There are instances when a company sells its products to another company in the same group. This is simple if taken with a layman’s perspective; however, there are tax consequences when there is an internal transfer of products. The transfer pricing rules come into play in these scenarios. It is very common within a multinational conglomerate to sell products from one company to another within the group. In the UAE, the primary guideline is available in the Federal Decree-Law No. 47 of 2022. In this blog, we are discussing the transfer pricing essentials for UAE multinationals.
What is Transfer Pricing?
The OECD provides a comprehensive guide on transfer pricing. The primary responsibility of the OECD in this case is to eliminate double taxation through the arm’s length principle. The guidelines provide a framework for pricing related-party transactions. This, in turn, will prevent tax disputes and promote a level playing field for tax authorities and businesses. Let’s understand the concept in basic terms.
Transfer pricing is a business practice that involves setting prices for goods or services exchanged between related parties. For instance, if a company buys material from another group company, what will be the price of the raw material? The primary goal of transfer pricing is to set prices that fairly allocate profits among the group companies. Furthermore, the transfer pricing policy must also comply with the tax regulations and other laws of the country. The basis of transfer pricing is the arm’s length principle. According to this principle, the prices for transactions between the related parties should be similar to what would be charged to unrelated parties. In simple words, transfer prices should be fair and as on the open market.
Transfer Pricing Essentials under UAE Corporate Tax Law
Article 34 of the corporate tax law provides comprehensive information on transfer pricing essentials and the arm’s length principle. Let’s discuss it in detail below.
Arm’s Length Principle
In determining the taxable income of a taxable person, all transactions between related parties must meet the arm’s length principle and any further conditions that may be specified by the Authority. A transaction or an arrangement meets the arm’s length principle if the result of the transaction with the related party is similar to what would have been the result with the unrelated party under the same circumstances.
Transfer Pricing Methods
Various transfer pricing methods can be used (any one or combination) to determine the arm’s length status of a transaction or an arrangement. The transfer pricing methods are:
a) The comparable uncontrolled price method
b) The resale price method
c) The cost-plus method
d) The transactional net margin method
e) The transactional profit split method
The taxable person may use any other method than the ones above if they can demonstrate that any other transfer pricing method satisfies the arm’s length principle and none of the above methods can be reasonably applied. The transfer pricing method should be the most reliable. The transfer pricing method must take into account the following factors:
a) The terms specified in the contract for the transaction or arrangement
b) The attributes and features of the transaction or arrangement.
c) The economic conditions under which the transaction or arrangement takes place.
d) The roles executed, resources used, and risks carried by the related parties involved in the transaction or arrangement.
e) The business approaches and tactics pursued by the related parties participating in the transaction or arrangement.
Role of the Tax Authority in Transfer Pricing Application
It is worth noting that different transfer pricing methods will result in different acceptable financial outcomes. However, it is subject to any specific terms set by the authority in its decision. Furthermore, if the result of a transaction does not fall within the arm’s length range, the authority will adjust the taxable income as per the arm’s length range. However, this modification should reflect the truth, fairness, and circumstances of the transaction.
When the authority makes changes to the taxable income, it must use information that the taxable person either already has or will have in the future. If the authority or a taxable person modifies the taxable income for a transaction or arrangement to ensure it aligns with the arm’s length standard, the authority shall also adjust the taxable income of the corresponding related party in that specific transaction or arrangement accordingly. If there is an adjustment to a transaction by a foreign authority to meet the arm’s length standard, the taxable person may make an application to the authority to modify their taxable income accordingly.
Transfer Pricing Documentation for UAE Multinationals
One of the transfer pricing essentials is to maintain documentation set out in the relevant laws. Article 55 of the tax law and Ministerial Decision No. 97 of 2023 provide comprehensive guidance on the document requirements for a taxable person transacting with related parties. The primary reason for this documentation is to comply with the relevant laws and satisfy the arm’s length principle. There are 5 types of documentation depending on the size of the business; most of these apply to large multinationals.
- Transfer pricing disclosure form: It covers details of the controlled transactions during a tax period.
- Master File: It provides a high-level overview of the group’s business and the allocation of income and economic activity within the group.
- Local File: It provides detailed information on operations of the local entity and analysis and testing of the outcomes of the controlled transactions against the arm’s length principle.
- Country-by-Country Report (CbCR): It provides jurisdictional quantitative information about an MNE Group. Furthermore, it also provides an overview of the different activities conducted by affiliates of an MNE Group.
- Additional supporting information upon request of the FTA.
Please note that a master file and local file are required from businesses that are part of an MNE group with consolidated revenue over 3.15 billion AED or where the revenue exceeds 200 million AED. CbCR also only applies to businesses that are part of an MNE Group with consolidated revenue over 3.15 billion AED.
Final Words
One of the crucial areas for UAE multinationals is to handle related party transactions and account for them as per relevant laws. However, it is not as easy as we say. Transfer pricing is a complex area, and it may have a substantial impact on a company’s financial performance and taxes. It requires careful preparation, documentation, and agreement with local and worldwide regulations to avoid legal and economic risks. The core of transfer pricing essentials is the understanding of the arm’s length principle. The transactions involving related parties must follow this principle and other guidelines as per the relevant laws and regulations. Therefore, businesses must make arrangements to adhere to related-party regulations, thus avoiding non-compliance.
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