Since the introduction of Transfer Pricing (TP) Regulation 2012 in Nigeria and its amendment via the Income Tax (Transfer Pricing) Regulation in 2018, Nigeria has only conducted a few TP audits. However, starting from the last quarter of 2020 till date, FIRS has issued quite a few TP letters to not just multinational entities (MNEs) but also, local entities with connected persons. This increases the number of potential TP audits in the coming months.
Nigeria does not currently have a threshold for TP reviews/audits, as all entities with connected persons regardless of size and jurisdiction of the entities, are subjected to the same level of compliance obligation.
The tax authority has been aggressive in its attempt to enforce the provisions of the 2018 TP Regulations and imposing the stiff penalties enshrined in the TP Regulations on defaulters. The recent increase in the request for the TP documentations and proof of transactions can be seen as a means to further drive compliance with the documentation requirement of the TP Regulations and to ensure that entities pay fair taxes on the profits generated from Nigeria. This initial request along with the TP returns filed by the company is usually reviewed and used as a basis of the TP risk assessment. This review might eventually lead to a full-blown TP audit, depending on the conclusions drawn by FIRS from the review.
It is therefore important for taxpayers to ensure they re-assess and review their controlled transactions in readiness for a possible TP audit. In this article, we have discussed some considerations and critical steps to be adopted by affected entities in this regard.
Need to Maintain a Contemporaneous TP Documentation
It is important to mention that a letter from the tax authority does not necessary equate to a TP audit. However, this is usually the first step taken by the tax authority to perform a risk assessment on the taxpayer. The TP documentation requested by FIRS, along with the previously submitted TP returns serve as one of the major bases for the tax authority to ascertain whether a taxpayer has complied with the TP Regulations or not.
The Regulation in summary, requires that all transactions with any connected person be done at arm’s length (i.e., as the transaction would have been if it were with an independent person) and any such method used in arriving at such pricing be properly documented to justify the pricing of the transactions that had occurred.
The first step in readiness for a TP audit is to ensure that all transactions have been properly priced. This step cannot be overemphasized, as it is one of the major bases for determining the risk level of a taxpayer. The TP Regulations require taxpayers to keep contemporaneous documentation that confirms that its transactions with related entities align with the arm’s length principle.
Given the above, MNEs or local entities with connected parties should ensure that a TP Policy establishing methods for pricing of transactions has been developed in setting the prices of all transactions within the Group. Where the pricing had been established by the parent company of a multinational outside Nigeria, it is important that this pricing regime is strictly followed and adopted by the local entity, provided that it aligns with the guidelines issued by the Organisation for Economic Cooperation and Development (OECD) and Nigerian TP Regulations.
Upon developing a TP Policy and setting the pricing, it is also critical to ensure proper implementation of the policy in conducting the transaction, as this cascades downwards into the annual TP documentation prepared to justify the transactions that had occurred in each year. Having a transfer pricing documentation that is prepared in line with the TP Regulations is the first step to proving that the connected transactions are consistent with the arm’s length principle. Please note that the onus of proof of compliance with the arm’s length principles is the sole responsibility of the taxpayer.
Regulation 16(4) of the TP Regulations expects this document to be in place prior to the due date for filing the income tax return for the year in which the documented transactions occurred. Therefore, taxpayers should ensure all documentation and support documents are available and ready for submission upon request from the tax authority. This will prevent the taxpayer from incurring the stiff penalties provided in the 2018 TP Regulations.
Other Important Documents to Maintain
Taxpayers should ensure that annual transfer pricing returns have been filed and that they are up to date. Regulations 13 and 14 of the Nigerian TP Regulations 2018, requires all connected persons to file their annual TP returns (disclosure forms and the declaration form) in an appropriate form. This annual TP return is one of the major requirements for any taxpayer in this category and non-compliance to this requirement attracts stringent administrative penalties.
A major issue that arises in a typical TP audit is the inability of a taxpayer to provide the adequate support documents needed to validate transactions that had occurred in the year. Therefore, the effort put into the development of a Policy and its implementation would have been wasted, if proper documentation of all necessary support and compliance documents to justify the transactions with related parties are not kept in a manner that they can be retrieved. Some of these important documents include contract / agreements, invoices, internal memos, financial statements, details of a third-party cost/pass-through cost, etc. Taxpayers should therefore ensure there is a proper system in place to document all necessary information that can support their claim in case of any TP audit exercise and these documents are readily available for submission upon request.
Transfer Pricing Risk Assessment – Health Check
This is an important step that should be considered by the taxpayer. It serves as an internal pre-audit evaluation to identify potential risk areas where there are gaps in the compliance requirements and in the pricing of transactions with connected persons.
The evaluation allows the taxpayer to consider its options and possible steps to mitigate any risk that might have been discovered during the risk assessment, including insight into the availability of necessary support documents or otherwise. This will also allow the taxpayer to evaluate the strength of the TP methods that have been adopted for specific transactions and proffer adjustments where necessary.
It is important to carry out TP risk assessment regularly, either internally or outsourced to a seasoned professional. It gives the taxpayer ample time to make necessary amends in the way it conducts its transactions or make necessary financial adjustments if required. Also, carrying out TP risk assessment can help a group entity neutralize the effect of TP adjustments.
In conclusion, given the recent drive of the tax authority to ensure compliance with the provisions of the TP Regulation, the continuous request for TP documentation is inexorable. However, the receipt of such letters does not necessary equate to a TP audit. It is just the first step taken by the tax authority to perform a risk assessment on the taxpayer.
Taxpayers should therefore take necessary actions to ensure their books are in order to avoid pitfalls, penalties and TP adjustments that may result from a TP audit.