March 20, 2018
One of the all-time bestselling non-fictional books, “The 7 Habits of Highly Effective People”, identifies two fundamental habits for any individual or firm that seeks to be effective: (i) be proactive; and (ii) begin with the end in mind. Considering that Transfer Pricing (TP) is arguably the most contentious and litigious area of taxation, one cannot overemphasize the importance of these two effective habits for taxpayers if they want to effectively manage their TP risks.
From a TP perspective, being proactive and beginning with the end in mind means that in addition to other proactive strategies, a taxpayer should assess its TP dispute resolution options from the onset as it complies with the Nigeria TP Regulations. Considering that this approach is often overlooked by taxpayers and their tax advisors, this article seeks to make a compelling case as to why Nigerian taxpayers that seek to significantly mitigate their TP risks should assess their TP dispute resolution options from the onset when they start making disclosures to the Federal Inland Revenue Service (FIRS or the Service).
TP is basically the price of transactions between related parties. As a discipline, TP seeks to demonstrate to tax authorities that a taxpayer’s pricing of its related party transactions is reasonable and does not adversely impact its profits and amount of taxes paid. Demonstration of the reasonableness of the TP hinges on the arm’s length principle (ALP) which is usually the main source of contention between taxpayers and tax authorities.
The ALP refers to a situation where a taxpayer prices its related party transactions as if it were dealing with an unrelated party under similar facts and circumstances.
Considering that in reality there are limited cases where taxpayers will transact the same or similar transactions with a related party and an unrelated party under similar facts and circumstance, taxpayers often have to resort to the use of pricing of similar transactions between two independent parties or indirect profit-based methods to demonstrate that the ALP has been met. However, the FIRS could disagree with the taxpayer’s presentation of the facts and circumstances relating to the controlled transactions as well as the benchmarking analysis performed to demonstrate the arm’s length nature of the related party transaction.
Another source of TP dispute is the question of economic substance. This is where a transaction with a related party is deemed by the FIRS not to have economic substance or commercial basis but entered mainly for tax avoidance reasons. This could result in such expenses disallowed for tax purposes.
These two sources of TP dispute can be exemplified in a number of controlled transactions. One of such is the procurement arrangement where a multinational group (Group) centralizes its procurement function for commercial reasons such as volume discount. Some of the sources of contention include the following: whether there is a clear economic substance associated with the arrangement; the characterization of the procuring entity as an agent or a buy-sell entity; and the appropriateness of the nature of remuneration as it relates to the base and the mark-up.
Having established that TP is a highly contentious discipline, we assess the TP dispute resolution options that highly effective Nigerian taxpayers have to review from the onset as they comply with the TP Regulations.