Nigeria: Increase In Transfer Pricing Audits In Nigeria: How Prepared Are You?

1.TP Risk Assessment and Desk Review: TP audits are resource-intensive thus, the FIRS carries out risk-assessment procedures to ascertain the risk profile of taxpayers before deciding to proceed with the TP audit. In practice, the documents received through the IDRs including TP documentation, financial statements, agreements etc. are used for this process. 

From our experience, taxpayers are usually unprepared for this stage and are overwhelmed by the number of documents requested by the FIRS. Often, taxpayers have either archived the information requested or have not kept proper records of information required to demonstrate the arm's length nature of RPTs, despite the requirement of the Regulations to keep such information contemporaneously.

The robustness of the TP documentation and the quality of information supplied to the tax authorities at this stage may go a long way in determining whether the tax authorities will proceed to the next stage of the audit. Other factors considered by the FIRS in their risk assessment include the type of RPTs entered into, the value of RPTs compared to third party transactions, the tax residence of the related parties among others. For example, transactions with entities resident in tax friendly jurisdictions, procurement transactions, intangible transactions, financing arrangements etc. are considered high risk and may result in the FIRS proceeding to the next phase of the audit. Where the FIRS deems the taxpayer as low risk, the TP audit will be concluded at this phase. 

2.Field Audit: This is the fact-finding stage of the TP audit and is very crucial to the success of the audit. The FIRS will notify the taxpayer prior to the commencement of the field audit. The objective of this phase is to get an understanding of the RPTs by ascertaining the substance of the RPTs– functions performed, assets utilized and risks borne and the pricing arrangement of each RPT. Where the substance of the transaction cannot be demonstrated, the entire transaction can be disallowed for tax purposes. 

At this stage, the taxpayer may be required to make presentations to the FIRS on its business operations and the RPTs carried out during the years under review. The FIRS will also conduct interviews with process owners with insight into the RPTs conducted by the Company. The FIRS may also conduct a factory/office/warehouse tour.

Due to the importance of this stage, the persons interviewed should be knowledgeable about the RPTs, as misrepresentation of facts could affect the outcome of the audit. For example, for a procurement transaction, the head of procurement would most likely be more knowledgeable about the details of the transaction and articulate the value proposition better than a factory worker. Also, it is paramount that taxpayers have the support of their tax advisers to guide them through the process.

After the interview sessions, the FIRS will issue interview notes for the interviewee's review and attestation. This document will serve as evidence of the facts gathered during the audit and will be referred to throughout the audit. It is therefore critical that the taxpayer and advisers critically review the interview notes and ensure the facts surrounding the RPTs were not misinterpreted. This phase ends with a close-out meeting with the FIRS. The FIRS may also request for additional documents.

3. Post-Field Audit: Following the field audit phase, the FIRS will issue an audit report stating their position on the RPTs based on information gathered during the first two phases. The taxpayer is allowed to rebut the FIRS' position and provide further documents to support its position. From experience, where the FIRS has arrived at a position, it can be difficult to change their position without a superior argument supported by ample documentary evidence.

Several reconciliation meetings may be held with the aim of arriving at an agreeable position to both parties. Where both parties are able to arrive at an agreeable position, an assessment will be raised by the FIRS and thereafter settled by the taxpayer thereby concluding the audit process. However, where an agreeable position cannot be reached, the audit progresses to the fourth phase.

4. Dispute Resolution: At this stage, the taxpayer may exercise its right to explore the following dispute resolution options to conclude the audit:

1. Decision Review Panel (DRP) – The Regulations allow for TP disputes to be presented before the DRP for resolution. The Panel which consists of five (5) members of the FIRS includingthe Head of the TP department is to deliberate on the issues taking into consideration the objections from the taxpayer. Unlike other dispute resolution options, the Regulations stipulate that the Head of the TP department is responsible for presenting issues before the Panel. There is no indication that the taxpayer can present its case before the Panel or be represented during the proceedings. Therefore, taxpayers may query the objectiveness of the Panel in resolving disputes due to the Panel being constituted of only FIRS officials.
2. Litigation – Taxpayers have the option of presenting their disputes to the courts starting from the Tax Appeal Tribunal up to the Supreme Court. This option is very expensive and usually the last resort. However, in adopting this dispute resolution option, it is imperative that the taxpayer has a TP expert working with its lawyers in building a case. One of the key learning points from the first TP case in Nigeria (Prime Plastichem Nigeria Limited vs FIRS) is the importance for an in depth understanding of TP when going through a litigation process.
3. Negotiation – This option provides an avenue for both parties to come to a mutually agreeable position through dialogue and negotiation. While this option ensures that the audit is concluded fairly quickly, issues resolved with this mechanism may be the subject of future disputes as positions agreed to are not legally binding.

We have observed that Nigerian taxpayers often select the negotiation option due to the lengthy and costly legal processes in Nigeria. Further, since TP is relatively new in Nigeria, there is a risk that the judges may not be able to have an appreciable understanding of the issues of the case. The DRP option has also been scarcely patronized because of the presumed bias due to the composition of the panel.