TEA | What is Transfer Pricing Anyway?

Transfer pricing is one of those topics in taxation – you either get it or you don’t. And this difference could mean that you speak impressively, or you gaze ignorantly. Or you can speak ignorantly. I don’t know LOL.

However, Transfer Pricing is one of the most important issues in international tax and is undoubtedly the area Nigeria has made the most progress. Well, I am the Yoruba superman who will explain TP to you in 1000 words. As always, my content is a product of Wikipedia, the rest of Google’s first search results and a little in-depth knowledge. (just kidding, absolutely none at all!)

And… go!

What is Transfer Pricing?

Globalization means that economies of the world have become inter-connected. There are companies with subsidiaries in many countries – multinationals (MNCs). For instance, MTN Group Limited. While the holding company is in Johannesburg, South Africa, there are subsidiaries in 22 countries! MTN Nigeria is a subsidiary registered to operate in Nigeria. It could buy/sell something from/to MTN Ghana. 

So yeah, transfer pricing happens whenever two companies that are part of the same group trade with each other.[1] These companies share common ownership/control. They are related. The transaction is controlled. Fixing a price for that controlled transaction is called transfer pricing. You get? Now, this is clearly not a problem as these companies can legally transact. The wahala is transfer mispricing – when both companies collude to distort pricing for tax avoidance purposes. What happens is that companies increase or reduce price to shift profits from one country to another.

In response to this ojoro there are established rules that governments use in pricing these controlled transactions. You see, mispricing cross-border transactions can distort taxable income and governments don’t want that. So, tax authorities intervene to adjust transfer prices that differ from what would have been charged by unrelated parties at arm’s length.

The thing called Arm’s-length

What is within arm’s-length? The question is what would an independent buyer pay an independent seller for an identical item under identical terms and conditions? Change the price to reflect that.

If Dangote and MTN trade with each other, they are likely to reach a market price. Because they do not know and did not send each other. This is called “arm’s-length” trading because the price will likely be a product of genuine negotiation. Ehn supply and demand have met right there. Remember your Economics? But when two related companies trade with each other, they may wish to artificially distort the price. As per we know each other/ na we we/ amorawa. This way, they can record low profits in a high-tax jurisdiction and record high profits in a low-tax jurisdiction. Thereby avoiding taxes and robbing governments. You get?

Ehen this is where tax authorities come through like beng de de deng. If prices charged between related parties are within arm’s length, then tax authorities do not need to adjust. Where prices are outside the stipulated range, the prices may be adjusted to the most appropriate point. Tax authorities can adjust prices for transactions, including transfer of goods and services (whether tangible or intangible). If a biro costs #50 (market price) and Jaye Ori Canada sells it to Jaye Ori Nigeria for #200 (artificial price) in order to move money from Nigeria to Canada, FIRS is gon be like hollup!

So, Transfer pricing regulation aims at ensuring that profits are taxed at the place where value is created. This is in fact a global objective, pursued by OECD and its BEPS Actions.

OECD! You again?

If you have been following, you will find that I am keen on the OECD (Organization for Economic Cooperation and Development)[2] and its BEPS (Base Erosion and Profit Shifting) Project.[3] I have written on Taxation of the Digital Economy (Action 1) and Controlled Foreign Corporations (Action 3). Action 8-10 are centered on Transfer Pricing and specifically seeks to “enhance the guidance on the arm’s length principle to ensure that what dictates results is the economic rather than the paper reality.”[4]

The OECD in Article 9 of the OECD Model Tax Convention recommends that transfer prices between related companies should be based on “market value”. What this means is that “prices should be the same as they would have been if the parties were not related to each other.”

Nigeria, how far?

In Nigeria, TP is regulated by the Income Tax (Transfer Pricing) Regulations, 2018 made by the FIRS, pursuant to is powers under the Federal Inland Revenue Service (Establishment) Act, 2007. The overall aim is “to ensure that the prices at which related entities exchange goods and services is in conformity with the functions performed, the asset used, and the risk assumed in generating the income to be taxed.”[5]

Nigeria’s Transfer Pricing Regulations empowers the FIRS (Federal Inland Revenue Service) to adjust the profits resulting from related party transactions to reflect market pricing. The affected transactions include: (1) Sale and purchase of goods and services; (2) Sale, purchase or lease of intangible assets; (3) Transfer, purchase, licence or use of intangible asset (intellectual property); (4) Provision of services; (5)Lending or borrowing of money; (6) Manufacturing agreement; and (7)Any transaction which may affect profit and loss or any other matter incidental to, connected with or pertaining to the above listed transactions.[6]

Persons are deemed to be connected (as in, related) where “one person has the ability to control or influence the other person in making financial, commercial or operational decisions, or there is a third person who has the ability to control or influence both persons in making financial, commercial or operational decisions”.

A company is required to declare its relationship with all connected or related entities not later than 18 (eighteen) months from the date of incorporation or within 6 (six) months after the end of the accounting year.[7] A company is to make disclosure of all controlled transactions that are subject to the Regulations without notice or demand. Failure to comply with the disclosure requirements within the prescribed period attracts payment of penalty by the defaulting company to the FIRS.[8]

A Taxpayer can seek review of TP adjustments from the Decision Review Panel. The decision of this Panel is final. However, judicial review of this decision can be sought in court on points of law.[9]

NSDC. That’s all for your fingertips. Now you know TP. Put your hands together for yourself. Next, I will be writing about Tax Transparency. Stay fixed!

[1] https://www.taxjustice.net/topics/corporate-tax/transfer-pricing/

[2] OECD means Organization for Economic Development and its basically a bunch of countries that come together to advance economic progress and inter-trade.

[3] BEPS refers to tax strategies that allow multinational enterprises to shift profits away from the locations where the actual economic activity and value creation takes place, into low or no-tax locations. As a result of the recognition that most international tax rules are outdated and unable to keep in touch with the complexities of multinational businesses, members of the OECD (Organization for Economic Cooperation and Development) and G20 negotiated the BEPS Actions to ensure that profits are taxed exactly where economic activities take place.

[4] https://www.oecd.org/tax/beps/beps-actions/action8-10/

[5] https://www.mondaq.com/Nigeria/x/764896/Transfer+Pricing/Transfer+Pricing+In+Nigeria

[6] Section 3 of the TP Regulations

[7] Section 13

[8] Section 14 – 16

[9] Section 21