Effects Of Transfer Pricing Under The New Corporate Tax Law In UAE
- September 28, 2023
- Posted by: admin
- Category: Corporate Income Tax
The United Arab Emirates has implemented transfer pricing regulations as a component of its newly enacted corporate tax law, (Federal Decree-Law No. 47 of 2022) which came into force on June 1, 2023. The transfer pricing regulations outlined in the tax decree-law establish a structure aimed to ensure that transactions involving related parties or payments to individuals associated with the business are conducted at ‘open market’ value or “arm’s length” value. These rules specify the approved methodologies for determining and confirming the use of an “arm’s length” valuation and outline the necessary compliance obligations. These regulations are in close accordance with the transfer pricing guidelines set forth by the OECD. In this guide, you’ll understand transfer pricing under the Corporate tax in UAE.
What is Transfer Pricing?
“Transfer pricing” refers to the internal accounting process in which regulations and techniques used to determine the pricing of transactions occurring within and between businesses that share common ownership or control.
Transfer Pricing can be best described with example:
Suppose one division of a company specializes in product design, while another division specializes in assembling the final product. In this scenario, the design division can sell its designs to the assembly division or any other external company.
Typically, the design division would sell its designs to the assembly division at a standard market price. However, there’s also the option for the design division to offer its products to the assembly division at a reduced price.
While this approach might result in decreased revenue for the design division, it can lead to higher profits for the assembly division due to the more competitive pricing of their products. The revenue lost by one division would thus be offset by the increased sales of the other division, ensuring that the company as a whole remains financially unaffected.
When these fundamental principles are employed within a tax context, the significance of “Transfer Pricing” for a company becomes clear. While the revenue loss on one side can be offset by increased sales on the other side, when income is subject to taxation in different countries, it can have a substantial impact on a company’s net income. This impact arises from the strategy of shifting the loss of income to the high-taxation country and the surplus of income to the low-taxation country.
Related Parties and Connected Persons
A related party is an individual or entity that has an existing connection with a business, falling under the purview of the UAE CT regime due to factors like ownership, control, or kinship (in the case of natural persons).
An individual and a legal entity, where the individual alone or together with a related party, holds a direct or indirect ownership stake of 50% or more in, or exercises control over, the legal entity.
Two or more legal entities, where one of the legal entities, either individually or together with a related party, holds a direct or indirect ownership stake of 50% or more in, or exercises control over, the other legal entity.
Two or more legal entities, in which a taxpayer, either individually or together with a related party, holds a direct or indirect 50% ownership share of each or exercises control over them.
Kinship (Natural Persons)
Two or more individuals related to the 4th degree of kinship or affiliation, including by birth, marriage, adoption or guardianship
The Arm’s Length Principle
The cornerstone of transfer pricing regulations in the UAE is the Arm’s Length Principle. This principle requires that transactions between related parties should be priced as if they were negotiated between unrelated parties in an open market. In other words, the prices set for goods, services, or intellectual property should be fair and reasonable, preventing the unnecessary shifting of profits. To ensure this, UAE law defines several transfer pricing methods.
- The comparable uncontrolled price method
- The resale price method
- The cost-plus method
- The transactional net margin method
- The transactional profit split method
These methods should be employed. However, alternative methods may be utilized if it can be demonstrated that none of the aforementioned methods are applicable, while also taking into account the provisions outlined in section 34 (5) of Federal Decree-Law No. 47 of 2022.
UAE Transfer Pricing Rules
The UAE Federal Tax Authority released Federal Decree-Law No. 47 of 2022 (Taxation of Corporations and Businesses) on December 9, 2022. The ensuing articles in this Decree-Law establish the regulations governing transfer pricing in the UAE.
Article 34 – Arm’s Length Principle
This article outlines the arm’s length standard, which necessitates that the outcomes of transactions between related parties must resemble those between independent parties.
Article 35 – Related Parties And Controls
This article provides a definition of related parties and discusses the in-depth analysis of various transactions conducted with related parties.
Article 36 – Payment To Connected Persons
This article specifies that payments to affiliated parties are tax-deductible only when:
- The transactions are conducted at arm’s length.
- The transactions occur at market value.
Article 55 – Transfer Pricing Documentation
Taxable individuals (with a turnover exceeding AED 200 million and being a part of an MNE group entity) are required to maintain transfer pricing documentation, including a Local file and Master file, and submit a disclosure form.
If the Authority requests any information to support the arm’s length range, it must be provided within 30 days of the request.
The Execution Of Transfer Pricing Regulations
The TP regulations are relevant to all taxable individuals in the UAE, including Free Zone entities engaged in intra-company trading. Consequently, there are certain compliance standards that must be met:
Along with the annual tax return for the fiscal year, a “Transfer Pricing Disclosure Form” wil have to be filled out.
- Details of Related Parties/ Connected Persons
- Details of Related Party Transactions (Nature, Volumes etc.)
- Brief Transfer Pricing Analysis
Local Country File
In addition to that, the taxable person will also have to maintain a so called “ Master File” as well as a “Local Country File”.
- Details of Related Party Transactions and Payment to Connected Persons
- Group Overview
- Industry Overview
- Functional, Assets and Risk Analysis (FAR) Economic Analysis/TP Benchmarking Analysis Conclusion on Arm’s Length Analysis
- Organizational Structure
- Description of MNE group’s businesses MNE group’s intangibles
- MNE Group’s intercompany financial activities
- MNE group’s financial and tax positions
Country by Country Report
Country by Country Report (CbCR) holds significance for multinational groups as it addresses cross-border business activities and legal evaluations in other countries.
Advanced Pricing Agreements
Advanced Pricing Agreements (APAs) are bilateral agreements between one or more taxpayers and one or more tax authorities. These agreements establish “Transfer Pricing” procedures in advance and are employed to prevent conflicts with the respective tax authority.
Taxpayers should keep in mind that failure to comply or cooperate is likely to result in penalties.
Transfer Pricing Reporting And Recordkeeping
The decree-law offers a comprehensive overview of the transfer pricing documentation that taxpayers might need to maintain. A Cabinet Decision will be issued in the future to specify which taxpayers will be subject to these documentation and reporting requirements.
The documentation list outlined in the decree-law comprises a master file and a local file, both of which align with standard OECD documents. The decree-law stipulates that these documents should be preserved in a format determined by the FTA, although it is anticipated that the format will closely resemble, if not mirror, the requirements set forth in the OECD guidelines.
These documents do not need to be included in the standard reporting process to the FTA. However, the FTA retains the authority to request them at its discretion. In the event of such a request, the taxpayer must provide the files within a 30-day timeframe.
Apart from the obligation to maintain a master file and a local file, the decree-law also mentions the potential issuance of a notice or decision that could mandate a taxpayer to submit a transfer pricing disclosure when filing their tax return. Currently, there is no indication as to whether such a notice or decision will be issued, and if so, whether it will apply universally or selectively to specific taxpayers.
Challenges of Transfer Pricing Regulations in the UAE
The implementation of transfer pricing regulations presents a fresh challenge for taxpayers in the UAE. It constitutes a vital element of the new tax framework and will have an impact on a broad spectrum of UAE-based enterprises. Any business engaged in transactions with group companies, whether domestically or internationally, and any owner or director receiving payments on behalf of the business, must assess their ability to comply with the transfer pricing requirements.
The transfer pricing regulations are explicitly mentioned in the provisions pertaining to free zone companies. Specifically, a free zone company cannot be considered a qualifying free zone company if it fails to satisfy the transfer pricing requirements. This is an important consideration for free zone companies as they prepare for corporate tax obligations.
Consequences of Non-Compliance
Failing to meet these conditions can have significant repercussions. In the end, profits may be subject to adjustments, potentially leading to additional tax obligations. Consequently, penalties may also become applicable.
The documentation and reporting obligations will impose a substantial compliance burden on certain taxpayers, and it’s important not to underestimate these requirements. Master files and local files are intricate documents that demand careful preparation, which in turn necessitates a significant investment of time and effort. If there is an additional annual reporting mandate in conjunction with the tax return, it will also demand meticulous attention and time commitment. It’s important to note that errors or non-compliance are likely to result in the imposition of penalties once again.