AS earlier stated, our transfer pricing regulation is benchmarked against the OECD transfer pricing guidelines. The Transfer Pricing Regulations also provide a “Safe Harbour”, which is an exemption from “documentation requirement” of Regulation 6 limiting it to when price is in accordance with the requirement of Nigerian statutory provisions and/or when price approved by other government regulatory agencies/authorities established by Nigerian law provided that FIRS is satisfied that the price is at arm’s length.
Though this can be tagged as mere “approval in principle” since the FIRS reserves the right to still scrutinise the transactions and ensure compliance to the “arm length” principle. The regulations also make provision for a dispute resolution panel to serves as an administrative dispute resolution mechanism from issues arising from the provisions of the Regulations.
In effect the regulations provide an appropriate basis for taxing economic activities of associated enterprises as well as tools for fighting tax evasion. Provisions of the regulations also reduce the risk of economic double taxation. Also included is a level playing field between MNE and independent enterprises.
The scope of the regulations covers sale and purchases 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 and any transaction incidental, connected or pertaining to the above transactions.
The regulations also adopt popular transfer pricing methods, such as comparable Uncontrolled Price (CUP), cost plus, resale price, transaction net margin method (TNMM) and transactional Profit Split. In all these, method used must be appropriate to the particular transaction bearing in mind the relative strength and weakness of each method, the nature of the transaction, availability of reliable information and degree of comparability.
The arm’s length principle, which is the global benchmark for establishing transfer prices between related parties is recognised in Regulation 4 of the Transfer Pricing Regulations. It empowers the Service to make adjustments where necessary to make a controlled transaction consistent with the arm’s length principle. The application of the arm’s length principle assists governments to ensure that the taxable profits of multinationals are not artificially or deliberately shifted out of their jurisdiction and that the tax base reported by multinationals in their country reflects the economic activity undertaken therein. It also limits the risks of economic double taxation that may result from a dispute between two countries on the determination of the remuneration for cross-border transactions between associated enterprises.
Nearly all systems require that prices be tested using an “arm’s length” standard. Using this method, a price is considered appropriate if it is within a range of prices that would be charged by independent parties dealing at arm’s length. This is generally defined as a price that an independent buyer would pay an independent seller for an identical item under identical terms and conditions, where neither is under any obligation to act.
There are clear practical difficulties in implementing the arm’s length standard. For items other than goods, there are rarely identical items. Terms of sale may vary from transaction to transaction. Market and other conditions may vary geographically or over time. Some systems give a preference to certain transactional methods over other methods for testing prices.
The application of the arm’s length principle is generally based on a comparison of the conditions in a controlled transaction with the conditions in comparable transactions between independent enterprises, referred to as a “comparability analysis”. The OCED Transfer Pricing Guidelines (‘TPG’), which has been adopted unchanged by some jurisdictions contain guidance on comparability analysis and a description of five transfer pricing methods, which can be used to establish whether the conditions of a transaction between associated enterprises satisfy the arm’s length principle. The OECD and the United Nations Tax Committee have both endorsed the “arm’s length” principle, and it is widely used as the basis for double taxation treaties between governments.
The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax authorities to adjust those prices where the prices charged are outside an arm’s length range. Rules are generally provided for determining what constitutes such arm’s length prices, and how any analysis should proceed. Prices actually charged are compared to prices or measures of profitability for unrelated transactions and parties. The rules generally require that market level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items with respect to the related party transactions or profitability being tested.
Most systems allow use of multiple methods, where appropriate and supported by reliable data, to test related party prices. Among the commonly used methods are comparable uncontrolled prices, cost-plus, resale price or mark-up, and the TNMM. Many systems differentiate methods of testing goods from those for services or use of property due to inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax controversy.
Most tax treaties and many tax systems provide mechanisms for resolving disputes among taxpayers and governments in a manner designed to reduce the potential for double taxation. Many systems also permit advance agreement between taxpayers and one or more governments regarding mechanisms for setting related party prices.
Many systems impose penalties where the tax authority has adjusted related party prices. Some tax systems provide that taxpayers may avoid such penalties by preparing documentation in advance regarding prices charged between the taxpayer and related parties. Some systems require that such documentation be prepared in advance in all cases.
Developing economies are keenly aware of the challenges posed by transfer pricing. Their goal is the same as for OECD countries: protecting their tax base while not hampering foreign direct investment and cross-border trade. The arm’s length principle can help them achieve that goal. The key is to tailor the legislative measures and administrative effort to the strategic needs and resources of each country.
Applying the arm’s length principle can become complex and resource-intensive, though policy makers should bear in mind that most OECD countries started modestly and built their transfer pricing legislation and practices gradually over several years. Indeed, they are still in the process of improving them.
The USA transfer pricing regulations of 1994 and the risk of severe penalties, even in case of non-deliberate deviations from the arm’s length principle have resulted in both the USA and countries revising their transfer pricing methods. Countries with less sophisticated tax systems and administrations run the risk of absorbing the effect of stronger enforcement of transfer pricing in developed countries, and, in effect, paying at least some of the MNEs tax costs in those countries. In order to avoid this, any countries have introduced new transfer pricing rules since that time.
Tax authorities in developing countries that wish to implement transfer pricing legislation may focus on the most common types of transactions and sectors in their economy first, for instance the exploitation of natural resources, manufacturing, or service activities. Enforcement objectives should be realistic, given the available capacity, and compliance requirements made reasonable for taxpayers in light of the size of the cross border trade. So-called “safe harbours” are sometimes used to simplify compliance by small taxpayers, or to deal with small and less complex transactions carried out by multinational enterprises.
Given the global and sometimes controversial nature of transfer pricing, it is important to develop internationally shared principles to help each country fight abusive transfers of profit abroad, while at the same time limiting the risk of double taxation of those profits. This is what the arm’s length principle is for. As more developing countries apply it, new lessons will be learned. This is a key step on the road to building a stronger and fairer world economy.
