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In our last publication, we discussed the need for Fintech Multinational Entities (MNEs) to take proactive steps in the design and implementation of their IP Transfer Pricing policy, in respect of its ownership, location, structure, valuation and other considerations.
Considering the fact that IPs are mobile and incorporeal assets, they provide veritable opportunities for legitimate MNE tax planning, which should ordinarily be backed-up by supportable underlying commercial substance. However, this is often not the case for most MNEs.
The treatment of IPs remains particularly challenging for most MNEs and relevant tax authorities around the world, principally because:
It is often the case that IPs are reported as assets in a jurisdictions different from where they were actually developed
For instance, in our last publication, we examined two ownership concepts in respect to the development and ownership of IP. We examined a scenario where post-Merger and Acquisition (M&A), a Parent Company can legally own both existing and any future IPs developed by a Fintech Company. The IP may then be licenced back to the Fintech Company for use. See our publication: “Post-Acquisition treatment of Intellectual Property”
It is also possible for the substantial income related to an IP to be subject to tax in a jurisdiction different from where they were generated.
For instance, a Fintech Company may not be entitled to the substantial portion of the income generated from the exploitation of IP, if it only has a so-called “Contract R&D (Research and Development) or “limited risk” arrangement with its Related Party (RP). This means, even though it performs the DEMPE functions (Development, Enhancement, Maintenance, Protection and Exploitation) related to the IP, it may not be entitled to substantial returns. This is because, the RP that funds the activities and bears the risk of negative outcome is deemed to be entitled to the substantial income from the commercialisation, while the Fintech Company will only be entitled to the recovery of its costs and a basic return.
Finally, it is also possible to claim R&D costs in a jurisdiction different from where they were incurred.
For instance, under the Contract R&D arrangement mentioned earlier, the Fintech Company will typically not be allowed to claim any of the R&D cost incurred in its jurisdiction, as they were incurred for and in the name of its Principal who typically resides in a different jurisdiction. However, such Fintech Company will seek cost reimbursement from its RP who can make the claim in its own tax jurisdiction.
In summary, there is a need for an understanding, as well as appropriate delineation of the fact and circumstances of the Fintech Company IP arrangement and the choice of contractual model adopted by the MNE.
Transfer Pricing Risks
We mentioned in our last publication that there is the requirement for the Parent Company to show that it made active contributions towards the creation of the IP in terms of functions performed, risk assumed, and assets used in performing the DEMPE of intangibles activities so as to be entitled to the residual income from the exploitation of the IP.
In practice, there have been instances that tax authorities have reviewed the credentials and experience of the core team members (for instance, Engineers and Analysts), in determining whether the DEMPE functions have been conducted by that entity. This may include an evaluation of the core team’s specific duties and responsibilities, record of their activities (e.g., through timesheet, mail exchange and the like). In some instances, the tax authorities may further review details of their employment contract to establish their residency status, their actual employer, especially with the advent of internationally mobile employees and remote workers.
Similarly, evidential requirement is usually required to ascertain the entity within the MNE that bears and controls the risk, as well as, the entity that provides funding or payment guarantee.
Where there is a contract R&D arrangement, the Company may be required to show that the outsourced functions were carried out under the management and control of the Parent Company, in accordance with the Nigerian Transfer Pricing Regulation (NTPR).
In essence, the Tax authority will seek to verify whether the conduct of the parties aligns with their Inter-company contracts. Besides, as the burden of proof is on the Taxpayer, there is the risk that failure to meet the evidentiary requirements of the NTPR may lead to the Federal Inland Revenue Service (FIRS) disregarding the inter-company contracts, re-characterising the arrangement, and imposing adverse TP adjustments.
TP analysis is fact-intensive exercise. Inadequate tax planning or Reactive tax management approach may negatively impact the MNE’s overall effective tax rate. It may also lead to missed planning opportunities and potentially results in conflicts with tax authorities of multiple jurisdictions.
Also, it is essential that the Government review its policy towards Fintech Companies, as their ubiquitous nature allows them to easily exit a jurisdiction that offers unfavourable policies. In the words of Thomas Jefferson: “Merchants have no country. The mere spot they stand on does not constitute so strong an attachment as that from which they draw their gains.”
Hence, like many other countries, the Nigerian Government needs to create an enabling environment for Fintech Companies by enacting more progressive tax and regulatory legislations. This would spur the growth of the local Fintech ecosystem by encouraging innovation and attracting the requisite funding to the Sector.
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