Abdulateef Olatunji Abdulrazaq (AOA)
Senior Manager - Tax, Regulatory & Advisory Services
Saffron Professional Services,
Lagos, Nigeria.
1.
Introduction
The
Income Tax (Transfer Pricing) Regulation No 1, 2012 released by the Federal
Inland Revenue Service (FIRS) in August 2012 which set guidelines on related
parties’ transactions. Companies are required to file their Transfer Pricing
documentation together with their Income Tax Returns from 2014. For example,
companies whose financial years are January 1st to 31st December are required
to file Transfer Pricing documentations with their Income Tax Returns by 30th
June 2014.
Transfer
pricing (TP) 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 in order for FIRS 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. Transfer Pricing audit have switched from an exercise in documentary
compliance to an examination of the substance of the reporting. In anticipation
of audits; companies need a clear and uniform approach to transfer pricing. Contemporaneous
documentation by multinational companies is critical
throughout the transfer pricing process. FIRS require companies to effectively
provide sufficient transfer pricing documentation to audit companies. Failure
to conduct appropriate analyses or to document transfer pricing policies could
result in significant transfer pricing adjustments and related penalties.
2.
Selection
of Taxpayers for Transfer Pricing Examination: Risk Assessment
Effective risk identification and
assessment are important steps toward ensuring that the most appropriate
companies are selected for audit. Given the resource constraints, it is
important for FIRS that high risk transfer pricing cases do not “slip through the tax net”. However, even the most robust
risk identification and assessment tools and processes may not always guarantee
success in audit. The reason for this is that the level of detail available at
the risk assessment stage may not always be sufficient to draw reliable
conclusions regarding the arm’s length nature of profits/prices. This will
depend on functional classification (based on the risks assumed, functions
performed and risks borne by each party), the methods applied, allocation keys
selected and so forth. There are several ways FIRS may conduct its risk
identification and assessment, and the approach taken is largely dependent upon
the type of information and data that is available and accessible. It is
important to draw a distinction here between the information related to filing
a tax return and that contained in transfer pricing documentation. This may
vary from country to country but in essence is as follows:
·
Filing information typically relates to
questions on a tax return. This may entail a tick the box (i.e. yes or no) a “fill in the box” response (e.g. inserting a quantum or
value);
·
Documentation, in the context of
transfer pricing, will generally include more substantial information such as
questions about a transfer pricing policy document, legal contracts, invoices,
valuations etc.
3.
Organization
and Staffing of Transfer Pricing Audits
The Nigeria Transfer Pricing
team was established in October 2013. This centralised team is located at the
FIRS Building in Ikoyi, Lagos. Presently, the Division comprises of about 31
officers; a Head of Division who is a Deputy Director assisted by two Heads of
Units in the rank of Assistant Directors and twenty eight other officers.In the
first fifteen months of the Division's existence, focus has been on aggressive
capacity building of the team and on sensitisation of taxpayers and
other tax offices on their obligation in successfully implementing the TP
regime in Nigeria. The
spectrum of transfer pricing work undertaken, policy regulations, level and
complexity of Materiality is a concept often used in auditing and accounting.
It denotes the significance of a stated amount, a transaction or a discrepancy
to the financial accounts. In this context a small transaction by a large
company may not be material to the financial accounts to that company, even if
there is an error or discrepancy.
Transfer pricing is not an exact
science and requires judgement and discretion; audits are often complex and
time intensive. Owing to this, it is critical that adequate resourcing is
available for such audits. Developing countries are generally more constrained
in transfer pricing resources, and a tax administration can be challenged by
the complexity and volume of audits. The matching of adequate and appropriate
skills and resources to a transfer pricing audit is nevertheless critical to
the efficient, timely and successful conclusion and even resolution of an audit.
The
challenge most developing countries face is the ability to employ, develop and
retain these resources. In this regard, developing countries need to be
innovative and strategic. Implementation of targeted recruitment and structured
training programmes will assist developing countries in attracting, developing
and retaining transfer pricing skills.
4.
Planning
for a Transfer Pricing Audit
Where the
transfer pricing unit (TPU) of FIRS decides to audit transfer pricing documents
of a company, the audit team should ideally be comprised of:
- An overall manager who has responsibility for more than
one audit;
- A
team leader who will manage the day-to-day examination of a taxpayer;
- A domestic
examiner who is responsible for audit activities primarily relating to
domestic issues;
- An international examiner who is responsible for audit
activities primarily relating to international issues;
- A transfer pricing economist who provides economic
analysis and support for the audit;
- A lawyer who is available for consultation on legal aspects
and may be involved in audit planning and implementation; and
- A computer audit specialist who assists with the soft
ware needed to analyse computer readable data received from the taxpayer,
and in organizing the data to assist the domestic and international
examiners as well as economists in analyzing transfer pricing issues.
5.
Preliminary
Examination
The
FIRS have certain transfer pricing information in their possession before a
transfer pricing audit starts. A desk audit of such information, especially financial
statements, should be made to evaluate whether there are any transfer pricing
issues. For instance, computing the following financial ratios based on tax and
financial data may be useful:
- Gross profit to net sales;
- Operating profit to net sales;
- Operating expenses to net sales;
- Gross profit to operating expenses (Berry ratio); and
- Operating profit to average total assets.
Comparing
the taxpayer’s financial ratios to applicable standard industry ratios is
useful if standard industry ratios can be found. Substantial deviations from
standard industry ratios may indicate a transfer pricing problem. The findings
from the desk audit should be analysed to determine what further action, if
any, is needed. Understanding the taxpayer’s business operations is an essential
part of the transfer pricing examination. This study can be commenced before
starting a transfer pricing audit or even after that time, and should include
an understanding of the following:
- The taxpayer’s operations;
- The operations of its affiliates (domestic and
foreign);
- The relationship between the taxpayer and its
affiliates (domestic and foreign);
- The role each entity plays in carrying out the
activities of the controlled group; and
- How much control and direction the taxpayer receives
from the headquarters of the group.
The
following may be useful sources for gaining an understanding of the taxpayer’s
business operations:
- Transfer pricing documentation;
- Annual reports;
- Books and other
publications describing the taxpayer’ s operations;
- Internal audit and management reports;
- Organization charts (the preparation of which may
require the taxpayer’s cooperation);
- Minutes of board meetings, committee meetings and
shareholders meetings;
- Policy and procedure manuals;
- Internal approval documents;
- Written inter-company pricing policies;
- Sales catalogues, brochures, and pamphlets; and
- Written correspondence between the taxpayer and its
affiliates.
6.
In
preparation for a tax audit, the taxpayer is advised to
- Manage its TP risks proactively
- Ensure contemporaneous TP
documentation and policy is in place
- Proper disclosure of related party
transactions and pricing arrangements
- Develop controversy strategy
- Consider industry and other
relevant developments
- Generally comply with the
provisions of the TP Regulations
- Consider obtaining FIRS rulings
and/or APA if possible
- Prepare well in advance
- Engage the services of a TP
advisor as early as possible
- Make ready the required
documentations for review.
- Establish structured communication
with tax officials
- Manage presentations with the TP
auditor
7.
The
documents which the TP auditor may request during TP audits include:
- Country specific TP documentation
report
- TP policy papers and country risk
assessment
- Legal agreements related to inter-
company transactions, and employment agreements
- Intercompany billings, invoices
and debit notes
- Minutes of (annual) general
shareholder's meeting and minutes of the meetings of board of directors
- Intellectual property right
registrations and policy statements
- Description of key personnel
functions and structure
- Corporate income tax returns
- Financial statements
- Other documents such as
Withholding Tax (WHT) and Value Added Tax (VAT) returns on intercompany
settlements, depreciation/ amortization schedules, shareholder register, bank
account statements and intercompany correspondences.
8.
Frequently
asked question by FIRS during TP Audit:
- What is your Transfer Pricing framework or Plan?
The
term ‘planning’ is generally used in a transfer pricing context to denote the
process by which a company designs intercompany pricing frameworks and
prioritizes its transfer pricing initiatives for a given time period. Before a
company sets, implements, or documents its intercompany prices, it must have a
plan for doing so. A strategic mindset is imperative in the planning phase, as
the quality of the decisions made in this phase will determine whether a
company’s time and resources will be wasted or put to good use and whether the
most important exposures will be neutralized, or the greatest opportunities
realized.
- How do you identify Intercompany Transaction for Analysis?
The
planning phase consists of identifying the relevant intercompany transactions
within the organization, understanding the roles and responsibilities of the
parties to the transactions, and prioritizing the company’s risks related to
those transactions.
- What are the type of Intercompany transaction in your organization?
Intercompany transactions between related
parties fall under services provided.
- How do you determine the potential Transfer Pricing Risk of
associated transactions
Companies
determine the potential transfer pricing risk as follows:
·
General
description of services being transferred;
·
Current intercompany pricing policy;
·
Payment
terms between entities;
·
Existence
of intercompany agreements corresponding to these transfers;
- How do you determine the price of associated transactions?
Companies
should select appropriate methods for analysing and pricing the transactions
and understanding the rules and requirements as stated under the Nigerian
Transfer Pricing Regulations.
- How often do you update your TP documentation?
Companies
should update their TP documentation when there is a significant change in the
conditions used in the comparability analysis.
- Is there any Transfer Pricing Policy and Procedure Manuals for the Group?
- How do you obtain information on comparable transactions or
companies in order to verify your TP with related parties?
Companies
relied on Databases such as ‘Bureau van Dijk’s Orbis Global’ in testing the
arm’s length nature of the transactions.
- What are the criteria and
relevance of the functional analysis performed.
Companies
process leading to the selection of the most appropriate method considered the
following:
·
Strengths
and weaknesses of each of the OECD recognized methods;
·
Appropriateness
of the method considered in view of the nature of the controlled transaction,
determined in particular through a functional analysis;
·
The
availability of reliable information (in particular on uncontrolled
comparables) needed to apply the selected method and/or other methods, to the
extent that they are consistent with the arm’s length principle;
·
The
degree of comparability between controlled and uncontrolled transactions,
including the reliability of comparability adjustments that may be needed to
eliminate material differences between them.
- Do you have any Advanced
Pricing Agreement (APA) in place or it could be considered in future?
9.
Conclusion
The
global growth of transfer pricing concerns makes it more essential that
consultant of multinational companies understand transfer pricing audit
triggers, audit processes, and methods to resolve significant tax disputes. A
company consultant ought to communicate with various executives in the company
about preparing for a transfer pricing audit to understand what is likely to
happen during an audit and to resolve it satisfactorily. Increasingly,
multinational companies must perform substantial functional, risk, contractual,
and economic analyses throughout their global operations.
Contemporaneous
documentation throughout the multinational company is critical in this whole
process. Failure to conduct appropriate analyses or to document transfer
pricing policies could result in significant transfer pricing adjustments and
related penalties. These costs should be transparent in the company’s financial
statements. However, documentation requirements for small companies should not
require excessively expensive transfer pricing studies that discourage global
business expansion. Advisers should encourage multinational companies to
consider entering into some type of APA with at least one tax authority.
Olatunji is Senior Manager (Tax ,Regulatory & Advisory Services) with Saffron Professional Services(Member firm of Geneva Group International), Lagos, Nigeria. E-mail:Oabdulrazaq@saffron-ng.com,Oabdulrazaq11@gmail.com
