, including a functional analysis;
• Selecting the appropriate method for determining the arm's length price; and
• Determining the arm's length price.

These steps cannot be effectively implemented without proper documentation. This is why many jurisdictions require taxpayers to prepare and file transfer pricing documentation. Such documentation enables tax authorities to assess whether transactions between related parties have been conducted on arm's length terms.

Nigeria's TP Documents Required for Filing with FIRS

Under Regulations 16 and 17 of the TP Regulations, any connected person involved in transactions with related entities is required to file specified documents with the Federal Inland Revenue Service (FIRS) within 21 days from the date of service of a demand notice. However, where the total value of controlled transactions is less than ₦300 million, such a connected person may opt not to maintain contemporaneous documentation. In that case, if the FIRS later deems it necessary, it may issue a notice requiring the taxpayer to prepare and submit the relevant documents within 90 days of receipt of the notice.

The required documents include:

• Master File: A group-level overview of the multinational's global operations, structure, intangibles, and financials, as set out in Annex I of the OECD TPG.
• Local File: Transaction-level details specific to the Nigerian entity, including functional and economic analysis, per Annex II of the TPG.
• Country-by-Country Report (CbCR): Aggregated data by jurisdiction showing income, taxes paid, and economic activity across the group, in line with Annex III of the TPG.
• Transfer Pricing Returns: Filed separately or with the annual tax return, outlining the nature and value of controlled transactions and applied methods.
• TP Declaration: Disclosure of all connected persons.
• TP Disclosure: Summary of all related-party transactions, including type, value, and parties involved.

Transfer Pricing Dispute Resolution

Where a connected person disagrees with a TP assessment issued by the FIRS, the taxpayer has the right to file an appeal to the FIRS Decision Review Panel within 30 days of receiving the notice of assessment.¹⁷ If dissatisfied with the Panel's decision, the taxpayer may further appeal to the Tax Appeal Tribunal (TAT). From there, the matter may proceed to the Federal High Court, and, if necessary, to the Court of Appeal and ultimately the Supreme Court.

Penalties for Non-Compliance with the Nigeria TP Regulations 2018

The TP Regulations impose specific penalties for failure to comply with transfer pricing obligations. The key infractions and corresponding penalties are as follows:

• Failure to file a Transfer Pricing (TP) Declaration: ₦10 million in the first instance, plus ₦10,000 for each day the failure continues.
• Failure to file an updated TP Declaration or provide notification on directors: ₦25,000 for each day the default continues.
• Failure to file a TP Disclosure: The greater of ₦10 million, or 1% of the value of related party transactions not disclosed; plus ₦10,000 for each day the default continues.
• Incorrect disclosure of transactions: The greater of ₦10 million, or 1% of the value of incorrectly disclosed related party transactions.
• Failure to file TP documentation upon request: The greater of ₦10 million, or 1% of the value of all related party transactions; plus ₦10,000 for each day the default continues.
• Failure to furnish information or documentation upon request: 1% of the value of each related party transaction to which the request relates; plus ₦10,000 for each day the default continues.

While the TP Regulations permit the FIRS to grant extensions under certain conditions, failure to comply within the extended deadline will trigger the applicable penalties in full.

Conclusion

This article has outlined the key principles, documentation requirements, and enforcement mechanisms under Nigeria's Transfer Pricing Regulations. It highlights how related-party transactions can impact tax outcomes and the importance of applying the arm's length principle to avoid non-compliance risks.

Given the growing scrutiny by tax authorities and the penalties attached to non-compliance, it is critical for MNEs to ensure accurate documentation, timely filings, and apply appropriate pricing methods. As a proactive measure, taxpayers may also consider entering into an Advance Pricing Agreement with the FIRS to secure greater certainty and minimize future disputes.

Footnotes

1. Angharad Miller & Lynne Oats (2006) "Principles of International Taxation" Tottel Publishing, Page 205

2. https://tpcases.com/spain-vs-nutreco-espana-s-a-february-2025-supreme-court-case-no-904-2025/. Being judgment delivered in February 2025, Supreme Court, Case No. STS 904/2025 – ECLI:ES:TS:2025:904. The facts of the case are that Nutreco España, S.A. had taken on significant debt to finance an acquisition of shares by other foreign group companies. Its role in the acquisition was limited to the channeling of funds. The debt consisted of an intercompany loan of 240 million euros granted by Nutreco Nederland B.V. and an amount of 100 million euros from a centralized treasury system (cash pool) within the Group. Interest payments on these loans totaled more than 30 million euros for the years 2011-2013, which Nutreco España, S.A. deducted from its taxable income. The tax authorities found that the financial arrangement was artificial and put in place only for the purpose of obtaining tax benefits. Deductions of expenses related to the debt was therefore denied and an assessment of additional taxable income issued. Nutreco España, S.A. filed an appeal which was dismissed. On further appeal to the Supreme Court, it was found and consequently dismissed same when it held thus:

"In short, the artificiality of the operation is constituted by the pursuit exclusively of a tax advantage, and not by the presence of a cross-border element, as the appellant repeatedly argues. 7. The tax administration has correctly identified the tax advantage sought, which consists of Nutreco España S.A. deducting the financial expenses of the loan used to make the aforementioned acquisition, thus eroding the tax base. Likewise, these financial expenses were also deducted in the tax jurisdictions where the group companies that made the acquisition are based. In this way, the Nutreco Group, with the operation designed in terms of how the funds were channelled, achieved a double deduction of the same financial expenses: in Spain and in the countries that finally made the acquisition from the Maple Group, Canada and the USA.

3. Regulation 27 of the Income Tax TPR 2018

4. Portugal vs "N...S.A.", March 2023, Tribunal Central Administrativo Sul, Case 762/09.0BESNT being judgment delivered in March, 2023 downloaded from https://tpcases.com/tag/controlled-transactions/

5. (Article 7(2)) of the OECD Treaty Model

6. Article 11(6) and 12(4)

7. See Reg 3(1)(a – g) of the Income Tax (Transfer Pricing) Regulations 2018

8. Regulations 3(2) of the Income Tax (TP) Regulations 2018

9. S.17(3)(b) of PITA; S.15(2) of PPTA; and S.20(3)(b) of CGTA.

10. Regulation 12 of Income Tax (Transfer Pricing) Regulations 2018.

11. Being judgment delivered in August 2024, by the Supreme Administrative Court, Case No II FSK 1381/21

12. Regulation 7 and 11(2) of Income Tax (Transfer Pricing) Regulations 2018

13. Being judgment delivered by the Tax Appeal Tribunal, Lagos Zone on 19/2/2020. The facts of the case are that Prime Plastichem (appellant) challenged the FIRS' imposition of additional income tax assessments on a transaction between the appellant and Vinmar Overseas Limited (a related company). The additional assessments arose from the transfer pricing adjustments made by the FIRS. The appellant had applied Transactional Net Margin (TNM) method due to inability to find a comparable transaction. FIRS was of the view that there was need to readjust the pricing. It then applied a Profit Level Indicator (PLI), different from that applied by appellant as the appropriate method for the determination of the arm's length price applicable to the transaction in the relevant financial years 2013 and 2014. In its judgement, the Tribunal upheld the FIRS's assessment and PLI method as appropriate and dismissed the appellant's case in its entirety.

14. See Regulation 9 of Income Tax (TP) Regulations 2018

15. See Regulation 9(7)

16. See Regulation 9(8)

17. See Regulation 21(5) of the Income Tax (TP) Regulations 2018

For further information on transfer pricing compliance, please contact Bashir Ramon.

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.