Most small businesses are unaware of how to handle related party transactions. Some even consider dealing with the related parties simple and easy, without any compliance repercussions. However, grasping related parties is a topic that is important for every business as it may result in legal issues. The key here is to follow the law and avoid unnecessary penalties. The UAE corporate tax law, Federal Decree-Law No. 47 of 2022, is very clear about this matter. In this blog, we will build an understanding of related party transactions under the UAE corporate tax law.
What is a Related Party?
We have various definitions, however; we will discuss a simple explanation here. So a business transaction that takes place between two parties that have an “existing relationship” is a related-party transaction. The parties are known as related parties because they have a joint business relationship or a common interest. For instance, a shareholder who has a significant interest or shareholding in two companies may influence the prices at which each company will deal with each other. Although related-party transactions are legal, sometimes they pose a risk of conflict of interest. Therefore, without a proper check, there is a risk of fraud.
Understanding Related Party Transactions under UAE Tax Law:
Article 35 of the corporate tax law considers any of the following as related parties:
a) Two or more persons who are related up to the fourth degree of kinship. This includes persons by way of adoption as well as guardianship.
b) A natural person and a legal entity in the following conditions:
1. When there is 50% or more direct or indirect ownership of the natural person (and their related parties, if any) in the legal entity.
2. When the natural person (and their related parties, if any) controls the legal entity directly or indirectly.
c) Two or more legal entities, under the following conditions:
1. When there is 50% or more direct or indirect ownership of one legal entity (and their related parties, if any) in another legal entity.
2. When there is direct or indirect control of one legal entity (and their related parties, if any) over another legal entity.
3. A person (and their related parties, if any) owns 50% or more or controls, directly or indirectly, such two legal entities or more.
Furthermore, the following are related parties as per Article 35.
a) A person and its permanent establishment (or a foreign permanent establishment).
b) Partners of an unincorporated partnership.
c) An individual (including its related parties) who has the role of trustee, initiator, creator, or recipient within a trust or foundation.
What is Control?
As we have mentioned above, a related party may have control over the other. Control means the ability of one person to influence another person through an agreement, personal capacity, or other arrangement. This includes the following:
a) The capacity to exercise 50% or more of the voting rights of another person.
b) The capacity to define the make-up of 50% or more of the board of directors of another person.
c) The capacity to obtain 50% or more of the profit of another person.
d) The capacity to have a significant influence over the business operations and affairs of another person.
How to Handle Related Party Transactions?
The fundamental concept here is the arm’s length principle. As per Article 34 of the corporate tax law, transactions between related parties must meet the arm’s length standard. The arm’s length standard states that the result of transactions between the related parties must be the same as if the transactions had taken place between unrelated parties in the same situations. Furthermore, Article 36 dictates that any payments or benefits to connected parties by a taxable person are only deductible if they meet two conditions. First, the payment or benefit is wholly and exclusively for the business purposes of the taxable person. Second, the payment or benefit should be a fair estimate (as per the arm’s length standard) for the service received.
In summary, a clear understanding of related party transactions is essential under the UAE corporate tax. These transactions often involve complex relationships and require adherence to the arm’s length principle outlined in the tax law. Furthermore, payments to connected parties are deductible only if they serve the business’s interests exclusively and align with the arm’s length standard. This understanding is crucial for businesses to navigate related-party transactions, mitigate risks, and ensure compliance with tax laws.
Creative Zone Tax & Accounting:
Sometimes it is difficult to navigate the intricacies of the tax law, or one might not have time. As a business owner, you always need to brush up on your concepts and seek professional guidance. If you are a businessman or looking to set up one, you can contact us for our services. From setting up your business to managing your books, contact us for our curated services.