Recent developments in Nigeria including the impact of the global COVID-19 pandemic on the economy, the urgent need for the Federal Government (FG) to raise more tax revenue to help fund the significant budget deficit and developments in the tax and Transfer Pricing (TP) space have contributed in making TP one of the riskiest areas in taxation in Nigeria.
Specifically, the release of the maiden TP judgment in Nigeria between Prime Plastichem Nigeria Limited (PPNL) and the Federal Inland Revenue Service (FIRS) [which resulted in a ₦1.7 billion additional tax liability], management changes within the FIRS International Tax Division (ITD), introduction of the Finance Act 2019 and the Significant Economic Order (SEP) 2020 were significant TP developments with implications for taxpayers. The negative impact of the pandemic on the economy also resulted in taxpayers earning abnormal returns, which could trigger TP audits.
The introduction of a TP specific penalty regime in the 2018 TP Regulations means that taxpayers do not only face the risk of TP adjustments and the assessment of additional tax liabilities, but also face the risk of being levied significant administrative penalties for non-compliance.
In light of these developments, among others, it is imperative for taxpayers to understand the potential TP implications for their businesses in 2021 and the measures they should put in place to manage these risks. This article provides an outlook of the potential implications of these developments on taxpayers in 2021.
Outlook for 2021
Impact of the COVID-19 pandemic
The impact of the COVID-19 pandemic has been profound and the effects will continue to be felt in 2021. The unique economic challenges and policies adopted by companies to cushion the effects of the pandemic on their businesses may lead to challenges in defending the arm's length nature of Related Party Transactions (RPTs).
One of such challenges will be how taxpayers will defend the reduced revenues/ profit margins earned from their RPTs during the COVID-19 period, which may be deemed to be non-arm's length during normal times.
For instance, companies with RPTs that were expected to make high profit margins may be reporting significantly lower margins or even losses for this period. Others may have significant intercompany debts/financing arrangements and need to ascertain whether the interest rates charged are reasonable from an arm's length perspective. It is important to note that TP policies, transfer prices and agreements, which were agreed prior to the pandemic, may be insufficient to capture the effects of the COVID-19 pandemic.
Hence, it is important for taxpayers to review their TP policies and RPTs in order to align transfer prices to current economic realities. Taxpayers also need to have in place robust TP documentation for 2020 to demonstrate that any returns lower than the arm's length returns during normal times were as a result of adverse economic conditions rather than transfer mispricing. This distinction will be important during any Post-COVID-19 TP audits.
Given that as at the time of preparing the TP documentation, third party information showing the impact of the economic downturn on financial performance might not be available, companies might have to conduct relevant economic adjustments while performing the comparability analyses.
It is also important that taxpayers conduct a COVID-19 impact analysis, continuously document happenings in the business environment and collate relevant documents, put in place measures to mitigate any TP risks and update their TP policies and intercompany agreements as necessary
Increased TP audits and investigations
The need to increase tax revenue and the management changes within the FIRS ITD resulted in an increased TP audit drive with a numerous Information Document Requests (IDR) sent out towards the end of 2020. Hence, it is expected that 2021 will see a spike in the number of TP audit cases due to the aggressive revenue drive.
Also, the access to more information for risk assessment purposes may lead to more companies being identified for TP audits. It should be noted that the victory of the FIRS at the Tax Appeal Tribunal (TAT) in the PPNL case, might influence the FIRS's behavior towards litigation as a way to close out audit cases henceforth.
Taxpayers therefore need to review their RPTs, proactively collate documents and determine their TP audit strategies in preparation for TP audits.
Need for robust TP documentation
Due to the various developments in the Nigerian TP space in 2020, it has become very pertinent for taxpayers to have robust TP documentation that can defend the arm's length nature of their RPTs. This is notable in the light of the lessons learnt from the PPNL case.
Specifically, while preparing the TP documentation for 2020, there will be a need to take into consideration the impact of the COVID-19 pandemic and the TP related provisions introduced in various laws passed in 2020.
Unquestionably, TP will be a major focus area for taxpayers and tax authorities in 2021. The TP space in 2021 will be heavily impacted by the various developments in prior years. It has therefore become pertinent that taxpayers ensure that they meet all relevant compliance obligations and are proactive in reviewing and developing strategies to manage their TP exposures.
Increased compliance burden on taxpayers
The developments in the Nigerian TP space in 2020 have increased the compliance burden on taxpayers. In addition to the TP compliance requirements of TP returns filing, preparation of TP documentation, Country by Country Reporting (CbCR) notification and filing, Common Reporting Standard (CRS) filing, taxpayers also have to understand, for compliance purposes, the new laws and regulations introduced during the year.
One of such is the SEP Order, 2020 which imposes some compliance obligations on foreign companies in Nigeria which meet certain criteria.
Also, taxpayers who in prior years depended on approvals received from government regulatory agencies will now have to carry out robust TP analyses to defend their RPTs.
Increased information for FIRS' risk assessment
With 2 years of CbC reports and the first CRS information returns available to the FIRS by the end of 2020, it is expected that the FIRS will have unprecedented amount of information about taxpayers for risk assessment purposes. Taxpayers therefore need to ensure that their RPTs are conducted properly and review their activities to ensure that they do not create any significant TP risk.
In view of this, taxpayers are advised to review their RPTs and tax planning strategies to mitigate TP risks and ensure all compliance obligations are duly met.
Imposition of penalties
The FIRS will continue to impose penalties on taxpayers that fail to comply with the provisions of the various Regulations. Taxpayers who failed to comply with the compliance obligations (notification and reporting) stipulated in the CbCR and the CRS filing obligations should expect to receive letters from the FIRS imposing penalties for non-compliance.
Particularly, the FIRS will now be able to apply the administrative penalties in the 2018 TP Regulations on the 2019 TP returns and other returns going forward. Thus, taxpayers must ensure that they meet all relevant compliance obligations to avoid these penalties.
Adoption of dispute resolution mechanisms
With the expected increase in TP disputes, it will be important for taxpayers to proactively evaluate their realistic dispute resolution options as part of their overall audit strategy. Some of the key TP dispute resolution options include arbitration via the FIRS' internal Decision Review Panel, negotiations with the FIRS officials and litigation.
Finally, should the FIRS provide further guidance on Advance Pricing Arrangements (APAs) in 2021, taxpayers may seek to proactively engage the FIRS to agree on appropriate prices for their controlled transactions to enable them achieve certainty
Unquestionably, TP will be a major focus area for taxpayers and tax authorities in 2021. The TP space in 2021 will be heavily impacted by the various developments in prior years. It has therefore become pertinent that taxpayers ensure that they meet all relevant compliance obligations and are proactive in reviewing and developing strategies to manage their TP exposures. Taxpayers should also review the dispute resolution options and engage knowledgeable TP advisors to assist with their TP needs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.