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How Transfer Pricing Works
For a given multinational company for example, the intricacies surrounding their production and distribution process is complex. Not only is it complex, it is fact specific. A more complex transfer pricing profile will involve multiple jurisdictions relating in multiple transactions involving tangible products, inter-company services, intangible assets (like the application of skill, patents, technology, branding etc.) and/or financing of the many such processes.
The best way to understand how transfer pricing works as it concerns multinational companies would be to consider analyzing the sub-sectors of its factors of production in relation to how many assets it owns, how it co-joins with the entire process, the burden of risk involved, as well as how well it makes use of abstract assets like skill and the like. These entities could be in form of distribution, production, sales, servicing, and the like.
A principal is usually at the helm of affairs in the area of directing and managing the activities undertaken by the other entities. The principal makes important decisions, and bears the reward or otherwise for the outcome of these decisions. The principal typically owns important intangible property. After ascertaining each entity’s primary activities as well as functions, the company gathers financial data that identifies the value of the transaction flows and the return attendant to each participant.
Depending on the specific transaction and the data, a transfer pricing method will be selected whereby the corporation’s inter-company transaction is compared to the most relevant comparable benchmark data. The selection of comparable is influenced a great deal by the findings of the functional analysis. To the highest possible extent comparable with functions, risks, asset bases and geographies, among other things, will be matched as closely as possible with those of inter-company transaction under review to provide the most reliable measure of an arm’s length result.
One of the characteristics of the transfer pricing study is that since it is a large determinant of the resultant pricing of a product or service, prudent management will maintain awareness of the volume and nature of inter-company transactions, and the issues and requirements in each jurisdiction.
Every corporation has unique facts and details that inform its transfer pricing opportunities and exposures. It is imperative that companies large enough to have large sub-sectors should identify jurisdictions in which they operate and graduate them by level of risk, and focus their efforts on jurisdictions and types of transactions they anticipate will fall under higher levels of governmental interest and scrutiny.
There are transfer pricing professionals who can help a corporation in reviewing current transfer pricing policies, implementing transfer pricing structures that have good bearing with the corporation’s value chain and tax planning objectives, and preparing documentation to minimize exposure to double taxation and non-deductible penalties.
Why Should there be Transfer Pricing?
As a consequence of globalization, more and more businesses form multinational groups which locate activities across countries. This structure challenges the tax systems incorporated worldwide as inter-company transactions may involve many different jurisdictions. While there are risks associated with the taxation of group income, e.g. the double taxation of income, a group structure also offers opportunities for tax planning.
Transfer pricing rules generally provide companies with the flexibility to set the conditions, but also sets limits and acts as a watchdog against overkill in pricing, as regarding their inter-company transactions. Planning allows taxpayers to optimize the allocation of income within the group.
Tax planning, in this context, is a legal and accepted way of minimizing taxes and has to be distinguished from tax evasion which is illegal. The minimization of taxes can generally be achieved by realizing temporary or permanent tax savings. At the same time, noncompliance with transfer pricing rules can be negatively consequential for multinational companies. Noncompliance can lead to double taxation, interest on tax underpayment and substantial penalties. It can also result in extended disputes with tax authorities, including litigation as is rightly applicable.
Transfer Pricing in Nigeria
The transfer pricing regime in Nigeria is set along with the realities of the economics and dynamics of doing business in Nigeria. The transfer pricing outline is a product of reports and surveys on the taxpayer awareness and the nitty-gritties of taxing and pricing as touching the Nigerian terrain. The summary of the outline is as follows:
The transfer pricing overview stipulates that the transfer pricing regulations were effective August 2012, and the regulations address transactions between “connected taxable persons” as defined by the regulations, of course.
The transfer pricing rules is important to Nigeria or any other taxing host country because the prices paid for by goods and services have a direct impact on the profits of the company, and consequently the taxing regime.
Scope of the Transfer Pricing Regime
Transfer pricing laws in Nigeria affects transactions between connected persons. These regulations apply to transactions between connected persons carried on in a manner congruent with the arm‘s length principle and encompasses
- Transactions between a Permanent Establishment (PE) and its head office or other related branches.
- Branches are treated as separate entities Sale and purchase of goods and services
- Selling, Purchase or Leasing of tangible assets
- Transfer, Purchase or use of intangible assets
- Provision of Services Lending or borrowing of money
- Production arrangement
- Dealings which may affect profit and loss
The aims of the Transfer Pricing Regime in Nigeria include all of the following:
-To give the country the opportunity to have a fair cut of the profit of connected taxable persons‘ transactions and dealings, by way of the Inland Revenue Service.
-To avail the country of the tools and methods to fight artificial transactions and shifting profits out of their jurisdiction by connected taxable persons.
-To minimize the hazards of economic double taxation.
-It provides a level playing field between connected taxable persons and independent Enterprises doing business in the Country.
-To provide connected taxable persons with certainty of fair transfer pricing treatment in the Country.
There are comparability factors and yardsticks as well as best practices that determine whether a transaction is constant with the globally recognized arms-length principle. This, the IRS will do by:
a) Ascertaining the characteristics of the goods, property or services transferred or supplied;
b) The functions undertaken by the person entering into the transaction taking into account assets used and risks assumed;
c) The contractual terms of the transactions;
d) The economic circumstances in which the transactions take place; and
e) The business strategies pursued by the connected taxable persons to the controlled transaction.
There shall also be documentation by a connected taxable person. He or the entity shall record, in writing or on any other electronic device or medium, sufficient information or data and an analysis of same to verify that the controlled transactions are consistent with the arm‘s length principle. The Service may, by notice, specify the items of documentation that a person is required to keep and make available to the Service for the purposes of this regulation. The burden of proof that the documents provided are not significantly and materially different from other comparable shall be that of the taxable person.
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