As the drive to increase government revenue continues in Nigeria, taxes have taken a bigger role in generation of the income to fund the budget. Transfer Pricing (TP) has not been left out, as TP audits have become more common with the Federal Inland Revenue Service attempting to conduct and conclude as many TP audits as possible. Therefore, the possibility of a taxpayer being selected for a TP audit has become significantly higher.

The increased probability of being selected for a TP audit coupled with the technical nature of TP and the potential for huge additional tax adjustments has made TP a major focus area for taxpayers. Further, due to the varying interpretations of and subjectivity in the application of TP concepts, the likelihood of taxpayers ending up in a TP dispute with the tax authorities is high. As such it is important that taxpayers take a proactive approach to TP audits, having in mind the end game from the start of the TP audit by evaluating the dispute resolution options.

This article aims at providing readers with an understanding the TP audit process in Nigeria, with a focus on the dispute resolution options available to taxpayers.

The TP Audit Process

A TP audit is a detailed review or examination of a taxpayer's Related Party Transactions (RPTs) by the tax authorities to ensure that they have been conducted in a manner consistent with the arm's length principle. It basically involves the review of the taxpayer's business operations, documents, records, financials and economic data. The TP audit exercise in Nigeria is typically carried out in four (4) phases:

  1. Phase 1 - TP Risk Assessment and Desk Review: TP audits conducted by the FIRS in Nigeria are resource-intensive and require careful risk assessment of taxpayers before proceeding. The audit process often begins with the issuance of an Information and Documentation Request (IDR), which covers multiple years and requests various documents such as TP documentation, financial statements, agreements, trial balance, and invoices. Some audit triggers include: consistent loss-making entities, RPTs with entities in tax-friendly jurisdictions, volume of RPTs, procurement arrangements, excessive intercompany loans etc.
  2. Phase 2 - Field Audit: Following a risk assessment and desk review, the FIRS may proceed on a fact-finding exercise that involves conducting interviews, site visits and documentation gathering to verify the functions, assets and risks regarding the RPTs. The FIRS may also conduct a factory/office/warehouse tour. This phase ends with a close-out meeting with the FIRS.
  3. Phase 3 - Post Field Audit: After completing the field audit phase, the FIRS will provide an audit report that outlines their position on the RPTs. The report is derived from the information collected throughout the initial two phases of the audit process. The taxpayer is expected to accept or rebut the FIRS' position and may provide further documents to support its position.
  4. Phase 4 - Post Audit: Where the taxpayer and the FIRS cannot reach a consensus on their differing positions, there are several dispute resolution options available. These include negotiation, decision review panel, and litigation. These avenues offer means for both parties to resolve their disagreements effectively.

Dispute Resolution Options

As stated above, there are different dispute resolution options available to taxpayers. In navigating the TP audits process, it is essential for taxpayers to proactively review these options and come up with strategies to the audit which can significantly strengthen the taxpayer's position where a dispute occurs.

This involves evaluating available TP dispute resolution options, to carefully understand the intricacies of each option, their potential benefits, drawbacks, and when they can be adopted. By conducting this thorough assessment, taxpayers can make informed decisions that will set the stage for their dispute resolution strategy.

Negotiations

This option provides an avenue for the taxpayer and the tax authorities to come to a mutually agreeable position through dialogue and negotiation. Both parties will discuss the issues under contention with a goal of resolving such issue amicably.

Typically, taxpayers find entering into negotiations to be a preferred first step for resolving TP disputes as it offers several advantages over other approaches.

Negotiations promote a cooperative and collaborative attitude between the taxpayer and the tax authorities. By coming to the table with the intention of finding common ground, both parties demonstrate a willingness to work together to reach a resolution that benefits all stakeholders involved. This approach helps to build trust and encourages open communication, which is vital for finding amicable solutions while ensuring compliance with tax laws.

Also, engaging in negotiations may generally be more cost-effective than pursuing formal litigation. Negotiations can lead to quicker and more efficient outcomes, saving both time and resources for both the taxpayer and the tax authorities.

While negotiations offer significant advantages in resolving TP disputes, the outcomes can set important precedents that have implications for future dealings with tax authorities. Successfully resolving a TP dispute through negotiations can establish a positive precedent for the taxpayer. On the other hand, if the negotiation results in a perceived concession by the taxpayer, it can set a negative precedent for potential future audits in Nigeria and in other jurisdictions where the group operates. It should also be noted that, issues resolved with this mechanism may be the subject of future disputes as positions agreed to are not legally binding.

To ensure successful negotiations and prevent potential negative precedents, it is crucial for companies to approach negotiations from a position of strength. Being well-prepared through the adoption of the proactive approach provides a solid foundation for the negotiation process.

Decision Review Panel (DRP)

The Nigeria TP Regulations (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 including the 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 DRP. It is unclear whether a the taxpayer can present its case before the DRP or be represented during the proceedings.

The DRP is designed to expedite dispute resolution compared to traditional litigation or appeals. The streamlined process reduces the time and resources spent on lengthy dispute proceedings, allowing for disputes to be resolved more efficiently.

The DRP is expected to provide impartial evaluations, ensuring that the decisions reached are fair, objective, and based on sound TP principles. This impartiality will promote trust in the resolution process.

However, due to the composition of the DRP, taxpayers may query the objectiveness of the panel in resolving disputes. The decision of the DRP on any issue brought before it represents the FIRS' final position on such issue. Where the taxpayer is not in agreement with the decision, the taxpayer may appeal and employ other dispute resolution options.

Litigation

The judicial route for resolving TP disputes in Nigeria allows taxpayers to seek redress through the court system. The Tax Appeal Tribunal, established specifically for tax-related matters, is often the starting point for these disputes. If unsatisfied with the decision at the tribunal level, taxpayers can appeal to higher courts, ultimately reaching the Supreme Court.

While resorting to the courts is an available option, it is generally considered a costly and time-intensive process. Legal fees, expert consultations, and other associated expenses can accumulate, making it a less preferred choice for taxpayers. Therefore, taxpayers usually attempt to resolve disputes through administrative channels or alternative dispute resolution mechanisms before turning to litigation.

When litigation becomes necessary, taxpayers must approach it from a position of strength. This means having a well-structured and convincing case supported by comprehensive documentation and strong arguments. Having a deep understanding of the applicable TP principles, relevant regulations, specifics of the RPTs and proper documents are essential for building a robust argument. It is also imperative that the taxpayer has a TP expert working with its lawyers in building a case.

During litigation, documents provided during the audit as well as responses and objections submitted to the FIRS can be put forward as evidence to defend the taxpayer or the FIRS' position. It is therefore important that taxpayers are conscious of the potential for litigation when providing responses and documents during the audit.

The landmark case of Prime Plastichem Nigeria Limited vs. FIRS, which resulted in an additional tax liability of ₦1.7 billion, serves as a notable example of the importance for an in depth understanding of TP when going through a litigation process. The court's ruling highlighted the significance of providing clear evidence, well-prepared TP documentation, and a comprehensive understanding and implementation of TP principles during litigation.

Conclusion

TP is a complex discipline in taxation, and as such, addressing TP matters with care is crucial. Reacting to TP issues as they arise can be financially and legally risky. Instead, a proactive approach is advised to deal with the tax authorities.

While taxpayers would ideally prefer to avoid disputes when undergoing TP audits, it is advisable that taxpayers are proactive in analysing the TP dispute resolution options and determining a dispute resolution strategy.

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.