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Nigeria: Transfer Pricing Comparable Data Constraints - Implications and Recommendations

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By Josh Bamfo


Since Nigeria Transfer Pricing Regulations (the Regulations) came into force in September 2012, with 2, August 2012 commencement date, transfer pricing has become one of the hottest tax issues in Nigeria. Taxpayers have complied with the Regulations by submitting transfer pricing returns on an annual basis, prepared contemporaneous transfer pricing documentation, and the Federal Inland Revenue Services (FIRS) has embarked on its first round of transfer pricing audits. However, one of the challenging aspects of the implementation of the Regulations is the lack of local and regional (African) external comparable data to assist with the application of some of the Regulation's recommended transfer pricing methods.

Transfer pricing basically refers to the pricing of related party transactions involving tangible goods, intangible goods, services and financial services. Revenue authorities are concerned about transfer pricing because, without transfer pricing regulations, multinational enterprises (MNEs) will have an incentive to misprice their related party transactions to take advantage of corporate tax rate arbitrage across countries, resulting in profit shifting from entities in high tax jurisdictions to related entities in low tax jurisdictions. This will result in loss of tax revenue for countries with relatively higher corporate tax rates. Hence, the need for local transfer pricing regulations to ensure that related party transactions are reasonably priced to ensure fair allocation of system profits between related entities, and therefore, between the respective tax jurisdictions, from a tax revenue perspective.

To this end, most countries across the globe have adopted the arm's length principle in line with the Organisation for Economic Cooperation and Development's (OECD's) Transfer Pricing Guidelines (OECD Transfer Pricing Guidelines) to ensure that related party transactions are reasonably and fairly priced. The arm's length principle basically refers to the requirement that related party transactions should be priced as if the transactions were conducted with independent parties. This is based on the basic economic principle that, all other factors remaining the same, a rational investor with a profit maximization objective will not under-price its transactions with an unrelated party; hence, market prices are appropriate benchmarks to ensure that taxpayers do not intentionally misprice their related party transactions to take advantage of corporate tax arbitrage.

A critical aspect of the application of the arm's length principle is the challenge of finding prices or returns from comparable third party transactions or companies to benchmark prices or returns earned from the related party transactions being analysed. To ensure that transfer pricing analyses yield reliable results, the OECD Transfer Pricing Guidelines provides five comparability factors that analysts are supposed to consider when performing transfer pricing analyses. These comparability factors include: product and service characteristics, functional analysis, contractual terms, economic circumstances and business strategy. Thus, a benchmarking analysis should consider these comparability factors in ensuring that the analysis yields reliable benchmark results.

The data constraint issue

Although the OECD Transfer Pricing Guidelines require an analyst to consider each of the comparability factors when performing a transfer pricing analysis, some of the comparability factors will be more important than others depending on the method selected as the most appropriate to apply. The method selected for testing the covered transaction is identified based on facts and circumstances relating to that transaction. Where analysts select the use of external comparable companies' data to apply methods such as the Resale Price Method (RPM), the Cost Plus Method (CPM) or the Transactional Net Margin Method (TNMM), one of the relevant comparability factors that needs to be considered is comparability of economic circumstances. This comparability factor considers relevant issues such as the need for the selected comparable companies to come from comparable economies with similar market risk and similar expected market returns as the company whose returns are being tested. As a result, when benchmarking appropriate returns of a tested party from countries such as US, UK, Germany, Italy, China, and Poland, to mention a few, they ideally prefer or require taxpayers to use comparable companies from the same country as the tested party. However, other jurisdictions such as African countries, including Nigeria, have significant constraints with respect to publicly available comparable data.