THE CONCEPT OF TRANSFER PRICING: PROSPECTS,

CHALLENGES AND THE

WAY FORWARD
By
Omirigbe Ochiwu Jeremiah
LL.M, BL, LLB (HONS) ACiarb,SEIPEN.
AND
IBRAHIM BELLO IBRAHIM
LL.B (HONS), LL.M (MERIT), ACiarb (UK), SEIPEN, AIPN (UK),
BL

The Concept of Transfer Pricing: Prospects, Challenges and the way forward

ABSTRACT

Goods and services are often exchanged, between various departments and divisions of an
organisation. What values or prices, should be assigned to these exchanges or transfers; is it
historical cost or market price or some version of either. The transfer pricing question is often
the most troublesome aspect of a control system. As with other techniques, transfer pricing
should be viewed in the perspective of the total system as a price attached to transactions
between the divisions, branches and subsidiaries of a Company. The objective of the paper is to
explain the concept of transfer pricing: prospects, challenges and the way forward, x-ray some
of its importance such as globalization, specialization, mergers and acquisition alongside the
methods and principles and issues involved therein. The research method employed in writing
this paper is the doctrinal research methodology which is defined as the reliance on textbooks,
articles, journals, monograms, newspaper articles as well as legislations and statutes relevant to
this area. In the course of the paper, it has been observed that many governments are utilizing
transfer pricing audits to increase tax revenues to offset economic reduction and that transfer
pricing has linkages with global stability, revenue generation, economic growth, trans-border
activities and international trade. Although, the current international taxation regime is a hodge-
podge system full of bandages and exceptions and needs to be re-evaluated, it is hoped that a lot
can be achieved if proposed reform come to light. It is therefore recommended that more
efficient legislations need to be put in place by developing Countries that would reflect through
its domestic tax laws in all jurisdictions and with modern technologies set out to ensure certainty
of transfer prices, transfer pricing principles and methods and its application would experience
tremendous turnaround from what is presently obtained.

Introduction

Transfer pricing is most often viewed, in the context of, one profit centers supplying a product or
service to another profit center. For instance, a firm may supply castings for an assembly
division;’ it may also sell castings to outsiders if, the foundry and the assembly division are
separate profit centers; the transfer price will have an important bearing on the reported profits of
each. More fundamentally, transfer price information, affects many critical decisions concerning,
the acquisition and allocation of an organisations resources, just as prices in the entire economy
affect decisions concerning, the allocation of a nation’s resources. Ideally, transfer prices, should
guide each manager to choose his input and output in coordination, with other subunits so as to
maximize the profits of the organisation as a whole.1
Of course, transfer pricing is not confined to accounting for profit centers alone. It takes many
forms. For example, the allocation of service department costs to production departments is
essentially a form of transfer pricing, because it is a measure of the services rendered to and
received from another sub-unit of the organisation.
Organisations, due to growth, sometimes decentralize their activities. This decentralization may
be within a country of domicile of the organization or across national borders, when such
subsidiaries are established across national borders, they are managed separately because, it has
become a Multinational Corporation (MNC) -meaning a large company with many foreign
branches. Though, they are managed separately, they have common corporate objectives to
achieve.2
1
Mary Riley, transfer pricing and international taxation: A continuing problem for taxing authorities (2014) Lexis
Federal Tax Journalhttp://www.lexisnexis.com/legalnewsroom/tax-law/b/internationaltaxation/archive/
2014/11/17 accessed on 22nd March, 2018.
2
C.P.A Mohamed,” Effect of transfer pricing in developing countries: Cases in Africa” ACCOUNTANTS Annual
Conference Journal (Banju, December 3rd, 2016)6
CONCEPTUAL CLARIFICATIONS
What is transfer pricing?
Transfer pricing is a profit allocation method used to attribute a Multi-National Enterprises net
income (profit or loss) to the tax jurisdictions where it operates its subsidiary controlled foreign
corporations (CFCs). The transfer price is defined as the price charged between related corporate
entities for goods or services in an intercompany transaction.3

Transfer pricing refers to the mechanism by which cross boarder intra-group transactions are
priced. In itself, it is a normal incident of MNE operations – it allows MNE to determine which
parts of the group are profit- or loss-making, for example. However, if the method used to
determine the price of such transactions, for whatever reason, does not reflect their true value,
profits might effectively be shifted to low-tax or no-tax jurisdictions and losses and deductions to
high-tax jurisdictions.4
According to ICAN (2014) Transfer is the process of arriving at a price charged for goods and
services supplied or transferred by one sub-unit of an organisation to another sub-unit or one
member of a group to another.
The Practice among MNEs of adjusting the price of goods and services as they move around
their global operations is commonly referred to as transfer pricing and described in the Nigerian
Tax Law (Company income Tax Act) Section 22 as “artificial or fictitious” transaction when not
at arm’s length (Mispricing) it may also be a scheme to evade or avoid tax. It is very complex,
particularly in relation to Multinational Companies, although the term can also purely apply to
domestic transfers5.
Importance of Transfer Pricing
Globalization: Advancement in technology (transportation, information and communication)
has brought the distant parts of the world closer than before, National boundaries are fast
disappearing as the flow of labour, capital, goods and services is no longer restricted to
geographical factors, in consequence, goods, services and intangibles produced by entities of a
group in one country must be transferred to entities of same based in another country.6
Specialization: Business entities are increasingly embracing the time-tested principle of division
of labour, specialization and comparative advantage to set up facilities in parts of the world that
offer them maximum yield on one unit of the factors of production, this has led to the
development of the concept of shared services.
Mergers and Acquisition: Increasingly companies are foraying into other countries; buying up
other companies, the cost of central administration or other transfers from one entity to another

3
Mary Riley, transfer pricing and international taxation: A continuing problem for taxing authorities (2014) Lexis
Federal Tax Journalhttp://www.lexisnexis.com/legalnewsroom/tax-law/b/internationaltaxation/archive/
2014/11/17 accessed on 22nd March, 2018.
4
United Nations Practical Manual on Transfer pricing, ‘Transfer pricing for developing Countries, Newsletter of
FfDO/DESA (New York, May 29, 2013)
5
Abdulahi Danjuma Zubairu, Understanding Nigerian Taxation (Husaab Global Press concepts Ltd 2014) 228
6
Ibid
in a group must satisfy tax authorities in the respective countries and that is what transfer pricing
seeks to achieve.

Significance of Transfer Pricing

Transfer prices at which goods and service are transferred between entities are significant for
both tax payers and tax authorities, because they impact on the income and expenses as well as
taxable profit of related companies in different tax jurisdiction in which the enterprises and Multi
nationals operate. Many companies are interested in in maximizing their head office profit hence
they may adopt transfer pricing mechanisms which will boost the head office profits at the
detriment of the associated or subsidiary companies in other high tax jurisdictions.in other words
transfer pricing affects the profits on which the other affected enterprises are subjected to Tax7.

Relevance of Transfer Pricing

Transfer pricing has linkages with “Global Stability, Revenue generation, Economic Growth,
Trans Border activities and international Trade” in the following three ways.
a. Promote stable flow of Labour, capital, goods and services across national borders of the
world.
b. Secondly, there is over-arching issue of the right of each country to generate the right
amount of tax revenue from the economic activities performed within its boundaries.
c. Thirdly, Transfer pricing would promote econo0mic growth at unilateral, bi lateral and
Multi-lateral Levels.

Legal Framework of Transfer Pricing

The institution of transfer pricing regime took a long time to get into Nigeria, several statutory
provisions gave powers to the Nigerian Tax authorities to make adjustments on tax returns if
transaction between connected persons or parties were not done in line with the arm’s length
principle. General Anti-avoidance rules (GAAR) have been in the books in Nigeria for many
years. Specifically section 17 of the personal income tax Act, Section 22 of the Companies
income Tax Act and Section 15 of the Petroleum Profits Tax Act all provide for FIRS to adjust
any transaction between intercompany or related parties which is deemed to produce a result
artificially reducing taxable income in Nigeria. Other statutory provisions include Section 61 of
the Federal Inland Revenue (Establishment) Act 2007: and the income Tax (transfer pricing)
regulation of 20128.

Purpose, Objective and Scope of the Income Tax (Transfer Pricing) Regulation 2012 (Now
Repealed)

The purpose of the regulation was to give effect to:

7
Loc cit
8
Abdulahi Danjuma Zubairu, Understanding Nigerian Taxation (Husaab Global Press concepts Ltd 2014) 228
 1. Section 17 of the Personal Income Tax Act, CAP P8, LFN, 2004.

2. Section 22 of the Companies Income Tax Act, CAP C21 LFN 2004 (As Amended) 2007
and

3. Section 15 of the Petroleum Profits Tax Act, CAP 13 LFN 2004 (As Amended) 2007.

With the following objectives:

i. To ensure that Nigeria is able to tax on appropriate taxable basis corresponding to

economic activities deployed by taxable person in Nigeria, including in their
transaction and dealings with associated enterprises.

ii. Provide the Nigerian authorities with the tools to fight tax evasion through over or
under-pricing of controlled transactions between associated enterprises.

iii. Provide a level playing field between multi-national enterprises doing business within
Nigeria.

iv. Provide taxable persons with the certainty of transfer pricing treatment in Nigeria

v. Reduce the risk of economic double taxation in Nigeria.

Scope of the Nigerian TP Regulation 2012, (Now Repealed)

The regulation shall apply to transaction between connected taxable persons carried on in a
manner not consistent with the arm’s length principle and include:

(a) Sale and purchase of goods and services.

(b) Sale, purchase or lease of tangible assets.

(c) Transfer, purchase, license or use of intangible assets.

(d) Provision of services.

(e) Lending and borrowing of money.

(f) Manufacturing arrangement and

(g) Any transaction which may affect profit and loss or any other matter incidental to,
connected with or pertaining to the transactions referred to in the regulation.

Country’s Domestic Tax Laws and the Income Tax (Transfer Pricing) Regulations 2018

Majority of African countries have adopted TP in their tax regimes each nation’s TP regime have
unique aspects and rules that should be considered when conducting business in that jurisdiction
Some have special TP regulations like Angola, DRC, Tanzania, Nigeria, South Africa Kenya
Malawi and Uganda. Others have TP rules within Tax Laws. These include Ghana, Mozambique
Tunisia etc.
In the exercise of its rule-making authority under its enabling legislation, 9 the Board of the
Federal Inland Revenue Service (“FIRS”) has issued the Income Tax (Transfer Pricing)
Regulations 2018 (the “2018 Regulations”). The 2018 Regulations revokes and replaces the
Income Tax (Transfer Pricing) Regulations 2012 (the “2012 Regulations”) which hitherto
governed regulations over transfer pricing in Nigeria. The 2018 Regulations fairly incorporate
the current international trends in the regulation of transfer pricing and is designed to guarantee
greater compliance with the transfer pricing regime in Nigeria 10. This would in turn increase
Nigeria’s tax revenue and reduce tax evasion occasioned through the underpricing or overpricing
of related party transactions11.
This overview is aimed at highlighting the headline changes introduced by the 2018 Regulations
and providing summaries of the key changes introduced by the new transfer pricing regime.

Scope and purpose

The new regime applies to both foreign and domestic controlled transactions between “connected
persons”,12 not “connected taxable persons” as was the case under the 2012 Regulations. The
definition of connected persons under the 2018 Regulations is extremely wide such that where
one person can control and/or influence the financial, operational, or commercial decisions of
another person, they would be deemed to be connected persons. Also, any third person who can
influence and/or control the financial, commercial, or operational decisions of the two connected
persons, would also be deemed to be connected with them. 13 Further, any person deemed to be
connected to another under the federal tax legislations in Nigeria, 14 or under the model tax
convention and transfer pricing guidelines of the United Nations (UN) or the Organization for
Economic Co-operation and Development (OECD), or under any double tax treaty executed
between Nigeria and another country, shall be deemed to be connected persons under the 2018
Regulations.15
This wide definition of connected person may have some unintended consequences for the
providers of credit. It is common place to have overbearing lenders who exercise a great deal of
influence and/or control over the financial, commercial and operational decisions of those to
whom they have advanced credit. Whilst it is unclear whether the FIRS intended to import the
“potential lender shadow-director liability” into the transfer pricing regime and to treat such
creditors as connected persons; it is advised that business people deal at arm’s length with
9
Section 61 Federal Inland Revenue Service (Establishment) Act 2007
10
Dipo Komolafe and Kenneth Okwor, Templars Key Highlights of the Newly Issued Transfer Pricing Regulations
2018.
11
Ibid
12
Regulation 3(1), 2018 Regulations
13
Regulation 12(1), 2018 Regulations
14
Regulation 12(2)(a) – (d), 2018 Regulations
15
Regulation 12(2)(e) & (f), 2018 Regulations
persons to whom they have advanced credit, to avoid possible liabilities under the new transfer
pricing regime.

Potential double taxation for importers

In relation to imported goods and services, the FIRS now has the power to reject the reported
value on which the customs duty was assessed, notwithstanding the fact that the reported value
had been accepted and acted upon by a competent agency of government.16 The FIRS may reject
such value and substitute it with its own estimates for the purposes of confirming compliance
with the arm’s length principle and assessing the tax liability of the importer.
Besides creating a conflict between two agencies of government, this new power of the FIRS
may lead to double taxation of the affected importers.

Deemed transfer prices for commodity imports and exports.

In any controlled transaction for the import or export of commodities, if the agreed price is
higher than the “quoted price” (for imports) or lower than the quoted price (for exports), then the
transfer price under the new regime would be the quoted price on the date of the transaction. For
exported goods which were resold by the offshore connected person to an unrelated third party at
a price higher than the quoted price, that higher price would be deemed to be the transfer price
for determining the offshore connected party’s tax liability in Nigeria. However, where the
taxable person in Nigeria (in the case of imports or exports) or the offshore connected person
provides evidence showing that the price was consistent with the arm’s length principle, then the
FIRS may accept the price used by the connected persons.17
The quoted price is the stated price of the commodity on an international or domestic
commodities exchange or from governmental price-setting agencies which is used by unrelated
parties in uncontrolled transactions.18

Intragroup services
The fees charged by service providers for providing services to connected persons, especially
within a corporate group would now be subjected to heightened transfer pricing scrutiny. Under
the new regime, such service fees would only be deemed consistent with the arm’s length
principle if and only if: (i) they are charged for service actually rendered; (ii) the provision of the
service has economic or commercial value to the recipient; (iii) if it were an uncontrolled
comparable transaction between independent parties, the recipient would still be willing to pay
the same amount for the provision of the service.19

Exploitation of intangible assets between connected persons

The full consideration or royalty paid for any transfer of a right in an intangible asset (such as
software leases and licenses over intellectual property or other arrangements which gives retains
ownership of the intangible asset in one party and gives the other party only a right to use)
16
Regulation 5(8), 2018 Regulations
17
Regulation 5(9)(a) & (b), 2018 Regulations
18
Regulation 27, 2018 Regulations
19
Regulation 6(1), 2018 Regulations
between connected persons would no longer be recognized as allowable expenses for tax
deduction. Under the new regime, the portion of the consideration allowable for tax deduction as
expenses is capped at 5% of the earnings before interest, tax, depreciation, and amortization
(EBITDA) arising from the exploitation of the intangible asset.20
Note that the 2018 Regulations make a carve-out for outright assignments/sales of the intangible
asset between connected persons. Where the transfer was an outright assignment/sale, the full
consideration would be allowed for tax deduction as expenses.21
The difference in treatment between outright assignments and leases/licenses is that while the
expenses in the former are recognized for tax deduction only once.

New transfer pricing disclosure obligations and associated penalties for non-compliance
A new suite of disclosure obligations have been imposed on connected persons. They include:
(a) Each connected person in Nigeria must make a transfer pricing declaration of all its
connected/related entities within and outside Nigeria within the earliest of eighteen (18)
months from the date of its incorporation or six (6) months after the end of the accounting
year.22 A failure to comply with this disclosure obligation attracts a penalty of N 10
million (approximately US$ 28, 000) and N 10, 000.00 (approximately US$ 28) for each
day in which the default continues.23
(b) (b) Each connected person must make an updated transfer pricing declaration within six
(6) months from the end of any accounting year in which any of the following occurs:
(c) (i) The merger of the declarant with any company whether intra-group or with an
unconnected entity;
(ii) The merger of the declarant’s parent with an unconnected person;
(iii) The merger or acquisition of the declarant by an unconnected person
(iv) An acquisition of up to 20% of the declarant’s parent by an unconnected person;
(v) An acquisition of up to 20% of the declarant by unconnected persons;
(vi) Any sale or acquisition of the declarant’s subsidiary; and
(vii) Any other change in the structure or arrangement (i.e. change of ownership) in the
declarant which would impact on the determination whether it is connected to some other
person or not.
A failure to comply with these disclosure obligations attracts a fine of N 25, 000.00
(approximately US$70) for each day in which the default continues.24

20
Regulation 7(5), 2018 Regulations
21
Ibid.
22
Regulation 13(1)(2) & (3), 2018 Regulations
23
Regulation 13(8), 2018 Regulations
24
Regulation 13(7), 2018 Regulations
(c) Every connected person must notify the FIRS whenever a new director is appointed, or an
existing director retires.25 A failure to comply with this disclosure obligation attracts a fine of N
25, 000.00 (approximately US$70) for each day in which the default continues.26

(d) Each connected person shall disclose all controlled transactions to which it is a party within
the earliest of eighteen (18) months from the date of its incorporation or six (6) months after the
end of the accounting year.27 Failure to comply with this disclosure obligation attracts a fine of N
10 million (approximately US$ 28, 000) or one (1%) percent of the controlled transaction not
disclosed or incorrectly disclosed, whichever is higher. For non-disclosure, there is an additional
fine of N 10, 000 (approximately US$ 28) for each day in which the default continues.28

(e) Each connected person must prepare documentation containing such information and data
that may be required by the FIRS in verifying whether the controlled transactions of that person
were consistent with the arm’s length principle. This documentation must be prepared before the
due date for the filing of the income tax returns for the year in which the transaction took place.
However, this documentation can only be made available to the FIRS within twenty-one (21)
days from the date the FIRS serves a written request for them on the connected person. 29 A
failure to comply with this obligation attracts a fine of N 10 million (approximately US$ 28, 000)
or one (1%) percent of all controlled transactions, whichever is higher, and an additional fine of
N 10, 000 (approximately US$ 28) for each day in which the default continues.30

Note that where the total value of a connected person’s controlled transactions is less than N 300
million (approximately US$ 900, 000.00), it may elect not to maintain the documentation above.
However, if the FIRS makes a written demand for the documentation, the connected person must
prepare and file them within 90 days from the date of the request.31
Disputed assessments
A tax payer who has an objection to an assessment made under the 2018 Regulations can no
longer approach the Decision Review Panel for review. Such a tax payer can only lodge its
objection with FIRS within 30days from the date on which it received the assessment. Under the
2018 Regulations, the head of the FIRS’ transfer pricing unit has a discretion whether or not to
refer a tax payer’s objection to the Decision Review Panel. This does not sufficiently protect tax
payers since there is the potential risk that the head of the transfer pricing unit may refuse to refer
the objection to the panel for review.

25
Regulation 13(6), 2018 Regulations
26
Regulation 13(7), 2018 Regulations
27
Regulation 14(1), (2) & (3), 2018 Regulations
28
Regulation 14(4) & (5), 2018 Regulations
29
Regulation 16(1) – (4), 2018 Regulations
30
Regulation 16(5), 2018 Regulations
31
Regulation 17(3), 2018 Regulations
Forms or Principles Governing Transfer pricing in International Taxation

The forms of transfer in Multi-National Companies may be classified into four categories:

(a) Transfer of Tangible Goods

This covers inter-company sales and purchase of goods, such as raw materials intermediate
products, spare parts and finished products. The cost of manufacturing a particular brand of
goods may be borne by the parent, a member or a cost Centre and sold within the group. The
assigned price for the transfer of the goods between members may be higher than the price of
the same or similar goods sold by the MNE to an unrelated Company.

(b) Transfer of Services

The services centrally provided may include marketing, advertisement, corporate finance,
legal, consultancy, credit and accounting services, overhead, management and technical
services. The centralization is either in the parent company (head office) itself or in another
company formed for that purpose as such the cost may be pooled into ne base for allocation
to members.

(c) Transfer of Research and Development

The MNE may conduct research and development centrally, these costs contribution
arrangements whereby the members have a share in the cost of the R&D, even though the
cost may not have any direct benefit to the member. The problem here is matching of cost
payable by the Nigerian Subsidiary with the nature and quantum of benefits received and.

(d) Transfer of Intangibles

70 percent of all international Royalties involve payment between parent firm and their
foreign affiliates. These include copyrights, trademarks, patents, protection costs, corporate
logo costs, intangibles involved in manufacturing, advertisement, marketing, software,The
right to use industrial, commercial or scientific equipment. Rents and royalties are paid for
these intangibles.32

For the smooth operation of Transfer Pricing and its application in international Law, some legal
provisions and conventions have been put in place as discussed below.

OECD Model Convention on Transfer Pricing Guidelines

The OECD Reports and Guidelines have set out considerations and recommendations on how to
establish acceptable arm’s length prices. They are intended to help tax administrations and
MNEs to understand and apply regulations in practice by indicating ways to find mutually
satisfactory solutions to transfer pricing cases and thus to minimize conflicts between tax
administrations as well as tax administrations and MNEs and to avoid costly litigation.
The role of multinational enterprises (MNEs) in world trade has increased dramatically over the
last 20 years. This in part reflects the increased integration of national economies and
32
Abdulahi Danjuma Zubairu, Understanding Nigerian Taxation (Husaab Global Press concepts Ltd 2014)
technological progress, particularly in the area of communications. The growth of MNEs
presents increasingly complex taxation issues for both tax administrations and the MNEs
themselves since separate country rules for the taxation of MNEs cannot be viewed in isolation
but must be addressed in a broad international context.
The OECD Transfer Pricing Guidelines constitute the “international standard” used by the
Member States of the OECD and even for countries who are non-members of this international
organization in their domestic legislations and in those double tax conventions or DTCs that they
conduct.
Some authors have even held that the arm’s length principle implemented through reports,
recommendation and Guidelines of the OECD actually constitutes the “international transfer
pricing regime which forms an integral part of the denominated “international tax regime which
is backed and monitored by a representative group of states, with its proper principles, and
vertebrae from an international organization that operates as its axis (the OECD), with the aim of
disturbing the taxing power among states in connection with the income flow among associate
enterprises.33
The UN Model Convention
The UN Model was published in 1980 it has since then been updated in 2001, 2003 up to 2017.
The 2017 UN transfer pricing manual includes one part that puts transfer pricing into an
economic context; a second part provides substantive discussion of the arm’s length principle; a
third part deals with administrative issues; and a fourth part deals with country practices,
including practices in India, Brazil, China, South Africa, and Mexico, the new manual adds new
chapters on intragroup services, intangibles, cost sharing agreements, and business restructuring.

The New intangibles chapter is aligned with OECD/G20 base erosion profit shifting (BEPS) plan
transfer pricing work, the UN model tax treaty’s commentary to Article 9 is updated in 2017 to
make it consistent with OECD transfer pricing work on intangibles. The UN and OECD use the
same transfer pricing standards.
The new section on transfer pricing methods describes use of the 6th method, applicable to
pricing exports of commodities, which is employed in several Latin American countries. The
manual neither approves nor disapproves of the methods.
The UN Practical Manual on Transfer Pricing for Developing Countries was first adopted by the
UN Committee of Experts in 2012.
There are updates on the enhancement of the UN Practical Manual on Transfer Pricing, based on
the following principles:
- Reflect the operation and provisions of Article 9 of the UN Model Convention and relevant
Commentaries
- Reflect the realities of developing countries, at their relevant stages of capacity development
- Pay special attention to the experience of developing countries
33
Gevoian Ielyzaveta, The Role of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations for OECD and non-OECD countries(2013)3,5,7Masters thesis in European and international Tax
Law.
- Draw upon the work being done in other fora.
Response to the need, often expressed by developing countries, for clearer guidance on the
policy and administrative aspects of applying transfer pricing analysis to cross-border
transactions between related parties
The UN Model Tax Convention Article 9(1) states the following “Where
(a) An enterprise of a Contracting State participates directly or indirectly in the management,
control or capital of an enterprise of the other Contracting State, or
(b) The same persons participate directly or indirectly in the management, control or capital of an
enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their
commercial or financial relations which differ from those which would be made between
independent enterprises, then any profits which would, but for those conditions, have accrued to
one of the enterprises, but, by reason of these conditions, have not so accrued, may be included
in the profits of that enterprise and taxed accordingly”
In other words, the transactions between two related parties must be based on the arm’s length
principle (ALP). The term arm’s length principle itself is not a term specifically used in Article
9, but is well accepted by countries as encapsulating the approach taken in Article 9, with some
differing interpretations as to what this means in practice. The principle laid out above in the UN
Model has also been reiterated in the OECD Model Tax Convention and the OECD Guidelines
as supplemented and amended34.

Transfer pricing principles issues and methods.

Arm's length principle (ALP) - a cornerstone of international tax law
Given the backdrop of separate accounting (SA) being accepted by the OECD as the method of
allocating the profits to permanent establishments, there appears to be international consensus on
using the Arm’s-length principle (ALP) for allocation of income derived from such related-party
(subsidiaries, branches etc) transactions35.

A simple scenario which arm’s length principle attempts to provide a solution is as follows;

Suppose a corporation manufactures products in country A and sells the finished products in
country B (via its subsidiary S) to unrelated parties (say, the public at large). In such a case
taxable profit is determined by three factors:

a) Price at which it resells products to the unrelated parties

34
United Nations Practical Manual on Transfer pricing, ‘Transfer pricing for developing Countries, Newsletter of
FfDO/DESA (New York, May 29, 2013)
35
C.P.A Mohamed,” Effect of transfer pricing in developing countries: Cases in Africa” ACCOUNTANTS Annual
Conference Journal (Banju, December 3rd, 2016)6
b) Price at which the products were obtained from its parent corporation

c) Its expenses other than cost of goods sold

Now if country A where the products are manufactured has a tax rate much lower than B’s tax
rate where the products are sold to unrelated parties, then the corporation would try to book as
much profit as possible in country A and towards this show a very low sale value of products to
country B. If the tax rate were higher in A than in B then the corporation would show a very high
sale value and concentrate almost the entire profit in the hands of the manufacturer (country A).

In other words, when independent enterprises deal with each other, their financial relations are
usually determined by market forces. When associated enterprises deal with each other, their
financial relations may not be directly affected by market forces but other considerations.

Towards this the ALP seeks to determine whether the transactions between related taxpayers
reflect their true tax liability by comparing them to similar transactions between unrelated
taxpayers at arm’s length.

In the international arena given that there are widely varying rate of taxation, this leads to tax
avoidance practices and the ALP (via the transfer pricing methods) has been, till date, the main
weapon in the fight to prevent tax avoidance by MNE’s

Guidelines for applying the Arm's-length principle

The OECD provides guidance for applying the arm's-length principle. These guidelines which
we outline below provide a good understanding on how OECD expects the separate accounting
principles are to be applied to arrive at an arm's-length price for cross-border transactions.

The OECD guidance for applying arm's-length principle are as follows

(1) Comparability Analysis

Factors determining comparability:

(i) Characteristics of the property or services

(ii) Functional analysis (Functions, assets & risks analysis - FAR)

(iii) Contractual Terms

(iv) Economic circumstances

(v) Business strategies

(2) Recognition of the actual transactions undertaken

(3) Evaluation of separate and combined transactions

(4) Use of an arm's length range

(5) Use of multiple year data

(6) Losses

(7) The effect of government policies

(8) Intentional set-offs

(9) Use of custom valuations

(10) Use of transfer pricing methods

What we can learn from this guidance is that

1. Comparables play an important role in arriving at arm's length prices

2. Computing an arm's-length price is a very complex task; it requires lot of groundwork &
research. There are a variety of exceptions and set-offs which necessarily have to be applied to
the system to provide useful results.

3. OECD provides for a set of transfer pricing methods to be used

Transfer pricing methods

The OECD provides five major transfer pricing methods; usually the appropriate method has to
be applied to arrive at the appropriate arm’s length price for a transaction.

Before considering the methods we need to establish certain key terminology used in the
International tax regimes.

“Controlled group of Companies” - a multinational firm

“Tested party” is an individual member of a controlled group that one selects to be the subject of
analysis under certain transfer pricing methods.

“Profit level indicator” refers to one of several financial ratios that constitute accounting
measures of operating results.36

The OECD transfer pricing methods are:

1. Comparable Uncontrolled Price (CUP)

2. Resale price

36
Okwoma Augustine Akpojevwa, The Effects of International Transfer Pricing on Host Nations: An Overview of
Developing Nations(2014)35-37, SCSR Journal of Business and Entrepreneurship (SCSR-JBE) 35-37.
3. Cost-plus

4. Profit-splits

5. Profit-Comparison (TNNM)

The first three methods are called “traditional transaction” methods and are “recommended” by
the OECD and the last two are called “profit-based” methods; all these methods are generally
accepted by national tax authorities. It must be noted that the US provides for the use of
additional methods applicable to global dealing operations like Comparable Uncontrolled
transactions37.

(1) Comparable uncontrolled price method (CUP)

The CUP method compares the price charged for a property or services transferred in a
controlled transaction to the price charged for property or services transferred in a comparable
uncontrolled transaction in comparable circumstances. This method is reliable where an
independent enterprise sells the same product as that sold between two associated enterprises.

(2) Resale price method

The resale-price method is used to determine price to be paid by reseller for a product purchased
from an associated enterprise and resold to an independent enterprise. The purchase price is set
so that the margin earned by reseller is sufficient to allow it to cover its selling and operating
expenses and make an appropriate profit. What is left after subtracting the gross margins can be
regarded, after adjustments for other costs associated with the purchase of the product, like
custom duties, as an arm’s-length price for the original transfer of property between the
associated enterprises. This method is usually applied to marketing operations.

(3) Cost-plus method

The cost-plus method is used to determine the price to be charged by a supplier of property or
services to a related purchaser. The price is determined by adding to costs the supplier incurred
an appropriate gross margin so that the supplier will make an appropriate profit in the light of
market of conditions and functions he performed. What is obtained after adding markup to costs
may be regarded as arm’s-length price of the original controlled transactions.

When semi-finished goods are sold between related parties on the basis of joint agreements or
for the provision of services in controlled transactions this method is used.

(4) Profit-split methods

37
Profit-split methods take the combined profits earned by two related parties from one or a series
of transactions and then divide the profits using a defined basis that is aimed at replicating the
division of profits that would have been anticipated in an agreement made at arm’s length.

Arm’s-length pricing is derived from both parties by working back from profit to price.

Both the OECD and US allow for profit-split methods and the main ways of applying profit split
are as follows:

(i) Contribution profit-split (OECD)

Under the contribution profit split method the relative contribution of each member of a
controlled group to the profits derived from integrated transactions is valued on the basis of the
activities and risks undertaken by each member. The combined profits are then allocated among
the members of the controlled group on a pro-rata basis according to their contributions; to
determine their relative contributions the transactional methods may be used.

(ii) Residual profit-split

This applies typically when the combined profits of the controlled group because of mutual
economies of scale or become unique and valuable assets owned by the group. This method
involves 2 stages: first each member of the controlled group is allocated sufficient profit to
provide it with a basic return appropriate to type of transactions it undertook (primarily measured
by traditional methods). Then next stage is calculating residual profits based on analysis of how
it might have been allocated among independent enterprises

(5) Profit-Comparison Methods (TNNM)

These methods seek to determine the level of profits that would have resulted from controlled
transactions if return realized on the transaction had been equal to the return realized by the
comparable independent enterprise. The TNNM under OECD guidelines compares the net profit
margin of controlled transactions with the net profit margins of uncontrolled transactions.

The OECD does not recommend this method because it allows only comparison of net margins
on a transactional basis and only in last-resort situations I.e places where “transaction methods
cannot be reliably applied alone or exceptionally cannot be applied at all”.

The OECD clearly prefers transactional methods over profit-based methods. The hierarchy of
methods is using the transactional methods first and if they don't fit then apply profit based
methods next. The OECD does prescribe a hierarchy of results which is in contrast to the 'best-
method rule' adopted by the USA which allows any of the methods which best represent the
transfer price to be chosen.

Mutual Agreement Procedure (MAP)

The above sections provided a short introduction into the arm's-length principle and its
application today using the transfer pricing methods. However there is a question on what to do
about disputes between authorities of countries having tax treaties? The Models prescribe a
Mutual Agreement Procedure (MAP) for resolution of such disputes. The MAP is an instrument
used for relieving international tax grievances, including double taxation. Although the specifics
vary based on the laws of each country, they are only carried out between authorities of countries
or principalities with existing tax treaties. Although most conventions require that each party to
put forth all reasonable effort to resolve such disputes, they are generally not required to come to
any agreement. This means that although mutual agreement procedures can be an effective tool
for the relief of taxation grievances, they are not fail-safes38.

Some countries are beginning to insert into their tax treaties provisions for the mandatory
arbitration of mutual agreement procedures that do not reach resolution after a period of time.

Such arbitration provisions, for example Article 25 of the OECD model tax treaty as at 2008, are
intended to ensure that double taxation disputes under tax treaties reach a final and relatively
independent resolution within a fixed period of time39.

The Challenges or problems associated with Transfer pricing

Transfer pricing admits to a number of challenges or problems which may rare their ugly head
through abuses and mal-administration, some of these abuses arise when the MNE taxpayer uses
transfer pricing to shift income to low or no tax jurisdictions, typically by adding steps to an
intercompany transaction such that most of the profit is made in a low (or no) income tax
jurisdiction. This may eventually result in tax avoidance or evasion depending on the
circumstance of each transaction.

Some pertinent problems of transfer pricing are:

(1) Organization design: Highly decentralized operations are characterized by sub-unit

managers, with maximum autonomy to establish transfer prices, and to compare alternatives
outside the organisation. This suggests that organizations, with centralized operations, may not
readily enjoy transfer pricing benefits.

(2) Legal requirements: To avoid legal crisis with governmental tax authorities antitrust and
market regulators both host and headquarter countries, companies have an incentive to utilize
market-based prices to the extent that these prices are viewed as more objective than non -market
pricing base.

38
Brian J. Arnold and Michael J. McIntyre, International Tax Primer (The Hague; Kluwer Law International, 2007) 7 –
20.
39
Okwoma Augustine Akpojevwa, The Effects of International Transfer Pricing on Host Nations: An Overview of
Developing Nations(2014)39-40, SCSR Journal of Business and Entrepreneurship (SCSR-JBE) 39 – 40.
(3) Degree of international involvement: Companies international involvement makes them to
be exposed to a broader spectrum of risks and problems, than the domestic counterparts.

Transfer prices of multinational companies; tend to be influenced by a greater range of

environmental considerations.

(4) Cultural influence: The culture of the parent company influences the attitudes values and
decision of the management. Whereas, U.S, French, British and Japanese management, seem to
prefer cost-oriented systems: Canadians, Italians and Scandinavians seem to prefer market -
oriented systems. In most cases however, the setting of transfer pricing policy is the absolute
prerogative of parent company executives. In fact, the major consideration deemed important by
all firms is the acceptability of transfer prices to both host and parent country governments alike.

(5) Valuation of intangible property: In the event of transfer of intangible property to related
enterprises, there is usually a difficulty in the valuation of such transfer of intangible property.

(6) The Arms-Length Standard. The main purpose of the arm’s length standard is to ensure
related party transactions are transferred at prices competitive to the open market and to prevent
tax evasion.

In all the cases examined, the IRS sent a notice of deficiency due to disagreements over arm’s
length pricing.

Corporations who are issued a notice of deficiency must prove the related party transaction
comply with the arm’s length standard. Under the various transfer pricing methods, a comparable
unrelated party transaction is always needed to determine the arm’s length price40.

(7) Business Restructuring: Determining the appropriate prices for second-hand asset
transferred to associated companies is one of the issues associated with transfer pricing.

(8) Loss Making and Loss Merging: Should businesses not have the liberty of merging losses
within the group ?, This also has become a pertinent question that needs urgent answer.

(9) Effective Tax rate: Multi- National Enterprises do set for them effective tax rate, one way to
keep within this effective tax rate is to shift profit from high tax-rate jurisdictions to low tax rate
jurisdiction which may result in tax evasion or tax avoidance.

(10)Poor/ Non-existent documentation: Globally, transfer pricing documentation is still a

major challenge because many transfer pricing audits are done years after the transaction have

40
Okwoma Augustine Akpojevwa, The Effects of International Transfer Pricing on Host Nations: An Overview of
Developing Nations(2014)39-40, SCSR Journal of Business and Entrepreneurship (SCSR-JBE) 39 – 40.
been closed as such the record available for audit may not hold all necessary information for the
audit.

(11) Excessive Debt: Certain industries rely on debt funding (technology, oil and gas) and this
excessive debt may not reflect the true financial position of the company.

(12) Shared services: The relationship of the service with resulting income and whether the
service provider should charge market prices, if market prices are fixed and can an entity make
profit from itself is still a problem, how will resultant income tax paid on notional profits be
treated?41.

Possible solutions

In the face of numerous transactions of multi-national enterprises and their subsidiaries in the
present day business scene, a lot needs to be done in form of tax reforms both at domestic level
and the international sphere to ensure proper transfer prices and its application in international
taxation.

In the light of the above, some possible solutions are proffered as follows:

1. Documentation: it is the responsibility of tax payers to keep records that are considered
adequate for the purpose of proving that transfer prices conform to arm’s length
principles, such records must be kept for a minimum period of 6 years. The burden of
proof of compliance with arm’s length principle is on the tax payer but discharged upon
the provision of relevant documents.

2. The efficient use of technology: At a time where stone age methods are no longer a
means to smart and efficient methods of operation, the use of modern technology seems a
veritable tool to managing transfer price systems for efficacious disposal and
determination of genuine transfer prices.

3. Transfer pricing Adjustments: This requires compliance with Arm’s length principle
and empowers local tax authorities to make adjustments where necessary to make a
controlled transaction consistent with the arm’s length principle. The regulations further
provide that tax authorities should make corresponding adjustments in respect of
adjustment made by contracting state.

4. Transfer pricing Agreements: Tax authorities enter into Advance Pricing Agreements
for future transactions on request subject to a single minimum transaction value should be
met. Generally, APAs between the tax authority and CTPs will have a term of three years
unless cancelled under certain circumstances by either the tax authority or CTPs, or both.

41
Abdulahi Danjuma Zubairu, Understanding Nigerian Taxation (Husaab Global Press concepts Ltd 2014) 232- 233
 5. Standard Transfer pricing regimes and regulations: Transfer pricing regulations on
multi-national enterprises should work on the following issues for effective pricing
standards.

(i) Establish group TP Policy

(ii) Align group TP Policies with regulations

(iii) Set up internal structures to handle TP policies, documentation and reporting.

(iv) Design internal control and reporting system for controlled transaction.

(v) Secure services of TP Professionals to handle negotiation, documentation,

analysis and filing activities.

(vi) Ensure that the contracts for intra-group transfers are property documented.

(vii) Secure TP Compliance personnel.

6. Reduced Tax Liabilities through effective legislations: Multi-National Enterprises are

in the habit of moving from high tax rate jurisdiction to low tax jurisdiction for less
liabilities also leaving countries with high tax liabilities to countries with low tax burden.

This is as a result of some legislation in such jurisdictions which does not support the
business growth of the MNEs, this can be curbed by making tax legislations that conform
to best practices and still allow these enterprises make profit/income and still
conveniently pay their taxes.

Relevant case Law on Transfer pricing in International Taxation

1, In the recent case, Veritas Software Corporation & Subsidiaries v. Commissioner of

Internal Revenue42, the dispute is around intangible property valuation and the arm’s length
standard .

2. Also in the case between Xilinx, Inc and Consolidated Subsidiaries V. Commissioner of
Internal Revenue43, where the IRS questions the allocation of certain research and development
costs in a cost sharing agreement, and

42
United States Tax Court. 2009 U.S. Tax Ct. LEXIS 34; 133 T.C. No. 14; December 10, 2009, Filed. No. 12075-06.
43
United States Tax Court. 125 T.C. 37; 2005 U.S. Tax Ct. LEXIS 24; 125 T.C. No. 4; August 30, 2005, Filed; As
Amended, September 29, 2005. As Amended, September 15, 2005. Reversed by, Remanded by Xilinx, Inc. v.
Comm'r, 567 F.3d 482, 2009 U.S. App. LEXIS 11118 (9th Cir., 2009) Affirmed by Xilinx, Inc. v. Comm'r,2010 U.S. App.
LEXIS 5795 (9th Cir., Mar. 22, 2010) Nos. 4142-01, 702-03.
3. In National Semiconductor Corporation and Consolidated Subsidiaries V. Commissioner
of Internal Revenue44, the issues surround arm’s length pricing and comparable transactions.

The decisions of competent courts in the above cases put to rest some issues of transfer pricing
(1) The Tax Court ruled the buy-in payment was best valued using Veritas’s comparable
uncontrolled transaction method with a few adjustments and rejected the IRS’s allocation. (2) In
Xilinx Inc it was held that the stock-based compensation does not need to be included in the
research and development costs in a cost sharing agreement between two related parties and (3)
The court decided that based on the relationship between NSC and its Asian Subsidiaries, it is
unrealistic that the transfer prices used would result in operating losses for the parent company
while the subsidiaries incur high profits. The court made appropriate adjustments to bring the
pricing closer to reasonable arm’s length standards.

Observation and recommendations

Transfer pricing audits are growing in frequency and in the number of countries auditing these
issues, too. Many governments are utilizing transfer pricing audits to increase tax revenues to
offset economic reduction. With the implementation of some standard initiatives, the expectation
is that the number of countries doing this will grow further. The only question is to what extent
and how we will they successfully manage these controversies45.

It has been observed that transfer pricing has linkages with global stability, revenue generation,
economic growth, trans-border activities and international trade in the following ways:

(a) Promote stable flow of labour, capital, goods and services across national borders of the
world.
(b) There is an over-reaching issue of the right of each country to generate the right amount
of tax revenue from the economic activities performed within its jurisdiction.
(c) Transfer pricing would promote economic growth at unilateral, bilateral and multilateral
levels.
Transfer pricing methods tend to be not based on sound economic principles, thus the need for
re-evaluation of accepted international taxation principles been advocated by numerous
commentators, the present tax treatment of international capital flows is inefficient and
inequitable, almost irrespective of how one defines those words, reform efforts must be made
because the alternative could be a breakdown of the international tax system.

It is therefore recommended that more needs to be done to ensure best practice in international
transfer pricing in these areas:

44
United States Tax Court. T.C. Memo 1994-195; 1994 Tax Ct. Memo LEXIS 199; 67 T.C.M. (CCH) 2849; May 2,
1994, Filed; As Corrected May 2, 1994. Docket Nos. 4754-89, 8031- 90
45
Anita Kapur, Transfer Pricing Challenges For developing Countries (INDIA. May 29,2013)
 - Appropriate and more efficient legislations need to be put in place at the international
level to provide suitable basis for taxing economic activities of associated enterprises.
- Domestic Tax Laws should also reflect international standards and provide tools for
fighting tax avoidance and evasion.
- Modern technology should be employed in line with modern trends of pricing systems to
reduce the risk of double economic taxation and reduce the tax burden on MNEs.
- Tax treaties are expected to provide a level playing field between MNE and independent
enterprises as this would ensure health cost sharing and proper taxation on income.
- The international taxing dispensation should provide certainty of transfer prices in all
jurisdiction ns, as such:
-
CONCLUSION

Managers need to consider a complex range of issues when setting a transfer price. This is
because, transfer pricing can be used for different purposes such as: to provide information that
motivates managers, to make good economic decisions. It is also used to move profits between
divisions, which may involve moving profits from one country to another. The arbitrary shifting
of profits purely for tax avoidance or evasion is being challenged, through the enactment of
appropriate legislation by many countries globally.

The recurring theme in the 2018 Regulations is the FIRS’ desire to compel compliance with the
transfer pricing regime and huge penal sanctions have been prescribed to guarantee this. It is
expected that affected market participants should ensure that they are fully compliant with the
new regime and to regularize their positions if necessary.
The market is still trying to fully grasp the exact extent and implications of the new regime and
issues are very likely to arise in the future, such as the wide definition of connected person. We
expect the FIRS to provide some clarifications on the commencement date and the definition of
“commencement.” Some clarity is also required around the potential double taxation that may
occur if the FIRS rejects a price/value reported to and accepted by the Nigerian Customs Service
and on which import duties and other levies were assessed and paid at the port of entry. Further,
the 5% of EBITDA cap on tax deductible expenses accruing from the exploitation of intangibles
rights under a lease or licensing arrangement may operate against the core of the arm’s length
principle as it may lead to underpricing. In my opinion, the new rules governing objections to
disputed assessments do not provide adequate protection to the tax payer. However, such a tax
payer may have to obtain an order of mandamus to compel the referral of his objection to the
Decision Review Panel.
While the partial exclusion of entities with less than N300 million in total controlled transaction
value would lighten the compliance burden on qualifying entities, affected tax payers may need
to increase their budgetary allocations for compliance costs. This is particularly so for corporate
groups since each connected entity must separately meets its compliance obligations under the
new regime.
The current international taxation regime is a hodge-podge system full of bandages and
exceptions and needs to be re-evaluated. From the above critique, it should be clear that the
current systems has problems across board, at the both the concept level and the implementation
level, but with improved insight and the application of proposed reforms, a lot can be achieved in
ensuring transfer prices in all jurisdictions conform with international standard.

BIBLIOGRAPHY

1. Abdulahi Danjuma Zubairu, Understanding Nigerian Taxation (Husaab Global Press

concepts Ltd 2014) 232- 233.
2. Anita Kapur, Transfer Pricing Challenges For developing Countries (INDIA. May 29,2013)
3. Brian J. Arnold and Michael J. McIntyre, International Tax Primer (The Hague; Kluwer
Law International, 2007) 7
4. C.P.A Mohamed,” Effect of transfer pricing in developing countries: Cases in Africa”
Accountants Annual Conference Journal (Banju, December 3rd, 2016)6
5. . Gevoian Ielyzaveta, The Role of the OECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations for OECD and non-OECD
countries(2013)3,5,7Masters thesis in European and international Tax Law.
6. Mary Riley, transfer pricing and international taxation: A continuing problem for taxing
authorities (2014) Lexis Federal Tax
 Journalhttp://www.lexisnexis.com/legalnewsroom/tax-law/b/internationaltaxation/
archive/2014/11/17 accessed on 22nd March, 2018.
7. Okwoma Augustine Akpojevwa, The Effects of International Transfer Pricing on Host
Nations: An Overview of Developing Nations(2014)39-40, SCSR Journal of Business and
Entrepreneurship (SCSR-JBE) 39 – 40

STATUTES
1. Income Tax (Transfer Pricing) Regulation 2012
2. Income Tax (Transfer Pricing) Regulation 2018