OVERVIEW OF RECENT DEVELOPMENTS ON TRANSFER PRICING IN NIGERIA

Introduction?

Transfer Pricing is regulated by the Income Tax (Transfer Pricing) Regulations, 2018 (TP Regulations) made under the Federal Inland Revenue Service (Establishment) Act, 2007. The 2018 Regulations are to be applied in a manner that is consistent with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 (OECD TP Guidelines) and the UN's Practical Manual on Transfer Pricing for Developing Countries 2017 (UN Manual), as may be supplemented and updated from time to time.

1. Recent Developments in Transfer Pricing?

Finance Act 2019: The Finance Act 2019, which was signed into law on 13 January 2020, contains various tax changes with effect from 13 January 2020. For this article, we would be looking at the changes that affected Transfer Pricing. The introduction of a Seventh Schedule to the Companies Income Tax Act) and the tax-deductibility of related party transactions under Finance Act 2019.

FIRS Circular: Clarification on sundry provisions of the Finance Act 2019 as it relates to companies income tax act: Section 24(a) introduced a restriction on deductibility of interest for a Nigerian company or a fixed base of a foreign company in Nigeria that has incurred any interest or deduction of similar nature where loans or debts are obtained from a foreign connected person.?

Where a Nigerian company or a fixed base of a foreign company in Nigeria has incurred such interest or deduction of similar nature, the deduction allowed under Section 24(a) of CITA shall be restricted to only 30% of the company’s earnings before interest, tax, depreciation and amortisation (EBITDA).

NOTE:?

• The interest deductibility rule in the Seventh Schedule to CITA complements and does not replace the transfer pricing rule. As such, taxpayers are to ensure that interest expenses comply with the Income Tax (Transfer Pricing) Regulations 2018 before applying the interest deductibility rule.
• In computing the 30% of EBITDA allowed under section 24(a) of CITA for such companies, total interest paid or payable (including interest paid to third parties) shall be considered. However, such interest must be those directly incurred in respect of loan or debt obtained wholly, exclusively, necessarily and reasonably for the production of profits chargeable to tax. Where the loan or debt was not utilised for the production of the profits chargeable to tax, no portion of the interest is an allowable deduction.?
• Interest and deductions of similar nature mean the cost of borrowing money or other financial charges. It includes interest, discounts, fees, premium, share of profit, finance cost element of finance lease or foreign exchange losses that are paid or payable concerning a loan or a debt, or any other payment about derivatives used in hedging a loan or debt.?
• EBITDA shall be computed based on assessable profits i.e. assessable profits before the deduction of interest expense (or similar charges).?
• Any taxpayer that fails to apply the restriction on interest deductibility as provided by this rule will be liable to specific penalties and interest under paragraph 5 of the Seventh Schedule in addition to other relevant penalties or interest imposed by other relevant provisions of the tax laws.?

Where any amount of interest or deduction of similar nature has been disallowed by the limitation imposed, such amount may be carried forward for a period of not more than 5 years from the year for which the excessive interest expenditure was first computed. The amount so carried forward shall constitute interest to compute the restriction for succeeding years. For this purpose, the deduction of interest shall be on a first-in, first-out basis.?

The restriction provided in section 24(a) and the Seventh Schedule of CITA does not apply to a Nigerian subsidiary of a foreign company engaged in banking or insurance business. However, the rule shall apply to Nigerian banking or insurance companies that are parents to foreign companies, where the Nigerian Company paid interest to that foreign subsidiary.

2. Transfer pricing electronic filing portal:

The Federal Inland Revenue Service (FIRS) launched an electronic transfer pricing (TP) filing portal christened E-TP PLAT 2.0 in March 2020. This electronic filing solution will allow companies with TP and Country by Country Reporting (CbCR) obligations to file their annual TP and CbCR returns electronically.

The E-TP PLAT 2.0 will enable taxpayers to complete and submit the following TP forms online:

• TP Declaration and TP Disclosure forms
• Country-by-Country notification forms
• Country-by-Country report

The electronic filing platform for TP helps ease the compliance burden on Taxpayers and allows the FIRS better monitor compliance and analyse the data provided by taxpayers in their returns.

3. Transfer Pricing Audit

The FIRS intensified its efforts toward driving TP compliance, through the conduct of TP audit exercises, by rolling out letters requesting the submission of TP documentation and other supporting documents to several taxpayers.

Transfer pricing audit primarily focuses on reviewing transfer pricing returns and supporting TP documentation submitted by taxpayers who had engaged in related party transactions. This approach is necessary for the tax authority to independently confirm the arm's length nature of the related party transactions as documented in the TP reports, and to arrive at an appropriate TP adjustment if any.?

Essentially, a transfer pricing audit involves FIRS officials performing an independent examination of the taxpayer's TP documentation. Subsequently, an audit report is prepared showing compliance, or otherwise with the arm's length principle. In a situation where the related party transactions do not comply with the arm's length principle, the TP regulations empower the tax authority to make necessary adjustments to the arm's length price and this may result in additional tax liability to the affected taxpayer.

Transfer pricing analysis is a costly but necessary process due to the increased importance of documentation of transfer prices. Proper documentation is critical for five major reasons as follows:

• Legal requirements governing documenting appropriate transfer prices.
• Higher transfer pricing penalties may apply if companies lack proper documentation.?
• Companies generally bear the burden of proof for their tax positions.?
• Commercial reasons may exist, such as following best management practices to assure the efficient use of resources.
• Documentation helps to reduce retraining costs upon the inevitable departure of critical people within the company. Proper documentation also requires companies to take precautions in drafting the transfer pricing documents to protect the confidentiality of their trade secrets and commercially sensitive data.

4. Transfer Pricing Maiden case in Nigeria (Prime Plastichem Nigeria Limited vs. FIRS)

Prime Plastichem Nigeria Ltd (PPNL) trades in imported plastics and petrochemicals. In 2013, PPNL applied the Comparable Uncontrolled Price (CUP) method in evaluating the arm’s length nature of its purchase of petrochemical products from its offshore related party, Vinmar Overseas Limited (VOL). However, in 2014, it applied the Transactional Net Margin Method (TNMM) for the same purpose.

The Tax Appeal Tribunal (TAT or “the Tribunal”), delivered its first judgment in a TP case, ruling in favour of the FIRS and requiring Prime Plastichem Nigeria Limited to pay the taxes due of about NGN 1.7 billion. Prime Plastichem Nigeria Limited (PPNL) approached the TAT having been dissatisfied with the additional assessment of ?1,738,481,875.33 issued by the FIRS arising from the TP audit of its Related Party Transaction ("RPT") for the 2013 and 2014 Financial Years ("FYs").?

The TAT ruled in favour of the FIRS on all grounds and dismissed PPNL's appeal in its entirety. Prime Plastichem submitted five issues to the Tribunal for determination. It appealed to the Tribunal to determine whether the FIRS’s actions in benchmarking its TP transaction with the TNM methods and using the Gross Profit Margin (GPM) for the 2013 and 2014 FYs were valid and under the TP Regulations and the Organization for Economic and Development/United Nations Transfer Pricing Guidelines 2010 (OECD and UN Guidelines). It also sought the Tribunal’s determination on whether the FIRS was correct in its imposition of penalty and interests and whether the Decision Review Panel (DRP) purportedly set up by the FIRS was following the TP Regulations.

The TAT opined that the choice of the Transactional Net Margin Method (TNMM) by the FIRS, rather than the CUP Method used by the Company, in benchmarking the Company’s transactions is in line with the TP Regulations and the Organisation for Economic Development and Co-operation (OECD) TP Guidelines based on the following reasons:

• Although the Company used the CUP method, it could not provide a suitable justi?cation for its use.
• The Company admitted that it changed from CUP Method to TNMM in the subsequent year for a lack of reliable data.
• Per Paragraph 5 (2) of the TP Regulations, the availability of reliable information is a necessary condition in determining the most appropriate TP method.
• Consistency in the application of a benchmarking method is crucial, according to the OECD TP Guidelines of 2010, of which the Company has ?outed.

Conclusion?

Transfer pricing regulations application in Nigeria is becoming more rigorous because of the increase in the availability of data through an ongoing exchange of information between the FIRS and other competent authorities in other jurisdictions. It is expected that this would lead to a rise in transfer pricing audits and possibly a rise in transfer pricing disputes. The issuance of the Transfer Pricing?Regulations 2018 is in line with the global trend whereby different jurisdictions are taking legislative steps to incorporate the OECD’s Base Erosion and Profit Shifting (BEPS) final recommendations in their domestic laws

Olatunji Abdulrazaq

Founder, Taxmobile.Online