With the Federal Government in dire need of increased tax revenue to fund its expansionary fiscal policy, it is no surprise that the Federal Inland Revenue Service (FIRS) has been perceived in a recent survey of taxpayers to be aggressive with Transfer Pricing (TP) audits. Some of the TP audits have resulted in assessments of additional tax liabilities for multiple years that run into billions of naira. This article makes a compelling case for proactive strategies to mitigate taxpayers’ TP risk exposure in an aggressive TP audit regime.
Why an aggressive TP audit regime?
The Nigerian economy recently recovered from a year-long recession. However, it is imperative that the Federal Government sustains the positive economic growth rate to ensure that the economy attains a steady state high economic growth path that will help consolidate Nigeria’s status as a full-fledged middle-income economy in the medium to long term. To this end, the Federal Government has employed an expansionary fiscal policy to help develop the much-needed infrastructure to create the enabling environment for businesses to thrive. This policy coupled with the significant decrease in tax revenue from the oil sector means that non-traditional approaches to generating tax revenue have become a paramount fiscal policy strategy. TP is one of such non-traditional sources of raising additional tax revenue that has garnered much focus by the FIRS. Although it might not be making the headlines, the FIRS has been auditing taxpayers with both cross-border and domestic transactions with related parties to ascertain whether such taxpayers knowingly or unknowingly mispriced these transactions to leave them with lesser taxable profits. Where the FIRS determines that the prices of these related party transactions are not reasonable compared to what would have occurred in a comparable transaction with an unrelated party under similar circumstances, the taxable profit of the taxpayer is adjusted upward and the corporate income and educational tax rates applied to determine appropriate additional tax liabilities over the years being audited. Depending on the materiality of the volume of related party transactions and the resulting size of adjustments to the profits, the assessedadditional tax liabilities for some taxpayers for the multiple years under audit can run into billions of naira. In light of the significant TP risk exposure faced by taxpayers, this article reviews the FIRS’ aggressive TP audit regime and recommends a number of proactive strategies that taxpayers need to adopt to mitigate their TP risk exposure and protect their businesses in a currently fragile economy.
The status quo
Since the inception of the Nigeria TP Regime five years ago, most taxpayers have employed a reactive approach in complying with the Nigeria TP Regulations. For example, for most taxpayers, filing TP returns and preparing TP documentation reports on an annual basis are viewed merely as compliance obligations rather than their first line of TP audit defence. As such, they do not ensure that their TP documentation are robust, TP policies are effectively implemented and monitored, and thorny TP issues are proactively clarified with the FIRS.
Further, much resources and time are not dedicated upfront in preparing for potential TP audits. This means supporting documentary evidence are not tracked prior to TP audits and TP audit readiness reviews are not conducted. As a result, taxpayers are constantly in a reactive mode during TP audits which usually results in delays in providing information requested by the FIRS, thereby contributing to a potential adversarial TP audit process with the FIRS. Finally, a reactive approach means taxpayers are likely to be oblivious of their sources of TP risks. This is akin to going into a boxing match blind folded; suffering a knockout becomes inevitable. Clearly, in an aggressive TP audit regime where up to billions of naira is at stake, taxpayers need to employ proactive strategies to help mitigate their TP risk exposure.
Proactivity as a strategic approach This approach starts from a strategic decision on whether to outsource your TP function or not, through to preparing your TP documentation with your future TP audit defence in mind, to having a clear TP dispute resolution strategy from the onset. To this end, I present five proactive strategies that need to be employed by taxpayers to help mitigate their TP audit risk.
Outsourced vs In-house TP function
The strategic decision to outsource a TP function or have it in-house depends on factors such as size of the business, volume of related party transactions, consistency in implementation of TP policy across jurisdictions, amongst others. Irrespective of the option adopted by a taxpayer, some cardinal factors must be considered as part of your proactive strategy. Whether you outsource your TP function or develop an in-house TP function, it is imperative that the TP experts have the requisite skills and experience to not only prepare a robust TP documentation, but to defend the conclusions of the documentation during a TP audit. Thus, having the end game in mind when making these upfront decisions is critical in executing a proactive approach. A weak TP documentation with inconsistencies in relevant financial information that have been disclosed to the FIRS is pretty much indefensible, and the likelihood of the taxpayer suffering material assessment of additional tax liabilities is high.
Operationalization of TP policy
A number of taxpayers have prepared TP policy reports to guide their related party transactions, but have the reports shelved to accumulate dust. Having your TP advisors assist in a proper operationalization of your TP policy is a key proactive strategy to ensure that policies are adhered to in a timely manner. To this end, some of the very large Multinational Enterprises (MNEs) with material related party transactions across the globe embed their TP policies in their IT systems, whilst others perform quarterly or half yearly reviews and ensure that necessary true-ups are made before financial books are closed. Either approach helps to minimise any unpleasant surprises in the financial statements that are inconsistent with the Group’s TP policy.
Collectively addressing ambiguous TP issues prevalent in your industry
Often times, there are thorny related party arrangements or transactions that are prevalent in an industry that taxpayers might not be clear on how the FIRS will treat during an audit. Such uncertainty is a potential TP risk, therefore, an effective proactive strategy will be for taxpayers within such industry to collectively, through their industry associations, seek clarification on the thorny issues rather than deal with the uncertainty individually. Examples of such thorny TP issues include procurement arrangements, technical fees and royalties common in the manufacturing industry and cost sharing/ contribution arrangements in the upstream oil & gas industry. The probability of successfully getting the FIRS to clarify its treatment of these TP issues is higher if the industry associations take the initiative than if each taxpayer attempts to address them on its own.
Written by Dr Josh Bamfo, Partner & Head Transfer Pricing Services, Andersen Tax