OECD Base Erosion and Profit Shifting (BEPS):Effects on Nigerian Transfer Pricing Regulations.

1.    Introduction

The OECD’s Action Plan on BEPS was published in July 2013 with a view to addressing perceived flaws in international tax rules. The 40 page Action Plan, which was negotiated and drafted with the active participation of its member states, contains 15 separate action points or work streams, some of which are further split into specific actions or outputs. The Plan is squarely focused on addressing these issues in a coordinated, comprehensive manner, and was endorsed by G20 leaders and finance ministers at their summit in St. Petersburg in September 2013.

OECD’s BEPS Project aims to provide governments/ tax administrators with clear international solutions for fighting aggressive corporate tax planning strategies that artificially shift profits to locations where they are subjected to more favourable tax treatment. The concept of ‘fair taxes’ is at the heart of the BEPS discussions. It considers if taxpayers are paying adequate amount of tax in jurisdictions where the income-generating activities are performed, or whether the income is being artificially moved away to other jurisdictions resulting in the taxpayers paying little or no taxes on the income.

The Nigerian 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 regulations were released based on the general anti-avoidance provisions in the various tax laws. General anti-avoidance rules have been in Nigeria for many years. Specifically, Section 17 of the Personal Income Tax Act (2004), Section 22 of the Companies Income Tax Act (2004, amended 2007), and Section 15 of the Petroleum Profits Tax Act (2004) all provide for the FIRS to adjust any related party transaction or between unrelated parties, which is deemed to produce a result artificially reducing taxable income in Nigeria. Up until this point the rules were largely weak in practice, because there was no guidance or framework for enforcing anti-avoidance provisions in Nigeria.

For several years, Nigeria has worked to develop its own transfer pricing rules based on the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) and the commentary surrounding the creation of the UN Transfer Pricing Manual (UN Manual) which was formally approved in October 2012. The FIRS released the draft transfer pricing rules in May 2012, and the final rules in August 2012, as The Income Tax (Transfer Pricing) Regulations No. 1, 2012 (The Regulations).

The Nigeria TP regulations are applicable to Accounting periods commencing after August 2012.To avoid Transfer Pricing penalties, companies needs to maintain and upon request by FIRS, produce in a timely manner, documentation with sufficient quality so as to accurately and completely describe the transfer pricing analysis conducted by the company and the efforts to comply with the arm’s length principle.

The Organisation for Economic Co-operation and Development (OECD) has developed Guidelines on Transfer Pricing to assist Multinational Enterprises (MNEs) and Tax Administrators in the evaluation of TP transactions and provide an element of consistency among countries in the application of such rules. The first Guidelines were released in 1995 and have undergone various revisions over the years. The most recent edition is the 2010 Guidelines which provide new guidance on the selection of the most appropriate transfer pricing method to a given circumstance and which deals with the transfer pricing aspects of business restructurings.

The OECD Guidelines have been adopted by most tax authorities, including Federal Inland Revenue Service (FIRS) either wholesale or with some level of customization to address local issues.

2.    OECD BASED EROSIONAND PROFIT SHIFTING:SCOPE &PURPOSE

The purpose of the BEPS’ Actions is to ‘ensure that profits are taxed where economic activities take place and value is created’. There is concern that the international tax rules that were designed more than a century ago may no longer be adequate to address the current business environment. The BEPS approach focuses on three broad measures:

1. Coherence in tax systems globally;
2. Economic substance in cross border dealings; and
3. Transparency with respect to relevant taxpayers’ data to assist revenue administrations’ tax investigation efforts.

The BEPS’ Actions will be implemented through changes to domestic laws and practices and provisions of tax treaties. The Federal Inland Revenue Service (FIRS) has already incorporated some of the principles in its audit procedure. For instance, the FIRS is scrutinizing transactions between Nigerian subsidiaries and their foreign related parties especially those located in tax-friendly jurisdictions. The aim is to ensure that these entities actually provide the services contracted and are not simply letter-box companies.

Action 1: Addressing the tax challenges of the digital economy

The emergence of new information technology has significantly altered the way businesses are conducted. Information now flows real time and it is possible for a service provider to operate in a location different from that of the recipient. As a result, tax authorities believe that companies can artificially reduce taxable income or shift profits to low-tax jurisdictions in which little or no economic activity is performed.

The first BEPS’ Action recommends adoption of destination principle for collection of Value Added Tax (VAT). This is to circumvent artificial tax avoidance scheme when the tax is collected at any other point other than the end of the value chain. The other major recommendations aimed to prevent artificial definition of permanent establishment (PE) are discussed under the relevant sections below (See action 7)

OECD expects that the Actions recommended will be helpful in preventing the MNEs from taking advantage of perceived tax loopholes within the digital economy.

Action 2: Neutralizing the effects of hybrid mismatch arrangements

OECD defined hybrid mismatch as arrangements that ‘exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long-term deferral’. It therefore recommends that countries deny taxpayer’s deduction for a payment to the extent that it is not included in the taxable income of the recipient in the counterparty jurisdiction or it is also deductible in the counterparty jurisdiction.

This may expose profits from related party transactions derived by special purpose vehicles (SPVs) or letter-box companies based in tax-friendly jurisdictions to Nigerian tax. FIRS is currently probing some of these transactions. The Nigerian tax authority may however not be able to penalize any established case of mismatch until the tax laws are amended, unless it can prove that the transactions are artificial.

Action 3: Designing effective Controlled Foreign Company (CFC) rules

CFC can simply be described as companies that are incorporated in jurisdictions other than where the companies’ shareholders are based. CFC rules are therefore designed to address the risk that taxpayers with a controlling interest in a foreign subsidiary can strip the base of their country of residence and, in some cases, other countries, by shifting income into a CFC. The rule, once promulgated in a country, will permit the tax authority of the jurisdiction where the shareholders are resident to subject the profit earned by CFC to tax. The tax will be based on the percentage of control or influence.

Nigeria does not currently have CFC rules. It is however very likely that the rule will soon be put on the gazette. This may affect some Nigerian conglomerates that currently use SPVs incorporated in tax-friendly jurisdictions as intermediate holding companies (IHCs). The profit earned by the SPVs will be exposed to Nigeria tax if the tax rates in those jurisdictions are much lower.

Action4: Limiting Base Erosion involving interest deductions and other financial payments

Some MNEs are believed to achieve favourable tax results by increasing the amount of debt in a group entity to enable it enjoy significant interest deductions. Action 4 recommends the design of rules that limit deductibility of interest and other financial payments made to third parties and related parties. It suggests a Fixed Ratio Rule (FRR) where an entity’s deductible interest expense would be limited to a fixed ratio of the entity’s earnings before interest, tax, depreciation and amortization (EBITDA). The fixed ratio should be between 10% and 30%. Hence, excessive interest expense will not be tax deductible.

Currently, FIRS is not able to limit the deduction of interest expense even where it is established that net interest expense to EBITDA ratio is unjustifiably high. Rather, it has only been able to adjust or disallow interest expense that is proved not to be at arm’s length. Nigeria may therefore introduce thin capitalization rule sooner than expected.

Action 5: Harmful tax practices

OECD seeks to prevent profit shifting associated with preferential tax regimes. Preferential tax regimes, otherwise known as tax-friendly jurisdictions, are those offering advantageous treatment to non-residents or enterprises that are not active in the domestic market. Thus, under the new arrangement, MNEs that are benefiting from preferential tax regimes will need to demonstrate that there is substantial activity in the host country. This is to show that the taxpayer actually engaged in active economic activities and incurred expenditure.

The Action complements the efforts of the Nigeria tax authority to subject all companies, irrespective of residency, to tax on actual profit basis. Hitherto, non-resident companies pay tax on deemed profit basis. MNEs with links to preferential tax regimes will need to refine their structure to ensure that there are substantial activities and evidenced by tax deductible expenditure. Failure to comply may expose the subsidiaries in those jurisdictions to higher tax liability in Nigeria.

Action 6: Preventing the granting of treaty benefits in inappropriate circumstances

Taxpayers engaged in treaty shopping and other treaty abuses undermine tax sovereignty by claiming treaty benefits in situations where these benefits were not intended to be granted.

OECD therefore recommends inclusion of both a Limitation of Benefits (LOB) article and general anti-abuse provisions in the form of a principal purpose test (PPT) in their tax treaties.

Action 7: Permanent establishment (PE) status

This Action called for a review of the definition of PE to prevent the use of certain tax avoidance strategies. The document cited instances where arrangements are made through which taxpayers replace subsidiaries that traditionally act as distributors by commissionaire. This results in shift of profits out of the country where the sales took place without a substantive change in the functions performed in that country.

OECD will also outline how countries can introduce anti-fragmentation rule to ensure that it is not possible to benefit from PE exceptions through the disintegration of business activities among closely related enterprises.

The recommendations may also encourage FIRS to probe many contractual arrangements that currently shield the offshore component from Nigeria tax. Companies that benefit from contract splitting arrangements will therefore need to align terms of contract with their conduct to prevent the FIRS from setting aside any arrangement that may be deemed artificial.

Action 8-10: Aligning Transfer Pricing (TP) outcomes with value creation

Tax authorities believe that the existing international standards for TP rules can be misapplied so that they result in outcomes in which the allocation of profits does not align with economic activity that produced the profits. The revised guidance (Actions 8 to 10) takes the form of amendments to various chapters of the OECD Guidelines.

One of the key changes is the requirement that taxpayers should carefully delineate their actual transaction between the associated enterprises by analyzing the contractual relations between the parties in combination with the conduct of the parties. The conduct will supplement or replace the contractual arrangements if the contracts are incomplete or are not supported by the conduct.

The Nigerian tax authorities have commenced a painstaking review of companies’ TP policies and compliance documentation. The process also involves interviewing taxpayers’ officers that perform key functions in the related party transactions. It is expected that the recently released BEPS’ guidance will further strengthen the resolve and determination of FIRS to penalize contractual arrangements that vary from parties’ conduct. Companies with inadequate documentation may be exposed to significant adjustments.

Action 11: Measuring and monitoring BEPS

Measuring the scale of BEPS proves challenging given its complexity and the serious data limitations. In addition to significant tax revenue losses, BEPS causes other significant adverse economic effects.

OECD plans to work with governments to report and analyze more corporate tax statistics and present them in an internationally consistent way. For example, statistical analyses based upon Country-by-Country Reporting (CBCR) data have the potential to enhance the economic analysis of BEPS.

Action 12: Mandatory Disclosure Rules

The lack of timely, comprehensive and relevant information on aggressive tax planning strategies is one of the main challenges faced by tax authorities worldwide. Early access to such information provides the opportunity to quickly respond to tax risks through informed risk assessment, audits or changes to legislation or regulations.

This Action calls for recommendations regarding the effective and efficient design of mandatory disclosure rules to the tax authority.

Action 13: Transfer Pricing Documentation and Country-by- Country (CbyC) Reporting

Action 13 focuses on enhancing transparency for tax administrations by providing them with adequate information to conduct transfer pricing risk assessments and examinations which are critical to tackling the BEPS problem.

Thus, MNEs are required to develop and make available to the relevant authorities, a three-tiered standardized TP documentation. These are the master and local files together with the CbyC Report. The reports are expected to articulate transfer pricing positions and provide tax administrations with useful information to assess TP risks, make determinations about where audit resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries.

In the first instance, the enabling TP Regulations envisaged the proposed changes in OECD documentation standard and taxpayers are required to comply immediately. It is however also interesting to note that FIRS has started requesting Nigeria conglomerates to submit CbyC report. This was incorporated into audit process. One may therefore conclude that, in the absence of any judicial challenge by the taxpayer, FIRS is relying on the existing tax legislation to implement this Action.

Action 14: Making dispute resolution mechanisms more effective

Eliminating opportunities for cross-border tax avoidance and evasion as well as effective and efficient prevention of double taxation are critical to building an international tax system that supports economic growth and a resilient global economy. Countries agree that the introduction of the measures developed to address BEPS should not lead to unnecessary uncertainty for compliant taxpayers and to unintended double taxation. Improving dispute resolution mechanisms is therefore an integral component of the work on BEPS issues.

To this end, Action 14 focuses on improving the effectiveness of the mutual agreement procedure (MAP) in resolving treaty-related disputes. This will actually be beneficial to taxpayers in Nigeria involved in cross-border transactions because it will reduce the risk of double taxation.

Action 15: Developing a multilateral instrument (MLI) to modify bilateral tax treaties

The goal of Action 15 is to streamline the implementation of the tax treaty-related BEPS measures. As at 15 October 2015, 90 countries were participating in the development of the MLI. When implemented, MLI will have the effect of amending existing bilateral treaties and put into law, treaty-related aspects of BEPS actions such as those on PE without any need for separate bilateral negotiations.

Conclusion

FIRS has followed the BEPS project very closely. It has contributed to the final set of recommendations both directly and through the African Tax Administrator’s Forum (ATAF). Some of the short term and long term impacts of the BEPS deliverables in Nigeria are summarised below:

• Immediate application of changes to the OECD Guidelines since regulation 11 of the Nigerian TP Regulations allows changes to the OECD Guidelines to automatically apply.
• Potential legislative and regulatory amendments to incorporate other recommendations which are not part of the OECD Guidelines.
• Increase in the ability of the FIRS to identify and challenge instances of abusive transfer pricing.
• Increase in transfer pricing audits and more focus on substance in evaluating the appropriateness of transfer prices.

An increase in the demand (by the FIRS) for financial and other information of offshore related parties. This could include demands made to the local subsidiary (e.g. master file information) as well as demands made to the tax authorities of the Head Office (e.g. CbC reports) or non-resident affiliate through the mechanisms of the Convention on Mutual Administrative Assistance in Tax Matters.

Olatunji Abdulrazaq is Senior Manager, Tax, Regulatory & Advisory Services at Saffron Professional Services.

Email: oabdulrazaq@saffron-ng.com, oabdulrazaq11@gmail.com

Transfer Pricing Regulations and Intra Group Services in Nigeria

 1. Introduction

 The Income Tax (Transfer Pricing) Regulation No 1, 2012 released by the Federal Inland Revenue Service (FIRS) in October 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 regulations were released based on the general anti-avoidance provisions in the various tax laws. The regulations are applicable to Accounting periods commencing after August 2012.To avoid Transfer Pricing penalties, companies needs to maintain and upon request by FIRS, produce in a timely manner, documentation with sufficient quality so as to accurately and completely describe the transfer pricing analysis conducted by the company and the efforts to comply with the arm’s length principle.

The Organisation for Economic Co-operation and Development (OECD) has developed Guidelines on Transfer Pricing to assist Multinational Enterprises (MNEs) and Tax Administrators in the evaluation of TP transactions and provide an element of consistency among countries in the application of such rules. The first Guidelines were released in 1995 and have undergone various revisions over the years. The most recent edition is the 2010 Guidelines which provide new guidance on the selection of the most appropriate transfer pricing method to a given circumstance and which deals with the transfer pricing aspects of business restructurings.

The OECD Guidelines have been adopted by most tax authorities, including Federal Inland Revenue Service (FIRS) either wholesale or with some level of customization to address local issues.

In view of today’s dynamic business environment, multinational enterprises seem to designate a specialised responsibility for each entity within the group in order to achieve economies of scales or to ensure service efficiency and costs effectiveness. The TP Guidelines 2012 provide that intra-group services refer to the types of services provided by one or more members of a multinational group for the benefit of the other members within the group. In general, the type of services provided to each other can be provided with regard to the nature of the group’s business, which are not limited to management, administrative, technical and support, purchasing, marketing and distribution and other commercial services. Costs incurred on such services will initially be borne by the parent company or other service companies within the multinationals group, which are eventually recovered from other associated persons through intra-group arrangements.

Intra group service, as the name suggests, is a service provided by one enterprise to another in the same MNE group. For a service to be considered an intra group service it must be similar to a service which an independent enterprise in comparable circumstances would be willing to pay for in-house or else perform by itself. If not, the activity should not be considered as an intra group service under the arm’s length principle.

The rationale is that if specific group members do not need the activity and would not be willing to pay for it if they were independent, the activity cannot justify a payment. Furthermore, any incidental benefit gained solely by being a member of an MNE group, without any specific services provided or performed, should be ignored.

  2.TRANSFER PRICING DOCUMENTATION

The Income Tax (Transfer Pricing) Regulation No 1, 2012 released by the Federal Inland Revenue Service (FIRS) in October 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 year are January 1st to 31st December are required to file Transfer Pricing documentations with their Income Tax Returns by 30th June 2014.

To avoid Transfer Pricing penalties, companies needs to maintain and upon request by FIRS, produce in a timely manner, documentation with sufficient quality so as to accurately and completely describe the transfer pricing analysis conducted by the company and the efforts to comply with the arm’s length principle.

2.1 TRANSFER PRICING DOCUMENTATION TO BE PROVIDED BY TAXPAYERS

• Organizational structure
• Nature of the business and market conditions
• Details of controlled transactions
• Assumptions, strategies, policies used to determine controlled transactions
• Comparability, functional and risk analysis employed
• Description of the transfer pricing method used
• Application of the transfer pricing method selected
• Other background documents

1. Intra Group Services

Almost all MNE groups do require diversity of services for all of its group members, whether it is administrative, technical, and financial or either commercial. These services can be related to management, coordination and control functions for the entire group. In general such services will be performed centrally, at the level of the ultimate parent company and charged to the other group companies that require these services in order to be fully operational. Independent companies in need of certain services might obtain these services from a service provider that specializes in those types of services. Or in some cases this company might perform the services by itself. On the other hand, a member of an MNE group in need of such a service may obtain it directly or indirectly from independent companies, or from one or more related companies’ part of the same MNE group (i.e. intra-group), or may perform the service itself. If a company obtains such services from a related party, under certain conditions (provided below) these will be considered as intra-group services.

Some common intra-group services are provided below:

• Legal services
• Accounting services
• Central auditing services
• Financing advice
• Human resource management
• IT service

The services listed above could be provided where no intangible asset is transferred. In this scenario the price charged must be at arm’s length relationships as stated in the Nigerian Transfer Pricing Regulation. The price charged at arm’s length is based on a cost-plus formula where the “plus” element varies greatly with the value added of the services and extent of competition in the market.

The services provided could be technical assistance with transfer of an intangible, be it manufacturing or marketing. This is usually in the form of licence agreement where licensing fees are agreed within the MNE at an arm’s length. The services could also be technical in nature without the transfer of intangible, but where the services provided are paid for on an arm’s length basis.

How services are rendered with a group depends on the structure of the group. For example in decentralized MNEs, the parent company only monitors its investments (subsidiaries) as a shareholder and the subsidiaries performs the services functions themselves or acquires it internally from an affiliated enterprise or by an external party. Where as in centralized MNEs, a department of the parent enterprise performs or a regional office makes all important decisions and carries out all marketing, training and treasury functions.

3.1 Nigeria Transfer Pricing Regulations and Transactions between connected Persons

Transfers Pricing Regulation shall apply to transactions between connected persons carried on in a manner consistent with the arm’s length principle and includes;

• sale and purchase of goods and services;
• sales, purchase or lease of tangible assets;
• transfer, purchase, licence or use of intangible assets;
• provision of services;
• lending or borrowing of money;
• manufacturing arrangement;
• For purposes of applying these Regulations, Permanent Establishments (“PEs”) are treated as separate entities, and any transaction between a Permanent Establishment (“PE”) and its head office or other connected taxable persons shall be considered a controlled transaction; and

• any transaction which may affect profit and loss or any other matter incidental to, connected with, or pertaining to the transactions referred to in (a) to (g) of this regulation.

            3.2 Transfer pricing methods and evaluation of taxpayer’s controlled transaction

(1)        In determining whether the result of a transaction or series of transactions are consistent with the arm’s length principle, one of the following transfer pricing methods shall be applied -

(i)       the Comparable Uncontrolled Price (‘CUP’) method

(ii)        the Resale Price method;

(iii)       the Cost Plus method;

(iv)       the Transactional Net Margin method; or

(v)        the Transactional Profit Split method; and

(vi)       any other method which may be prescribed by regulations made by the Service from time to time

(2)        In each case, the most appropriate transfer pricing method shall be used taking into account -

(a)   the respective strengths and weaknesses of the transfer pricing method in the circumstances of the case;

(b)   the appropriateness of a transfer pricing method having regard to the nature of the controlled transaction determined, in particular, through an analysis of the functions performed, assets employed and risks assumed by each person that is a party to the controlled transaction;

(c)  the availability of reliable information needed to apply the transfer pricing method; and

(d) the degree of comparability between controlled and uncontrolled transactions, including the reliability of adjustments, if any, that may be required to eliminate any differences between comparable transactions.

(3)        When examining whether or not the taxable profit resulting from a taxpayer’s controlled transaction or transactions is consistent with the arm’s length principle, the Service shall base its review on the transfer pricing method used by the taxable person if such method is appropriate to the transaction.

(4)           A connected taxable person may apply a transfer pricing method other than those listed in this regulation, if the person can establish that-

(a)        none of the listed methods can be reasonably applied to determine whether a controlled transaction is consistent with the arm’s length principle; and

(b)    the method used gives rise to a result that is consistent with that between independent persons engaging in comparable uncontrolled transactions in comparable circumstances.

(5)       If a taxpayer carries out, under the same or similar circumstances, two or more controlled transactions that are economically closely linked to one another or that form a continuum such that they cannot reliably be analysed separately, those transactions may be combined to:

• perform the comparability analysis set out in regulation 9of these Regulations; and
• apply the transfer pricing methods set out in sub-regulation (1) of this Regulation.

1. Determination of Intra Group Services in MNEs

Intra group services occur when a service is performed by one member of the MNE for the benefit of one or more members of the same MNE .This is determined by considering whether an unconnected enterprise in similar circumstances would have been willing to pay for the activity if performed for it by an unconnected company or would have performed the activity by itself. Furthermore, the beneficiary of the service should gain commercial or economic value by receiving the service. If not, then it would not be considered as an intra-group service. There are some specific services that need attention that will not qualify as intra-group services. These are touched upon below.

Shareholder activities

An intra-group activity may be performed relating to group members even though those group members do not need the activity (and would not be willing to pay for it if they were unrelated companies). Such an activity would be one that a group member (usually the parent company or a regional holding company) performs solely because of its ownership interest in one or more other group members, i.e. in its capacity as shareholder. This type of activity would not justify a charge to the receiving companies. These activities are recognized as “shareholder activities”.

Some examples of shareholder activities are provided below:

• Costs of activities relating to the juridical structure of the parent company itself, such as meetings of shareholders of the parent, issuing of shares in the parent company and costs of the supervisory board
• Costs relating to reporting requirements of the parent company including the consolidation of reports
• Costs of raising funds for the acquisition of its participations

Note that the list above is non exhaustive and other services can qualify as well as ‘shareholder activities’.

Duplication

In general, no intra-group service should be found for activities undertaken by one group member that merely duplicate a service that another group member is performing for itself, or that is being performed for such other group member by a third party. An exception may be where the duplication of services is only temporary, for example, where an MNE group is reorganizing to centralize its management functions. Another exception would be where the duplication is undertaken to reduce the risk of a wrong business decision (e.g. by getting a second legal opinion on a query).

On call services

There is another difficulty with respect to services provided “on call”. Is the availability of such services itself a separate service for which an arm’s length charge (in addition to any charge for services actually rendered) should be determined. A parent company or a group service centre may be on hand to provide services such as financial, managerial, technical, legal or tax advice and assistance to members of the group at any time. In that case, a service may be rendered to related companies by having staff, equipment, etc., available. An intra-group service would exist to the extent that it would be reasonable to expect an independent company in comparable circumstances to incur “standby” charges to ensure the availability of the services when they are required. It is not unknown, for example, for an independent enterprise to pay an annual “retainer” fee to a firm of lawyers to ensure entitlement to legal advice and representation if litigation is brought. Another example is a service contract for priority computer network repair in the event of a breakdown. These services may be available on call and they may vary in amount and importance from year to year. It is unlikely that an independent enterprise would incur stand-by charges where the potential need for the service was remote, where the advantage of having services on-call was negligible, or where the on-call services could be obtained promptly and readily from other sources without the need for stand-by arrangements. Thus, the benefit conferred on a group company by the on-call arrangements should be considered, perhaps by looking at the extent to which the services have been used over a period of several years rather than solely for the year in which a charge is to be made, before determining that an intra-group service is being provided.

1. Arm’s length Remuneration for Intra Group Services

Under the Organization for Economic Co-operation and Development (OECD) Guidelines, in relation to intra-group services, a service is considered as “rendered” if:

1. The activity provides a respective group member with economic or commercial value to enhance its commercial position; and

1. If so, an independent enterprise in comparable circumstances would have been willing to pay for the activity performed or if the same activity was performed in-house itself.

Once it is determined that an intra-group service has been provided, it is necessary, as for other types of intra-group transfers, to determine whether the amount of the charge is in accordance with the arm’s length principle. In other words, is the charge for an intra-group service in line with those that would have been agreed between independent companies in similar circumstance. This can either be done through the direct-charge method (preferred) or indirect-charge method (most used).

Direct-charge method

The direct charging method is appropriate when the arrangement of services are readily identifiable, which makes it possible for the provider to charge the recipient for every specific service it provides. This is why direct charging is the most favorable charging method by tax administrations. This allows the services performed and the basis for the payment to be clearly identified. Consequently, the direct-charge method eases the determination of whether the charge is consistent with the arm’s length principle. This is the preferred method by the OECD to determine an arm’s-length price for intra-group services. In practice it is difficult to apply the direct-charge method and therefore, the indirect-charge method is used frequently.

Indirect-charge method

The indirect charging method is regarded as a second hand choice and should be used when direct charging is not possible. Indirect charging is suitable in situations when the rendered service cannot be quantified except on an approximated or estimated basis. For example, in centralized marketing campaigns it is difficult to estimate the actual benefit for each member of the MNE, since it is difficult to determine how much of the sold goods are derived from a specific campaign. In these situations, the indirect charging method would make an estimated split of the costs between the recipients, which would be calculated in reference to what an independent enterprise would be prepared to accept. As stated, in practice it might be very difficult to apply the direct-charge method. In such scenario, MNE groups may find they have few alternatives but to use cost allocation and apportionment methods which often force some degree of estimation or approximation, as a basis for calculating an arm’s length charge. The allocation might be based on turnover, or staff employed, or some other basis. Whether the allocation method is appropriate depends on the nature and usage of the service. For instance, the usage or provision of payroll services may be more related to the number of staff than to turnover, while the allocation of the stand-by costs of priority computer back-up could be allocated in proportion to relative expenditure on computer equipment by the group members. Typical allocation keys are based on turnover, heads (staff employed), production, or other on some other basis as stated below

• IT: number of PCs
• Business management software (e.g. SAP): number of licenses
• Human Resources: headcount
• Health and safety: headcount
• Management development: headcount
• Tax, Accounting, etc.: turnover or size of balance sheet
• Marketing services: turnover
• Vehicle fleet management: number of cars

Cost Sharing Arrangements

Cost sharing arrangements (CSA) is an arrangement, between, all or some, members of the MNE, to share the costs and risks for the provision of property or services. It is not necessarily a distinct juridical entity that provides some or all MNE members with services and should therefore not be mixed up with Group Service Centre (GSCs). The difference is that CSA is a contractual arrangement to share costs and which does not have to be the purpose for a GSC, even though the result is that the recipients share them. However, it is not impossible that the GSC is formed through a CSA. There are many types of CSA, but the most common in joint development of intangible property (i.e. R&D). However, members of a MNE might also join together to pool costs.

Methods to determine the arm’s length price

The generally preferred method to determine an arm’s length price is the CUP method. This method can be used if there is a comparable service provided between independent enterprises in the recipient’s market, or by the associated enterprise providing the services to an independent enterprise in comparable circumstances. For instance, this might be the case where accounting, auditing, legal, or computer services are being provided to related as well as unrelated companies, if these transactions are comparable. A cost plus method is the most appropriate method in the absence of a CUP method where the nature of the activities involved, assets used, and risks assumed are comparable to those undertaken by independent companies.

Mark up

As intra-group services will typically only attract a modest mark up, establishing an appropriate cost base is relatively more important. Once the cost base of an intra-group service is determined it is then appropriate to consider what mark up, if any, on those costs should be applied. The OECD acknowledges that a markup is not always justifiable. If it is appropriate to use a mark up for intra-group services rendered, this will normally be modest and experience shows that typically agreed mark ups fall within a range of 3-10%, often around 5%. However, the facts and circumstances of the arrangement for intra-group services may support a different mark up.

Mostly, in determining the arm’s length price to intra-group services, the Comparable Uncontrolled Price method (CUP) or Cost-Plus method may be applied. The CUP method is ideal only if comparable products are available or if reasonably accurate adjustments can be made to eliminate material product differences. Comparable products may refer to a comparable service provided by an independent entity to another independent party, or the service renderer in the related party transaction (RPT) also provides similar services to an unrelated party or vice versa. The cost-plus method requires compilation of costs incurred by the service renderer such as contract research, management or other business services in the course of delivering its services to the related party. Service providers applying the cost-plus method transacting at arm’s length may generally add up an appropriate markup, limited to rewarding the services rendered, to the costs in determining the transfer price.

  6.Conclusion

  In view of today’s dynamic business environment, multinational enterprises seem to designate a specialised responsibility for each entity within the group in order to achieve economies of scales or to ensure service efficiency and costs effectiveness. The TP Guidelines 2012 provide that intra-group services refer to the types of services provided by one or more members of a multinational group for the benefit of the other members within the group. In general, the type of services provided to each other can be provided with regard to the nature of the group’s business, which are not limited to management, administrative, technical and support, purchasing, marketing and distribution and other commercial services. Costs incurred on such services will initially be borne by the parent company or other service companies within the multinationals group, which are eventually recovered from other associated persons through intra-group arrangements.

Intra Group Services have become a useful tool for the effective organisation of management structures within group of companies. However, their implementation is far from risk free. The most sensitive area is the provision by the parent company of core executive management functions, such as finance, IT, legal, and Tax or human resources.Cautious planning at the pre-implementation stage will help companies to avoid unforeseen tax exposures, and ensure that their intra-group management arrangements are effective.

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