Transfer pricing: the arm's length principle, methods, documentation and penalties

A Nigerian subsidiary makes a product for ₦1,300 a unit and sells it to its parent in another country for ₦1,500. Independent buyers pay ₦1,900 for the same product. The parent resells it at a healthy profit abroad, and the Nigerian company shows a thin margin and a small tax bill. Nobody has broken a rule on paper, because both companies agreed the price.

The Nigeria Revenue Service (NRS) will ask what an independent buyer would have paid, and tax the Nigerian company as if it had been paid that.

This topic covers the meaning of transfer pricing, the arm’s length principle, the legal framework (the Nigeria Tax Act (NTA) 2025 and the Income Tax (Transfer Pricing) Regulations 2018), who is a connected person, the five pricing methods with worked figures, advance pricing agreements, documentation and returns, disputes, penalties and the deduction of payments for intangibles. The previous topic covered tax treaties. The next covers base erosion and profit shifting.

Key terms in plain English

Syllabus check

This topic is in syllabus area C (international taxation, 20% of marks). It covers:

• the arm’s length principle and the transfer pricing methods;
• the Nigerian regulations, documentation, returns and filing dates;
• dispute resolution, offences and penalties, and the deduction of payments for intangibles.

CAMA 2020 and related party dealings

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Meaning and why it matters

Transfer pricing covers the prices of tangible goods (raw materials, spare parts, finished goods), services (marketing, legal, accounting, insurance, management, training) and intangibles (trademarks, patents, copyright) between connected taxable persons. These prices fix the income, cost and taxable profit of each group member in each country. A multinational can push profit from a high-tax country to a low-tax one by over- or under-pricing.

Regulation exists for two reasons: to stop the loss of tax revenue through shifting profit, and to avoid economic double taxation, which arises where one country adjusts a price and the other does not make the matching adjustment. Developing countries are exposed because company tax is a large share of their revenue.

The arm’s length principle

Article 9 of the OECD and UN model conventions allows profit to be taxed in one country where conditions between two associated enterprises differ from those between independent enterprises. The Nigerian rules follow the OECD Transfer Pricing Guidelines. Aligning with them gives tools against artificial profit shifting, certainty for multinationals, less economic double taxation and a level field between multinationals and independent businesses.

The Pacific Association of Tax Administrators, whose members are Australia, Canada, Japan and the United States, has a common documentation package for the same purpose.

Legal framework

• NTA 2025 s. 191. Where a transaction that reduces tax is artificial or fictitious, the tax authority may disregard it or adjust the liability. A transaction between connected persons that is not at arm’s length is deemed artificial.
• NTA 2025 s. 192. A company in an arrangement with a related party must make sure the terms are at arm’s length and report the arrangement as the tax authority prescribes. The authority may adjust a non-arm’s length arrangement under the Transfer Pricing Regulations. “Arrangement” includes any agreement, understanding, scheme, financial or commercial relation, transaction or series of transactions.
• Income Tax (Transfer Pricing) Regulations 2018 (in force from 12 March 2018, replacing the 2012 Regulations). The Nigeria Revenue Service (Establishment) Act 2025 repealed the Federal Inland Revenue Service Act, and the NRS administers the Regulations from 1 January 2026.
• Income Tax (Country-by-Country Reporting) Regulations 2018 and the Common Reporting Standard Regulations 2019 (automatic exchange of account information).

The Regulations cover sales and purchases of goods and services, sale, purchase or lease of tangible assets, transfer or licence of intangibles, services, lending and borrowing, manufacturing arrangements and any transaction that affects profit or loss.

Connected persons (s. 202 NTA 2025)

• Individuals: married or relatives.
• Trustee and settlor: the trustee and the settlor, or the settlor’s spouse or relative.
• Partnership: a partner and the other partners, their spouses and close relatives.
• Company: a person and a company he or his spouse or close relative controls; two companies under the same control; a company and persons who together control it; two companies where one takes part directly or indirectly in the management, control or capital of the other, or the same persons take part in both.
• Other: two persons where one can be expected to act on the directions or wishes of the other, both act on the wishes of a third, or one can control the business decisions of the other. Persons are not connected merely because one is the employee or client of the other.

In practice the NRS looks at subsidiaries and parents, members of a local group or conglomerate, joint ventures, entities in a free zone, an entity with pioneer or incentive status, a loss-making entity in a profitable group, and related parties taxed at different rates.

The methods

The methods fall into two families. The traditional transaction methods are the comparable uncontrolled price, resale price and cost plus. The transactional profit methods are the transactional net margin and profit split methods. The NRS may prescribe other methods.

Functional analysis and comparability

A functional analysis lists the functions each party performs (manufacturing, marketing, distribution, research, management), the risks it carries (market, credit, operating, financial) and the assets it uses (tangible, intangible, financial). It is the base for TNMM and for choosing comparables. The comparability factors are: functions; contract terms; economic conditions; property or services; risks; industry and market; location; business strategy; the tax and regulatory setting; and timing.

Benchmarking uses databases of listed and private company accounts, royalty rate data and industry reports, helped by analytics software.

Advance pricing agreements

• A connected person may ask the NRS for an APA on the criteria for pricing future controlled transactions.
• The request describes the activities and transactions, the functions, assets and risks, the proposed duration, the pricing proposal with the method, comparability analysis and critical assumptions, and any other country that should join.
• The NRS may accept, modify or reject the request, and may deal with the taxpayer alone (unilateral) or with another competent authority (bilateral).
• An APA covers a period of not more than three years. While the terms are met, no transfer pricing adjustment is made to the covered transactions.
• The NRS may end an APA for a material breach, a failed critical assumption, a relevant change in law or a misrepresentation. The taxpayer may end it for a material change in the facts, structure or law. Information given is confidential.

Documentation, returns and dates

• Documentation. A transfer pricing policy (group and local), the compliance report or documentation that proves arm’s length pricing, and the returns. The burden of proof is on the taxpayer. Documentation is contemporaneous: ready before the annual return is due, and produced within 21 days of a request. Connected persons with total controlled transactions below ₦300 million need not keep the contemporaneous documentation, but still file the forms.
• Policy. A transfer pricing policy looks forward, changes only when the business changes, shows likely intercompany transactions and gives guidance on pricing and method.
• Declaration form. Reporting company, parent, directors, major shareholders and related parties, ownership structure, subsidiaries and connected persons, auditors, tax consultant, company secretary, the person making the declaration and the declaration itself.
• Disclosure form. Reporting company, income from and cost of controlled transactions, a summary of transactions with connected persons, the method and documentation, financial information on the entity and the group, and the declaration.
• Dates. The declaration and disclosure forms go in annually with the company income tax return, which for a December year-end is due by 30 June. The country-by-country notification is due by the last day of the group’s accounting year, and the CbC report within 12 months after it (31 December for a calendar-year group).
• Documentation tiers. Master file, local file, benchmarking study, financial statements, the policy, intercompany agreements, the CbC report and supporting studies.

Country-by-country reporting

An ultimate parent resident in Nigeria whose group has consolidated revenue of ₦160 billion or more (or €750 million) files a CbC report. A late report costs ₦10 million and ₦1 million for each month of default; an incorrect report ₦10 million; failure to notify costs ₦5 million and ₦10,000 a day.

Disputes

A taxpayer who objects to an assessment lodges the objection with the head of the NRS Transfer Pricing Unit within 30 days of the notice. The head decides whether to refer it to the Decision Review Panel. Other routes are APAs, the mutual agreement procedure between competent authorities, arbitration, mediation, audits and appeals to the Tax Appeal Tribunal.

Offences and penalties

Payments for intangibles to non-residents

A royalty, licence fee or technical fee to a non-resident is deductible only if it is wholly and exclusively for the business, made at arm’s length, supported by records of the agreement and the benefit received, and consistent with any treaty. A payment to a connected person that is not consistent with the Transfer Pricing Regulations is not deductible (NTA 2025).

Withholding tax applies to the payment, and thin capitalisation and anti-avoidance rules can deny the deduction.

Worked examples

1. The independent price is the arm's length price.
2. Profit is understated by 20,000 × (1,900 − 1,500) = ₦8,000,000.
3. Extra tax at 30% = ₦2,400,000.

1. Arm's length price.
   ₦400 × 145% = ₦580 a unit.
2. The cost G Ltd can deduct.
   10,000 × 580 = ₦5,800,000, not ₦7,000,000.
3. The ₦1,200,000 excess is disallowed, which adds ₦360,000 of tax at 30%.

1. Arm's length purchase price.
   1,200 × (1 − 25%) = ₦900.
2. The ₦800 charged is ₦100 a unit too low, so the supplier's profit is understated by ₦100 a unit.

1. Arm's length profit.
   8% × 2,000 = ₦160m.
2. Adjustment = 160 − 60 = ₦100m.
3. Extra tax at 30% = ₦30m.

1. 1% × 2,000m = ₦20m, which is higher than ₦10m.
2. The penalty is ₦20m plus ₦10,000 for each day the failure continues.

How to score full marks

• Define the arm’s length price and the controlled transaction.
• Name the method and say why it suits the facts.
• Show the adjustment and the extra tax at 30%.
• Cite NTA ss. 191, 192 and 202 and the 2018 Regulations.
• Quote the ₦300m, 21-day, 30-day and three-year limits.
• State the penalty as the higher of ₦10m and 1%.

Common mistakes in the exam

• Treating any price agreed by the parties as acceptable.
• Using the wrong base: gross margin for resale price, mark-up on cost for cost plus, net margin for TNMM.
• Forgetting the comparability adjustments.
• Quoting an APA of five years.
• Lodging a transfer pricing objection with the Decision Review Panel directly.
• Leaving out the daily penalty of ₦10,000.

Quick revision

• Arm’s length price: what independent parties would agree.
• Five methods: CUP, resale price, cost plus, TNMM, profit split.
• ₦300m documentation threshold; 21 days to produce it.
• APA: up to three years. Objection: 30 days to the head of the Transfer Pricing Unit.
• Penalty: higher of ₦10m and 1%, plus ₦10,000 a day.
• CAMA 2020: ss. 305, 306, 308, 377(1), 378.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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