It is a common practice of the tax authorities to issue tax audit notification letters to 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.
This year, in addition to the usual state tax audit and corporate tax audit notifications, you may be receiving an additional notification for Transfer Pricing audits. In a seminar about the next steps on TP for the Federal Inland Revenue Service (FIRS), held in December 2014, the head of TP division of FIRS made known the Revenue’s intention to commence TP audits from the beginning of this year. Your company may or may not have received a notification for TP audit yet. But whatever the case, the necessary compliance steps should be taken at the right time to prevent that anxiety that wells up in our minds once there is a mention of ‘Tax audit’.
Preparation for state tax audits
The preparation for state tax audits does not commence just before or after we receive the tax audit notification letters, it begins when the Pay As You Earn (PAYE) tax returns and withholding taxes (pertaining to state tax authorities[1]) are filed on or before the 10thor 21stof every month following the months of deduction[2]. It also starts when the annual employer and employee PIT returns are filed to the relevant tax authorities on or before the 31stof January and 31 March respectively as stipulated by the law. The returns should be filed to the tax authority of the income earners’ deemed state of residence.
If the management of the company envisages that the monthly PAYE and WHT returns for the previous assessment year had not been completely or correctly filed, it may carry out an in-house check or pre-audit review of PAYE and state WHT compliance to enable the company make up for any deficient tax payment before the tax audit begins. This remedial payment is advisable to prevent any tentative[3]interest and penalty on assessments levied by the tax authority.
Lastly, if your 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 state tax authority, the Revenue authorities would usually give some years’ gap in between tax audit periods. 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[4]). 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), you would notice that FIRS continuously notifies the public of any approaching monthly and annual tax filing deadlines such as 10thof every month for PAYE returns, 21stof every month for WHT and VAT returns and 30thor 31stof every month for corporate tax returns, for companies which accounting year ends fall six months earlier. 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 eventually come, your company may engage the services of a professional tax adviser to provide the necessary support to the company through preparation, field reviews and tax audit reconciliations stages.
Preparation for TP audits
Currently, we know about State Boards of Internal Revenue (SBIR) and FIRS’ tax audits. We may have experienced it several times before now and may even be undergoing any of these tax audits as we speak. But TP audits are what we cannot say we have experienced before now in Nigeria.
Transfer pricing (TP) audit is a bit different from normal tax audits; in that 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 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 liability.
Like the other taxes which we discussed above, TP does not end in preparing annual contemporaneous documentations. It is rather a process that needs to be closely complied with all through the financial year.
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, from our experience, that many Nigerian companies are yet to focus attention on. The paramount issue for them currently is to carry out benchmark analysis on existing 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 while initiating transactions.
Customs duty, VAT and WHT are also areas that need to be paid attention to throughout the year as intercompany payments are made. Are these taxes based on the arm’s length prices of intercompany transactions? Custom valuations versus actual Cost in Freight (CIF) values of imported goods are also bound to impact on the arm’s length pricing of these goods. Safe harbor certifications by the TP division of FIRS is also very important on intercompany agreements previously approved by National Office for Technology Acquisition Program (NOTAP). We understand that FIRS is currently working with NOTAP to establish a consensus on how intercompany prices requiring NOTAP approvals are to be tested and approved. This will automatically qualify those NOTAP approved transactions as safe harbor transactions for TP purposes.
An in-house TP resource person would be advisable to monitor the company’s TP processes throughout the year and to call in professional TP advisers as the need arises throughout the financial year
Other preparations that can be made for TP audits apart from the foregoing and ensuring that TP documentations and policies are in place include:
- 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) – is an option but yet to be commenced by FIRS.
Documentation requirements
Proper documentations is key in preparing for all tax audits. Your company would need to keep proper record of the following documentations in preparation for tax and TP audits:
- Financial statements
- 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 and TP requirements, proper tax/TP planning and periodic tax reviews are ways your company could 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 help in ensuring a hitch free tax audit exercise and in projecting your company in a good light during tax audits.
[1]These are withholding taxes deductible from payments to sole proprietors, individual or freelance contractors and partnerships
[2]These are the major tax returns required by law to be filed to the state tax authorities. Other minor levies include the business premises and development levies.
[3]As against the current practice by the State Revenue authorities, please note that by law, the tax authority cannot input interest and penalty on any additional assessment made unless it is neither objected to nor paid within 2 months after the assessment was made. If there has been an objection to the assessment, interest and penalty can only apply if payment of agreed liability is not made after one month of resolution of objection. This however does not apply where late returns penalty accrues on default of tax filing on or before the due dates.
[4]These are withholding taxes deductible from payments to corporations.