Background
Nigeria introduced transfer pricing rules into its tax system last year. Transfer pricing is the price at which goods, services or intellectual property are transferred between company divisions and departments within one country or between related companies of a multinational organization across international borders. The Nigerian transfer pricing rules officially known as Income Tax Regulations No 1, 2012 regulates transactions between connected taxable persons. The regulation seeks to ensure that transactions among connected taxable persons are carried on at arm’s length. Applying the arm’s length principle can be a tedious and time consuming process hence the need to exempt some transactions or categories of taxpayers from transfer pricing rules. This partial or full exemption is known as safe harbour or safe haven provisions. This article will attempt to review the safe harbour provisions in the Nigeria transfer pricing rules with a view to teasing out the salient points.
Global Perspective
The Organisation for Economic Co-operation and Development (OECD) [1] has published the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines) [2] to assist multinational enterprises and tax authorities in the evaluate transfer pricing transactions as well as provide a level consistency among countries in the application of such the arms length principles. The OECD TP Guidelines have been adopted by most tax authorities, either wholesale or with some level of customization to address local fiscal issues.
According to the OECD TP guidelines, applying the arm’s length principle can be a fact-intensive process and can require proper judgment. It may present uncertainty and may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both legislative and compliance complexity. These facts have lead OECD member countries to consider whether safe harbour rules would be appropriate in the transfer pricing area. The challenge posed by a strict application of subsisting transfer pricing rules can be circumvented by providing circumstances in which tax payers could elect to follow a simple set of rules under which transfer prices would be automatically accepted by the tax authorities. Safe harbor provisions offer essentially benefits to taxpayers and tax administrators with benefits of compliance relief, administrative simplicity and certainty.
Safe harbours can take two forms, exclusion of certain classes of transactions from transfer pricing regulations; and stipulation of margins or thresholds for prescribed classes of transactions. Developed and developing economies alike have adopted safe harbour provisions.
In the United States, there are safe harbour provisions for intra-group services and other non-core services. Similarly, in Brazil, a taxpayer will be deemed to have an appropriate transfer price with respect to export sales when the average export sales price is at least 90% of the average domestic sales price of the same property, services, or intangible rights in the Brazilian market during the same period under similar payment terms. In Mexico, companies engaging in contract manufacturing (Maquiladoras) [3] operations are subject to a flat tax rate under the safe harbour provisions of the Mexican tax authorities. Australia and New Zealand have safe harbour provision with respect to certain categories of non-core intra-group services.
Nigerian Perspective and Matters Arising
According to Paragraph 15 of the Income Tax Regulations No 1, 2012, “a connected taxable person may be exempted from the requirements of regulation 6 of these Regulations where –
(a) the controlled transactions are priced in accordance with the requirement of Nigerian statutory provisions; or
(b) the prices of connected transactions have been approved by other Government regulatory agencies or authorities established under Nigerian law and satisfactory to the Service to be at arm's length.” (emphasis mine)
While cursory review of the above provisions may lead to the conclusion that Nigeria has safe harbour provisions, a critical analysis of these provisions makes one question the adequacy or perhaps the existence of same.
Contrary to what is obtainable in other tax jurisdictions, no specific categories of taxpayers or specific types of transactions have been identified in the regulation to which the safe harbour provision will apply. This indeed denies taxpayers the benefit of certainty. The phrase “… in accordance with the requirement of Nigerian statutory provision” is rather too generic if not ambiguous. Paragraph 15 (b) appears to provide a leeway to taxpayers with respect to connected transactions for which approval has been obtained from other government regulatory agencies or authorities established under the Nigerian law. However, the provision quickly added that such approvals must be satisfactory to the tax authority to have been given at arm’s length.
It is important to note that although a government regulatory agency may consider economic and commercial circumstances when reviewing taxpayers’ application for the relevant approval, it may not necessarily apply the arm length principles. For instance, a company that depends on its foreign related entities for management and technical services is required by law to obtain approvals from the National Office for Technology Acquisition and Promotion (NOTAP). In granting the relevant approval, NOTAP has often times adopted rule of the thumb. Approval for licenses such as patent and trademarks is usually set at 0.5 to 5 percent of net sales value or profit before tax when net sales value is not available. Management service fees approval is usually set at a range of 2 to 5 percent of the local company’s profit before tax.
From the foregoing, it is clear that the arm’s length condition attached to the Paragraph 15(b) totally defeats the essence of a safe harbour provision as put forth by the OECD transfer pricing guidelines.
Thus, the benefits compliance relief, administrative simplicity and certainty are therefore unavailable to the taxpayer and tax authority alike.
Further, it is also important to note that the Nigeria transfer pricing regulations did not specify the categories of tax payers or the types of transactions to be covered by the safe harbour provisions. This is contrary to the norms as put forth in the OECD transfer pricing guidelines. According to Paragraph 4.95 of the guidelines, “A safe harbour may have two variants regarding the taxpayer’s conditions of controlled transactions: certain transactions are excluded from the scope of application of transfer pricing provisions (in particular by setting thresholds), or the rules applying to them are simplified (for example by designating ranges within which prices or profits must fall)…”
For the safe harbour provisions to be useful to taxpayers, the Federal Inland Revenue Service (FIRS) may need to publish further guidance in this regards. The FIRS may also need to amend Paragraph 15(b) to make it conform to global best practice.
Conclusion
Safe harbour provisions of the Nigeria transfer pricing regulation leaves a lot to be desired. The FIRS has the responsibility to provide further clarifications so as to unlock the benefits inherent in adoption of safe harbour provisions based on global best practices. The clarifications should provide the needed relief of certainty, simplified method and administrative ease to taxpayers and the FIRS.
Additional Information
1The Organisation for Economic Co-operation and Development (OECD) is an international economic organisation of 34 countries founded in 1961 to stimulate economic progress and world trade. It is a forum of countries committed to democracy and the free-market economy, providing a platform to compare policy experiences, seek answers to common problems, identify good practices, and co-ordinate domestic and international policies of its members. (Source: Wikipedia)
2The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations provide guidance on the application of the "arm's length principle" for the valuation, for tax purposes, of cross-border transactions between associated enterprises. In a global economy where multinational enterprises (MNEs) play a prominent role, governments need to ensure that the taxable profits of MNEs are not artificially shifted out of their jurisdiction and that the tax base reported by MNEs in their country reflects the economic activity undertaken therein. For taxpayers, it is essential to limit the risks of economic double taxation that may result from a dispute between two countries on the determination of the arm’s length remuneration for their cross-border transactions with associated enterprises. (Source: www.oecd.org)
3 Maquiladora is the Mexican name for manufacturing operations in a free trade zone (FTZ), where factories import material and equipment on a duty-free and tariff-free basis for assembly, processing, or manufacturing and then export the assembled, processed and/or manufactured products, sometimes back to the raw materials' country of origin. (Source: Wikipedia)
He has written several articles on transfer pricing and BEPS in local and international journals and magazines.