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Thursday, May
28, 2020 / 12:15 PM / by KPMG Nigeria / Header Image
Credit: Dozilla
The Tax
Appeal Tribunal (TAT or "the Tribunal") sitting in Lagos recently delivered
judgement in the case between Prime Plastichem Nigeria Limited (PPNL or "the
Appellant") and the Federal Inland Revenue Service (FIRS or "the Respondent")
on Transfer Pricing (TP). This is significant as it was the first TP judgement
delivered in Nigeria since inception of the TP Regulations in 2012.
PPNL is
a private limited liability company engaged in trading of imported plastics and
petrochemicals in Nigeria. During 2013 and 2014 financial years (FYs), PPNL
entered into a related party transaction with Vinmar Overseas Limited (VOL) for
the supply of petrochemical products.
PPNL
adopted the Comparable Uncontrolled Price (CUP) TP method to test whether the
terms of the transaction with VOL for 2013 FY were at arm's length. In 2014 FY,
PPNL changed the testing method to Transactional Net Margin Method (TNMM) using
Operating Margin (OM) as the Profit Level Indicator (PLI). This, according to
PPNL, was due to lack of information required for applying CUP. While the FIRS
agreed with the change, it opted for Gross Profit Margin (GPM) as the most
appropriate PLI, albeit for the two years. This led to an additional assessment
of N1.7 billion.
TAT
ruled in favour of the FIRS on all the issues raised by PPNL. A review of the
issues tabled before the TAT by the Appellant shows that the Appellant based
its case largely on the powers of the FIRS to make the adjustment. On the other
hand, the FIRS based its response on core TP technical position to support the
approach adopted. We have summarized below, the issues raised in the appeal and
the pronouncement of the Tribunal in each instance.
Issues for Determination
Issue 1:
Whether
the Appellant proved its case before the Tribunal to be entitled to the claims
and reliefs sought against the Respondent
TAT's Ruling
TAT
agreed with the FIRS that the Appellant did not provide satisfactory
information to justify both its use of the CUP method and subsequent change in
methodology.
KPMG's Comments
Based
on FIRS' arguments, PPNL did not provide adequate and consistent information to
enable it to establish that the transaction was consistent with the arm's
length principle. The 2012 and 2018 Nigerian TP Regulations clearly state that
the burden of proof of compliance with the arm's length principle is on the
taxpayer. Furthermore, Regulation 9 of the 2012 Nigerian TP Regulations states
that:
"The documentation retained by a connected taxable person shall be adequate to enable the Service verify that the controlled transaction is consistent with the arm's length principle."
As
provided in the TP Regulations, it is important that taxpayers prepare detailed
documentation on all related party transactions to justify decisions made, in
accordance with the TP Regulations, the Organisation for Economic Cooperation
and Development (OECD) Guidelines and the United Nations (UN) TP Manual. This
is necessary to ensure that in the event of a TP dispute, taxpayers are able to
successfully defend the arm's length nature of their related party transactions
and counter any argument raised by the tax authority. This should also enable
taxpayers to defend the method adopted as the most appropriate to analyze their
related party transactions.
Issue 2:
Whether
the Respondent's action in benchmarking the Appellant's TP transaction with the
TNMM for 2013 and 2014 FYs was valid and in accordance with the Transfer
Pricing Regulations 2012 and the OECD/UN Guidelines.
TAT's Ruling
The TAT
held that the Appellant did not provide sufficient documentation to
satisfactorily explain its use of different TP methods in 2013 and 2014 FYs.
The Appellant had selected the CUP as the most appropriate method in 2013 FY
and the TNMM in 2014 FY. Essentially, the TAT agreed with the position of the
FIRS that the Appellant had failed to discharge its burden of proof concerning
the selection of TP methods for the relevant years.
Furthermore,
the TAT held that consistency in the application of methods from year to year
is very important and fundamental.
KPMG's Comments
Best
practices concerning selection of TP methodology involves a process that starts
with a consideration of the respective strengths and weaknesses of the various
TP methods, followed by a detailed Function, Asset and Risk (FAR) analysis. The
FAR analysis enables the taxpayer to accurately characterize the related party
transaction. Accurate characterization of a controlled transaction will enable
the taxpayer to select an appropriate TP method for analyzing the controlled
transaction. Finally, the taxpayer is expected to consider the availability of
information required to apply the method as well as the degree of comparability
between the controlled and uncontrolled transactions.
There
are instances where more than one TP method may be considered appropriate in
analyzing a controlled transaction after following the TP method selection
procedure. In such instances, the OECD Guidelines and UN TP Manual recommend
the selection of the Most Appropriate Method (MAM) based on the information
obtained from the selection procedure. However, the chosen TP method is
generally expected to be applied consistently by the taxpayer.
While
the taxpayer is expected to apply the chosen TP method consistently, the TP
method may be changed if there are any changes in the facts of the controlled
transaction, functions of the entities involved or availability of data in
subsequent periods. It is, therefore, very important for taxpayers to select a
TP method based on the recommended procedure, maintain clear and sufficient
documentation of the selection procedure and provide records of any changes
which occurred during the relevant period that necessitated the change in the
TP method.
Issue 3:
Whether
the Respondent's action of using the GPM as the PLI in the instant Transfer
Pricing transaction is valid and in accordance with the TP Regulations, OECD
and UN Guidelines.
TAT's Ruling
The TAT
held that the TNMM with the GPM as a PLI was the most appropriate PLI in this
instance based on OECD Guidelines as explained by the Respondent.
KPMG's Comment
Based
on the rules on the application of the TP methods in the OECD Guidelines and
the UN TP Manual, the TNMM seeks to test the net profit margin of a company
relative to an appropriate base, e.g., costs, sales or assets. Gross profit
level indicators should ideally be used when the selected TP method tests a
company's performance at the gross profit level such as where a taxpayer
selects the Resale Price Method (RPM) or the Cost-Plus Method (CPM). Regulation
18 of the Nigeria TP Regulations provides that the TP Regulations shall be
applied in a manner consistent with the OECD Guidelines and UN TP Manual.
However,
in complete contrast to the OECD Guidelines, the FIRS applied the TNMM using a
gross profit level indicator, that is, the GPM. It is, therefore, clear that
the FIRS was wrong in saying that the method applied to analyze the transaction
was the TNMM, as the PLI (GPM) adopted is not consistent with the definition
and application of the TNMM as described in the OECD Guidelines and the UN TP
Manual. This is because the OECD Guidelines and UN TP Manual both recognize the
GPM as the PLI to be applied when using the RPM.
Issue 4:
Whether
the Appellant's failure to file their returns within the prescribed period
required by the extant tax laws validates the penalty and interest imposed by
the Respondent vis-Ã vis the provisions of paragraph 4(2) of the TP Regulations
2012, Section 55 of the Companies Income Tax Act, Cap. C21 LFN, 2004 (CITA) and
Section 32 of the Federal Inland Revenue Service (Establishment) Act 2007
(FIRSEA).
TAT's Ruling
TAT
held that the FIRS was right to disregard the TP method used by the Appellant
and upheld the imposition of penalty and interest based on the Appellant's
failure to file its returns and pay the relevant taxes as and when due.
KPMG's comments
Section
55 of CITA and Section 32 of FIRSEA establish the FIRS' authority to impose
penalties on companies that fail to self-assess and file their tax returns
within 6 months of their year-end and to further impose penalties and charge
interest for as long as the returns remain outstanding. But the TP Regulations
does not specify any penalty where the FIRS makes an adjustment to the
conditions imposed by connected taxable persons in controlled transactions. In
addition, Section 22 of CITA which empowers the FIRS to adjust "artificial
transactions" does not stipulate the imposition of penalties or interest where
such adjustments are made.
However,
the TAT, in its judgement in Weatherford S.D.E.R.L vs the FIRS, where the FIRS
had imposed penalty and interest on additional CIT assessments originating from
a tax audit, ruled that penalty and interest on additional assessments should
only be applied when the assessment or demand notice becomes final and
conclusive. This position is further buttressed by the TAT's judgement in Tetra
Pak West Africa Limited vs FIRS.
Based
on the above, the appropriateness of the TAT decision upholding the imposition
of interest and penalty on tax liabilities arising from the FIRS varying the TP
method adopted by a taxpayer is questionable.
Issue 5:
Whether
the Defendant Decision Review Panel purportedly set up by the Respondent was in
accordance with the TP Regulations.
TAT's Ruling
TAT
held that the action to trigger the filing of the appeal is the receipt of
Assessment on the Adjustment and not a formal notification from FIRS of the
setting up of the Decision Review Panel (DRP or "the panel"). The TP
Regulations, 2012 mandates the FIRS to set up a DRP for resolving any dispute
or controversy arising from the application of the provisions of the
Regulations. The FIRS' setting up of the DRP and subsequently inviting the
taxpayer, is in line with the TP Regulations.
KPMG's comments
According
to Regulation 14(1) of the TP Regulations (2012), the FIRS is empowered to set
up a DRP to resolve any dispute or controversy arising from the application of
the provisions of the TP Regulations. The DRP is responsible for hearing and
addressing the issues raised by either the FIRS or the taxpayer. Regulation
14(3) stipulates a 30-day period within which the taxpayer may refer the
adjustment received from the FIRS to the DRP. The DRP also reserves the right
to issue a formal adjustment where a taxpayer fails to refer the adjustment to
the Panel within thirty days of receipt of the adjustment. It appears that
there is a misconception about the role and modus operandi of the DRP. However,
this has been made clearer in the 2018 TP Regulations which vests the FIRS with
the sole power to refer a TP dispute to the DRP.
Conclusion
This
landmark judgement by the TAT is indicative of the growth in the TP practice in
Nigeria. The ruling also highlights the importance of maintaining robust TP
documentation and the need for taxpayers to pay more attention to their TP
affairs by ensuring availability of ample information to defend the arm's
length nature of their related party transactions.
From a
technical point of view, however, the outcome of the judgement may have been
different if both the Appellant and the Respondent had made use of expert
witnesses to clarify and further strengthen their arguments. It is common
practice to use expert witnesses in court proceedings requiring technical
knowledge. The use of expert witnesses would have provided a platform for an
in-depth and technically sound judgement as their expertise would have provided
clarity on certain key issues, such as the TP method selection procedure, the
application of the method selected and the rationale behind a change in
methodology. The TAT based its judgement on the information made available to
it by the Appellant and the Respondent, which did not provide sufficient
information for a more informed decision.
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