Transfer Pricing   an introduction

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Outline. What is transfer pricing?Examples of how it worksNigerian Law provisionsChallengesLegal work in transfer pricing. The transfer pricing problem. Most Countries enforce tax laws based on the arms length principle, limiting how transfer prices can be set and ensuring that their country gets to tax its fair share.

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Transfer Pricing an introduction

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1. Transfer Pricing – an introduction Kayode Sofola & Associates June 2010

2. Outline What is transfer pricing? Examples of how it works Nigerian Law provisions Challenges Legal work in transfer pricing

3. The transfer pricing problem

4. How can it work

5. Other Examples Springs from the assumption that a multinational group of companiess will manipulate income and deduction across borders to get most tax effecitve ans and tax trates Springs from the assumption that a multinational group of companiess will manipulate income and deduction across borders to get most tax effecitve ans and tax trates

6. reality The size and nature of the market, the quality of the goods, the extent of the competition, cost and desired profit margin are all factors which bear on the selling price. Send goods ast low prices to countries with high import duties – ship goods at high taxes to countrs with low import duties The size and nature of the market, the quality of the goods, the extent of the competition, cost and desired profit margin are all factors which bear on the selling price. Send goods ast low prices to countries with high import duties – ship goods at high taxes to countrs with low import duties

7. Not just sale of goods Sale of goods transactions are easiest to understand but this concept also applies to – research and development services, licensing of intellectual property, agency/commissionaire arrangements, back-office services, credit facilities, provision of security to third parties.

8. Principle is applied to a controlled transaction by

9. Internationally accepted methods Comparable uncontrolled price method(CUP) By reference to the prices agreed between unconnected parties for comparable goods or services in the external market. Cost plus method The cost to the supplying company of obtaining or providing the relevant goods or services and adding an appropriate mark up. Resale price method The final selling price of the goods or services outside the group, minus an appropriate gross margin. Profit split method First, a functional analysis is carried out to establish the functions performed by each member of the group, the assets used by each member and the respective risks assumed. Following this analysis, each party is allocated a share of the group’s overall profit or loss (profit split) that it would have expected to receive on that basis (typically assessing the issue at the time when the relevant arrangements were set up). Transactional net margin method (TNMM) The net margin achieved by unconnected entities on similar transactions, based on criteria such as turnover, cost or capital employed. That margin is then applied to the company’s income or expenses to identify the pricing for its intra-group arrangements.

10. Nigerian context What are the provisions of Nigerian law on transfer pricing? What circumstances will trigger the recognition of a transfer pricing model as a potential scheme for tax avoidance?

11. Nigerian Law Section 13 (2)(d) Companies Income Tax Act (CITA) Cap 21 LFN 2004 empowers the Federal Inland Revenue Service to – Make adjustments in order to reflect arms length transactions Where “in its opinion” it deems trade or business or activities between related parties to be artificial or fictitious ”The profits of a company other than a Nigerian company from any trade or business shall be deemed to be derived from Nigeria – Where the trade or business or activities is between the company and another person controlled by it or which has a controlling interest in it and conditions are made or imposed between the company and such person in their commercial or financial relations which in the opinion of the Board is deemed to be artificial or fictitious, so much of the profit is adjusted by the Board to reflect arms length transaction” 13(2)(d) CITA

12. Where the board thinks a disposition or transaction is artificial/ fictitious, it may Disregard such disposition Counteract the reduction of liability to tax Section 22 CITA 2004 IMPLICATION Issues of determining transfer pricing in the Nigerian context is an exercise of subjective judgement by the tax authority! (Humphrey Onyeukwu)

13. SOME Factors that may cause the exercise of the “opinion” of the tax authority What transactions are at variance with the arms length principle? Presence of intercompany intangible transactions – consistent losses of the tax payer Significant changes in the profitability of the tax payer and its associated enterprises Unjustifiably large payment of management charges not passing the benefit test Losses incurred by routine distributers Low mark up for services Transactions with companies situated in tax havens Subsidiary of a foreign parent In India, should the value of a transaction exceed $3.75M, it must be audited

14. challenges Among the biggest losers of tax revenue from this capital flight between 2005 and 2007 were Nigeria, Pakistan, Vietnam and Bangladesh. Developed countries have stringent TP rules to ensure profit stays within Lack of comparable data in Nigeria Few players in a given sector Where available its costly and incomplete Lack of knowledge and skill set to implement Terms such as arms length are not defined No rules concerning documentation Burden of proof on assessing officer No rules for determining arms length prices

15. Legal ADVICE Required to draft and review documentation that may have an impact on the tax structuring of an intra-group transaction - documentation to reflect arm’s-length arrangements Review and monitoring of arrangements, particularly in respect of the pricing, the allocation of risk and the conduct of the parties Drafting/negotiating advance pricing agreements Understand how documentation may be scrutinised by tax authorities Understand penalty regimes – if they apply Transfer pricing planning – with economists, tax, IP and ADR specialists

16. CONTACT US For any advice on transfer pricing or any tax matters contact us at: KAYODE SOFOLA & ASSOCIATES 9, ONDO STREET, OSBORNE FORESHORE ESTATE, IKOYI, LAGOS. 01 2717094 www.kslegal.org

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