It is a common practice of the tax authorities to issue tax audit notification letters to selected companies in the first or second month of each New Year, generally signifying the end of the previous assessment year and the need to verify the correctness of the self-assessments filed in that previous period.
Since Transfer Pricing (TP) compliance is expected from every Company in Nigeria operating within a group structure from August 2012, it is expected that the tax authority would also seek to check compliance in this area through TP audits.
It is therefore expedient for the necessary compliance steps to be taken at the appropriate time to mitigate the usual anxiety that follows a notification of tax audit by the tax authorities.
Preparation for state tax audits
Preparation for state tax audits does not commence just before or after receiving the tax audit notification letters, it begins when the Pay As You Earn (PAYE) tax returns and withholding taxes (pertaining to state tax authorities ) are filed on or before the 10th or 21st of every month respectively, following the months of deduction . It also starts when the annual employer and employee PIT returns are filed to the relevant tax authorities on or before the 31st of January and 31 March respectively as stipulated by the law. These returns are to be filed to the tax authority of the income earners’ state of residence.
If and when there is an impending tax audit, and the management of the company is unsure as to whether the monthly PAYE and WHT returns for the previous assessment years had been completely or correctly filed, it may carry out an in-house check or pre-audit review of these taxes to enable the company make up for any deficient tax payment before the tax audit begins. This remedial payment option helps in preventing any tentative interest and penalty charges on assessments levied by the tax authority.
Lastly, if and when a company receives any tax audit notification letter from the tax authority, it may engage the services of a professional tax adviser to support the company through its preparation, field reviews and tax audit reconciliations stages.
Preparation for FIRS tax audit
FIRS tax audits are usually not performed on a year by year basis like that of the SBIR (State Boards of Internal Revenue), FIRS would usually give some years’ gap in between tax audit periods to allow some open years to accumulate. The taxes usually checked for compliance and completeness during FIRS tax audit reviews are companies income tax, tertiary education tax, capital gains tax (if there had been chargeable assets disposal), value added tax and withholding tax (payable to FIRS ). These are apparently majority of the taxes business organizations are required to pay.
In the news section of the FIRS website, and in business day newspaper (on Wednesdays), one would notice that FIRS continuously notifies the public of any approaching monthly and annual tax filing deadlines such as 10th of every month for PAYE returns, 21st of every month for WHT and VAT returns and 30th or 31st of every month for corporate tax returns, for companies which accounting year ends fall six months earlier (the weekly Wednesday FIRS' publications have been suspended WEF 2 September 2015) due to some process reviews within the Service). These are measures put in place by the Revenue authority to help companies comply with their periodic tax returns even before the tax authorities contemplate audits.
Computing backlog of these taxes in arrears, especially for companies with high volumes of monthly transactions and many employees can be a challenging exercise. It is better done in bits and on time as the deadlines fall due. That way, adequate preparations are made for tax audits long before it is time for the company to be audited. Periodic tax health check reviews can also help in identifying any remedial areas in the tax compliance process.
When the tax audit notification letters are received eventually, the company to undergo reviews may engage the services of a professional tax adviser to provide the necessary support to the company through preparation for the tax audit, field reviews and tax audit reconciliations stages.
Preparation for TP audits
TP audit is a bit different from normal tax audits because it typifies the process of preparing a TP documentation. This approach is necessary in order for the tax authority to independently confirm the arm’s length nature of the related party transactions as documented in the TP reports, and to arrive at the appropriate TP adjustment figures if necessary.
Basically, a transfer pricing audit should involve the TP auditor carrying out an independent investigation on the taxpayer’s TP documentations. Afterwards, an audit report is prepared showing compliance, or otherwise of the intercompany prices with the arm’s length principle. In a situation where the related party transactions do not comply with the arm’s length principle, the TP Regulations empower the tax authority to make necessary adjustments to the prices, which may result in more tax liabilities.
Like the tax types discussed above, TP does not end in preparing annual contemporaneous documentations. It is rather a process that needs to be closely monitored all through the financial year.
Firstly, before intercompany prices are set and agreed in written contracts, benchmark analysis would need to be carried out to arrive at the arm’s length range of prices for comparable transactions in an unrelated party circumstance. This is one area in which, from experience, many Nigerian companies are yet to focus attention on.
The paramount issue for them currently is to carry out benchmark analysis on existing or prior year transactions in order to be able to document the arm’s length nature in a TP documentation report or probably to make yearend adjustments before accounts are closed for the year. Why wait till year end? Why wait to make adjustments? These can be prevented by proper TP planning at the time of initiation of the intercompany transactions just like tax planning helps in achieving tax effectiveness when carried out before initiating transactions.
Secondly, customs duty, VAT and WHT relating to related party transactions are areas that need to be paid attention to throughout the year. The arm’s length nature of the transactions on which these taxes are based would need to be determined. Custom valuations versus actual Cost in Freight (CIF) values of imported goods are also bound to impact the arm’s length pricing of these goods. Safe harbor certifications by the TP division of FIRS is also very important for intercompany agreements previously approved by National Office for Technology Acquisition Program (NOTAP).
It is our understand that FIRS is in collaboration with NOTAP to establish a consensus on how intercompany prices requiring NOTAP approvals are to be tested and approved. This collaboration would hopefully bring about an automatic qualification of those NOTAP approved transactions as safe harbor transactions for TP purposes.
Retaining an in-house TP resource person would also be advisable to monitor the company’s TP processes throughout the year and to advise for engagement of the services of professional TP advisers as the need arises throughout the financial year.
Other preparations that can be made for TP audits apart from the foregoing include:
• Ensuring that TP documentations and policies are in place
• Proper disclosure of related party transactions and pricing arrangements
• Keeping track of industry and other relevant developments
• Generally complying with the provisions of the TP Regulations
• Advance Pricing Agreements (APA)
Tax audits documentation requirements
Proper documentations is key in preparing for all tax audits. The initial documentations which a company may be asked to provide for review during tax audits would include:
- Financial statements
- Schedule of deferred tax computations and reconciliations (specifically for FIRS tax audits)
- Details of administrative and selling expenses
- Trial balance, lead sheets and audit adjustment journals
- IFRS conversion journals
- General ledgers
- Fixed assets schedules
- Bank accounts statements and even cheque stubs
- List of suppliers
- All taxes remittance receipts
- All taxes computations and remittance schedules where applicable
- Contract agreements
- Employee contract letters and schedules of benefit-in-kind
- Employee payroll and breakdown of staff cost
- Invoices, receipts and payment vouchers
- Importation documents
- Certificate of fixed assets acceptance
- Certificate of capital importation
- Memorandum and articles of association
- NOTAP approvals
For TP audits specifically:
• Country specific TP documentation report
• TP policy papers and country risk assessment
• Legal agreements related to inter-company transactions, and employment agreements
• Intercompany billings, invoices and debit notes
• Minutes of (annual) general shareholder’s meeting and minutes of the meetings of board of directors
• Intellectual property right registrations and policy statements
• Description of key personnel functions and structure
• Corporate income tax returns
• Financial statements
• Other documents such as Withholding Tax (WHT) and Value Added Tax (VAT) returns on intercompany settlements, depreciation/ amortization schedules, bank account statements, shareholder register and intercompany correspondences.
Monthly and annual compliance to tax, proper tax/TP planning and periodic tax reviews are ways a company could proactively keep off back duty taxes and reputational issues associated with nonpayment of taxes. Properly kept books, records and verifiable schedules supporting income earned and taxes paid on such income also go a long way in ensuring a hitch free tax audit exercise and in projecting every business organisation in a good light with the tax authorities.