December 4, 2018
The Federal Inland Revenue Service (FIRS), in a bid to implement some of the key recommendations of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Project, published the Income Tax (Transfer Pricing) Regulations, 2018 (Revised TP Regulations ) in August 2018. The Revised TP Regulations also incorporated major recommendations from the African Tax Administration Forum (ATAF)1.
Among the key revisions introduced is the provision on transactions involving the transfer of rights, technology, know-how amongst other forms of intangibles, under a licensing arrangement (referred to as intangible transactions).
Regulation 7 of the Revised TP Regulations provides guidance on the procedures to adopt in determining the arm’s length remuneration for intangible transactions. However, Sub-regulation (5) provides that for intangible transactions, the allowable deductions for tax purposes shall be limited to five (5) percent of Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA). This provision is inconsistent with the arm’s length principle, the international standard that both OECD member countries and non-member countries (including Nigeria) have agreed to be used for TP purposes by tax administrations and taxpayers.
This article reviews the implications of this provision for businesses in Nigeria and the reasonableness of the restrictions in line with the arm’s length principle, international best practices and the principal Acts governing the Revised TP Regulations.
Chapter 6 of the OECD Guidelines defines Intangible Asset as something, which is not a physical asset, or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer, would be compensated had it occurred in a transaction between independent parties in comparable circumstances.
Typically, these assets include both trade intangibles (know-how, trade secrets, technology among others) and marketing intangibles (trademarks, tradenames, customer lists among others).
Intangibles are recognized as revenue drivers because they directly affect the premium a product commands in the market and the product’s market share. For example, marketing intangibles such as brand awareness is a critical value driver in the FMCG industry. Hence, in accordance with arm’s length conditions relating to the exploitation of intangibles as stipulated in Regulation 7 of the Revised TP Regulations and Chapter 6 of the OECD Guidelines, an arm’s length remuneration commensurate with valuable functions such as the development, enhancement, maintenance, protection and exploitation of the intangibles should be determined to compensate the relevant entities. Typically, the remuneration for the license of comparable intangibles in transactions between independent parties is based on a percentage of the revenue generated by the user (Licensee) of such intangible (i.e. percentage (%) of revenue). This connotes that owners of the intangible are rewarded based on a percentage of the variable that the intangibles drive, typically revenue generated from the sale of products or services.
Thus, the restriction introduced in the Revised TP Regulation is inconsistent with the arm’s length principle requirement of Regulation 4 the Revised TP Regulations as well as Regulation 7(1). Further, it is contrary to international best practice and does not align with the arm’s length principle as defined within the OECD guidelines.