Executive summary
Nigeria’s Federal Inland Revenue Service (FIRS) recently released The Income Tax (Transfer Pricing) Regulations, 2018 (new Regulations), with an effective date of 12 March 2018. The new Regulations replace the Income Tax (Transfer Pricing) Regulations, 2012 (old Regulations) and shall apply to financial years beginning after 12 March 2018.
The new Regulations were issued to reflect some of the main transfer pricing (TP) related changes introduced to the 2017 edition of the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TPG) and the United Nations Practical Manual on Transfer Pricing for Developing Countries (UN TP Manual).
Significant penalties for non-compliance are included in the new Regulations. This is considered a significant step taken by the FIRS towards ensuring increased compliance and implementation of the arm’s-length principle in a manner consistent with the OECD TPG and UN TP Manual.
Detailed discussion
The issuance of the new Regulations is in line with the global trend whereby various countries are taking legislative steps to incorporate the OECD’s Base Erosion and Profit Shifting (BEPS) final recommendations in their domestic laws. These updates are the first to be made to the TP Regulations in Nigeria since their introduction in August 2012.
Key highlights of the changes and updates in the new Regulations are:
Purpose
The new Regulations have expanded the objectives to give effect to the provisions of the Capital Gains Tax Act and Value Added Tax Act in addition to the legislation already covered in the old Regulation namely the Personal Income Tax Act, Companies Income Tax Act and Petroleum Profits Tax Act.
Covered persons
The new Regulations replaced the concept of “connected taxable persons” with a more extensive definition of “connected persons” to include persons covered in the old Regulations and considered to be related, associated or connected under the Capital Gains Tax Act; the UN and OECD Model Tax Conventions; the OECD TPG, UN TP Manual and the Avoidance of Double Taxation Agreements between Nigeria and other countries.
Use of statistical measures for the determination of arm’s-length remuneration
The new Regulations specifically provide for the interquartile range to be considered as the arm’s-length range where the application of the most appropriate method results in a number of financial indicators under uncertain circumstances in the degree of comparability between the controlled transactions and uncontrolled transactions.
Arm’s-length nature of customs valuations
The FIRS will independently review prices of imported goods as prices applied for customs valuation purposes will not automatically be accepted by the FIRS as arm’s-length prices for TP purposes. Although this has been the FIRS practice during the years of applying the old Regulations, introducing this provision to the new Regulations will essentially give effect to the established practice in this regard.
Guideline on pricing of commodity transactions
The TP Regulations provide taxpayers with specific guidance on pricing of commodity transactions with connected persons. While the old Regulations were silent on the ways to price commodity transactions, the new Regulations prescribe rules that should apply to transactions involving import and export of commodities.
In the case of import or export, the quoted prices for similar commodities that are listed on an international or domestic commodity exchange market on the dates of the transactions shall be the transfer prices for tax purposes if the agreed prices with connected persons are higher for import or lower for export, unless the taxpayer provides sufficient evidence to justify the reasons why the quoted prices should be adjusted to reflect the arm’s-length principle.
With respect to exports of commodities to related parties for subsequent resale to third parties, the transfer prices for tax purposes will be the prices at which the commodities are sold to third parties (if the resale prices are higher than the quoted prices), unless sufficient evidence is provided to justify the reasons the resale prices should be adjusted to reflect the arm’s-length principle.
Intragroup services
The new Regulations provide that in justifying the arm’s-length nature of an intragroup service charge, taxpayers must conduct the benefit test to establish that services are actually rendered, as well as ensure costs associated with shareholders’ activities are not considered in the determination of the intragroup service charge. Further, it includes conditions under which allocation criteria will be considered reasonable.
Pricing of controlled transactions involving intangibles
The new Regulations include detailed guidance on the determination of arm’s-length conditions for controlled transactions involving the exploitation of intangibles. It focuses on the contractual arrangements as well as performance or control of functions performed, assets employed and risks assumed in relation to the development, enhancement, maintenance, protection and exploitation of the intangibles in determining the arm’s-length reward from the exploitation of the intangibles.
With this provision, the tax deductible payments for the transfer of rights for an intangible is capped at 5% of earnings before interest, tax, depreciation and amortization (EBITDA).
The “Capital-rich, low function companies” concept
Capital-rich low function companies that do not control the financial risks associated with their funding activities will only be entitled to a risk-free return. Profits or losses associated with the actual risk assumption will be allocated to the entities that manage those risks and have the capacity to bear them.
Annual TP forms
The new Regulations set out specific provisions for the filing of the TP Declaration and Disclosure forms.
A connected person is expected to complete and file a TP Declaration form providing details of all its connected persons resident in Nigeria or elsewhere no later than 18 months after incorporation or within 6 months after the end of the accounting year, whichever is earlier.
An updated declaration form is also required to be completed and filed with the FIRS where there is a merger or acquisition of up to 20% of an entity or its parent; or any other change in the structure or arrangement of the entity.
Where there is an appointment or retirement of a director of a connected person, a notification is to be made to the FIRS as part of the TP declaration and submitted within six months of the financial year end.
TP documentation
Prior to the release of the new Regulations, there was a contemporaneous TP documentation requirement and the FIRS through an appendix to letters sent to taxpayers requesting TP documentation prescribed guidance on information to be contained in the documentation. The new Regulations incorporate the Master File and Local File Concept as recommended under BEPS Action 13 on TP documentation.
It includes a schedule on information and documents to be maintained in the TP documentation. It reserves the right of the FIRS to request additional information and documents, which are deemed necessary in the course of an audit exercise.
The TP documentation is still expected to be contemporaneous (be in place before the due date for filing income tax returns) and submitted upon request within 21 days.
Materiality threshold
a. TP documentation
The new Regulations stipulate that connected persons with total intercompany transactions of less than NGN300 million may choose not to maintain the contemporaneous TP documentation. However, they must prepare and submit the TP documentation within 90 days from the date of receipt of a notice from FIRS.
b. Advance Pricing Agreement (APA)
While the old Regulations provided a threshold set at NGN250,000,000, the new Regulations did not set out any threshold. Also, the new Regulations incorporate a section to clarify that the provision on APA will be effective upon the publication of relevant notices and guidelines by the FIRS.
Non-compliance and penalties
In the old Regulations, penalties were imposed based on the respective tax laws affected. However, the new Regulations have introduced several material penalties for non-compliance with some provisions and for incorrect disclosures. These penalties include:
- Failure to file TP declaration: NGN10 million1 in the first instance and NGN10,000 for every day in which the default continues.
- Failure to file updated TP declaration/provide notification about directors: NGN25,000 for every day in which the default continues.
- Failure to file TP disclosure: the higher of NGN10 million or 1% of the value of related-party transactions not disclosed and NGN10,000 for every day in which the default continues.
- Incorrect disclosure of transactions: the higher of NGN10 million or 1% of the value of related-party transactions incorrectly disclosed.
- Failure to file TP documentation upon request: the higher of NGN10 million or 1% of the value of related-party transactions not disclosed and NGN10,000 for every day in which the default continues.
- Failure to furnish information/documentation upon request: 1% of the value of each related-party transaction for which information/document relates and NGN10,000 for every day in which the default continues.
Note that the FIRS has the power to grant extensions for filing deadlines under certain conditions, but full penalties will apply, as if no extension was granted, where a taxpayer is unable to meet up with the extended timelines.
Safe harbor
The safe harbor provisions in the old Regulations relating to statutory or regulatory prescribed prices have been removed. The new Regulations provide that the FIRS may publish specific guidelines on safe harbors from time to time and only prices of controlled transactions in line with such published guidelines will qualify as a safe harbor.
Dispute resolution
The new Regulations give the head of the FIRS TP Division the right to refer a transfer pricing matter to the Dispute Resolution Panel (the Panel), upon receiving a taxpayer’s objection to an assessment. This stands in contrast to the provision in the old Regulations which delegates the right to refer an assessment from the FIRS to the Panel to the taxpayer.
The membership of the Panel has been increased from three to five members, including a representative of the legal department of the FIRS with no member below the rank of a Deputy Director.
Implications
The updates and changes to the new Regulations are far reaching and could have significant impacts on the TP affairs of affected taxpayers. While the exemption of some taxpayers (based on materiality threshold) from the contemporaneous TP documentation requirement is a positive development, there will be increased burden of proof for taxpayers who are part of “large multinational groups” and with significant values of related-party transactions.
The new Regulations incorporate updates on safe harbor, penalties for non-compliance, and the materiality threshold, among others, to clarify some gray areas under the old Regulations. However, the limit introduced on tax deductible payments for royalties is one of the potential areas of concerns considering its impact for taxpayers (beneficiaries of rights in an intangible) which are loss making or low profit margin due to valid commercial reasons.
Finally, companies are encouraged to take the necessary steps to proactively examine the potential gaps that may arise from full implementation of the new Regulations, as well as perform an in-house review to help mitigate the related tax risk exposures. In addition, considering the magnitude of the penalties that could arise in the event of default in filing after the due date or incorrect disclosures, it is important that companies ensure they not only prepare and file the required documents, but also do so accurately to avoid imposition of penalties.
Endnote
1. NGN refers to Nigerian Naira. Based on data from Morningstar on 3 September 2018, NGN1 is equivalent to US$0.0028.
