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