The Arm’s Length Principle And Its Implication On Taxation In Nigeria

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In many developing countries, a major challenge which occurs in
related-party transactions is transfer pricing. A transfer price
can be defined as the price at which related parties (that is,
companies having existing relationship as a result of common
ownership or control) transact with one another. In such
circumstances, related parties have the tendency of transacting
business at a price lower or higher than the market value in other
to allocate profit for tax or other purposes. Transfer pricing can
deprive governments of their fair share of taxes as well as expose
corporate entities to possible double taxation. To combat these
problems, several countries have adopted the Arm’s Length
Principle in their laws and regulations. In Nigeria, this principle
is found in the Income Tax (transfer Pricing) Regulation 2018 (the
“Regulation”) established by the Federal Inland Revenue
Service (“FIRS”).

When is a transaction said to be at Arm’s Length?

A transaction between related parties is said to be at Arm’s
Length where it is conducted in a manner that would not have been
different if the parties were independent entities and have no
pre-existing relationship. Thus, the transaction is conducted in
the same manner a third party would have conducted it in comparable

Where related-party transactions are deemed as non-conforming
with the Arm’s Length Principle, the Regulation empowers the
FIRS to make necessary adjustments to the taxable profits accruing
from such transaction to bring it into conformity with the

Implications of not complying with the Arm’s Length

The Regulation provides stiff penalties for related-party
transactions which do not comply with the Arm’s Length
Principle. Below are some highlights of the transactions and their
tax implications.

a. Transactions with respect to export and import of

In the case of export, where the agreed price between related
parties is lower than the price obtainable from an international or
domestic commodity exchange market on the date of the transaction
(“quoted price”), FIRS will disregard the agreed price
and use the quoted price in computing the taxable profits.

In the case of import, where the agreed price is higher than the
quoted price, the quoted price will be used by the FIRS in
computing the taxable profit.

The above will however not apply where the taxpayer can show
that the increase or decrease in the quoted price, as the case
maybe, was reasonable.

b. Intra- group services

A test applied by FIRS in determining whether a service rendered
by a taxpayer to a related party is consistent with the Arm’s
Length Principle is whether such service enhances the economic or
commercial position of the recipient and whether an independent
person in comparable circumstances will be willing to pay for such
service at the agreed price or would have performed the service
itself in-house.

Where the service does not fulfil the above conditions, the FIRS
would make adjustments to the taxable profits of the taxpayer.

c. Transfer of Intangibles property between related

Intangible property includes copyright, patents, goodwill,
trademarks and trade names. The test applied by the FIRS is whether
an independent person in the position of the transferor would be
willing to transfer such property at the agreed price and if in the
position of the transferee, would consider such property useful to
its business.

Whatever the case maybe, tax deductions on intangible property
shall not exceed 5% of earnings before interest, tax, depreciation
and amortisation.


Companies in related-party transactions should ensure that
compliance with the Arm’s Length Principle is a priority to
prevent arbitral adjustments of their taxable income by the

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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