Aspects of Transfer Pricing in UAE

The UAE's Ministry of Finance made a groundbreaking announcement of implementing Corporate Tax (CT) in the region. On 9 December 2022, the UAE Federal Tax Authority (FTA) released the final version of the UAE CT law through Federal Decree Law No. 47 of 2022. This includes a comprehensive Transfer Pricing (TP) regime modeled along the lines of The Organisation for Economic Co-operation and Development (OECD). The UAE has undertaken this action in its attempts to adhere to the global standards and to align with OECD's Global Minimum Tax Proposal under Pillar 2.

Scope and Applicability

The TP law would apply to entities both in the UAE Mainland as well as the Free Zones. The effective date of the TP regime is the same as the CT law, i.e., the financial years starting on or after 1 June 2023.

Article 34 – Arm's Length Principle

All related party transactions/ arrangements must meet the arm's length standard in determining the taxable income as enumerated in Article 34.

TP Benchmarking Methodology

In order to determine the Arm's Length Price (ALP), taxpayers can apply the following acceptable TP method:

  • Comparable Uncontrolled Price (CUP) Method
  • Resale Price Method
  • Cost-Plus Method
  • Transactional Net Margin Method (TNMM)
  • Transactional Profit Split Method (PSM)

This concept of the arm's length principle is predominantly in line with the OECD TP guidelines, which recommends transactions between unrelated parties as a measure of the arm's length standard.

There is no prescribed methodology or any preference for the order in which the methods might be applied. One or a combination of the above methods or any other method not listed above can be used to determine the ALP depending on the facts & circumstances of each transaction or arrangement (T/A).

In addition to the above, while selecting the most reliable TP method, the following parameters must be considered:

  • Contractual terms and characteristics of the T/A;
  • Economic circumstances in which the T/A is conducted;
  • Functions performed, assets employed, risks assumed (FAR) and business strategies employed by the Related Parties entering into the T/A.

Arm's Length Range is not defined as yet

An acceptable ALP may be a range of results or indicators (rather than an absolute number). While the concept of ALP has been introduced, the arm's length range has not been specified (i.e., the use of inter-quartile range, percentile, minimum to maximum, etc.)

Corresponding Adjustment is possible

In a scenario where the pricing in relation to the transaction or arrangement does not fall within the arm's length range, the Authorities can make a TP adjustment on the taxable income to achieve the arm's length result.

TP Benchmarking Methodology

In order to determine the Arm's Length Price (ALP), taxpayers can apply the following acceptable TP method:

  • If the T/A does not fall within the ALP range, then the FTA may adjust the taxable income to reach ALP. Also, the FTA shall make a corresponding adjustment to the taxable income of the affected related party.
  • The ALP principle also applies to transactions that are entered between taxable business and other activities of a government entity or government-controlled entity or, an extractive business of the same person, or a non-extractive natural resource business of the same person.

Article 35 – Related Party and Control

The definition of related parties is broadly in line with the OECD TP guidelines and includes the following (exhaustive list):

  • Two individuals when they are related.
  • An individual and company would be regarded as related parties where the said individual, either alone or jointly with relatives, directly or indirectly are:
    • shareholders in a company with 50% or greater ownership;
    • 'controls' the company.
  • Similarly, two companies would be regarded as related parties where one company, alone or together with its related parties, directly or indirectly:
    • owns 50% or greater ownership interest in the other company;
    • controls the other company;
    • is controlled by a company that also controls the other company (Common Control).
  • Partners in the same unincorporated partnership.
  • Trustee, founder, settlor or beneficiary of a trust or foundation, and its related parties.
  • Furthermore, the Decree-Law has given a brief understanding with respect to the term 'Control,' which inter-alia includes the ability to:
    • exercise at least 50% of the voting rights.
    • determine the composition of the majority of the Board of Directors.
    • receive at least 50% of the profits.
    • determine or exercise significant influence over the conduct of the business and affairs.

Article 36 – Payments to Connected Persons

Any payment or benefit a taxable person provides to its connected person shall be deductible only if the payment corresponds with the market value or is incurred wholly and exclusively for the taxpayer's business.

  • A connected person includes:
    • Owner of the taxable person or owner's related party.
    • Director/Officer of the taxable person or Director's related party.
  • The above-mentioned conditions on deductibility do not apply in the event that the payment or benefit is provided by any of the following:
    • taxable person whose shares are traded on a Recognized Stock Exchange.
    • taxable person subject to the regulatory oversight of a competent authority in the State.
    • any other person as may be determined in a decision issued by the Cabinet.

Article 55 – Transfer Pricing Documentation

The following TP Documentation (TPD) requirements for taxable persons are as follows:

  • Compliance Requirements: The taxable person is required to file a disclosure form that encapsulates details of T/A with related parties and connected persons along with their tax return.
  • Maintaining the Master File and local file is applicable if either of the following conditions are met:
    • a total consolidated group Revenue of AED 3.150 Billion or more in the relevant tax period; or
    • taxable person's revenue in the relevant tax period is AED 200 million or more.
  • The documentation as mentioned above must be submitted to the Authorities within thirty days following a request by the Authorities, or by any such other later date as directed by the Authorities.
  • The UAE also recently introduced Country-by-Country Reporting (CbCR) rules for multinational group of enterprises (MNE), which are in accordance with the OECD Model Legislation. The UAE CbCR rules shall apply to MNE groups:
    • with consolidated revenues of at least AED 3.15 billion in the FY immediately preceding the reporting period, based on the consolidated financial statements of that preceding year (i.e., FY18); and
    • if the ultimate parent entity (UPE) of the MNE group is resident in the UAE; or
    • if a UAE-resident Constituent Entity (CE) of the MNE group (with its UPE outside the UAE) is nominated as the APE; or
    • if the MNE group has a UAEresident CE, which is neither the UPE or an APE.
  • Furthermore, the CbCR Notification must be submitted by the last day of the financial year (Except for those constituent entities of UAE who are members of a foreign-headquartered MNE), and CbCR report must be submitted within twelve months from the end of the financial year.

Administrative Provisions

  • Article 56 - Record Keeping: Books of accounts and all other records and documents are required to be maintained by taxable persons for at least a period of seven years. This requirement also applies to exempt persons.
  • Article 57 - Tax Period: A tax period shall generally be the Gregorian calendar year (January to December) or any 12-month period.
  • Article 59 - Clarifications: a person can make an application to the Authority to obtain a clarification on the application of the CT Law or to enter into an advance pricing agreement with respect to a T/A proposed or entered into by the person. The form and manner of the application is to be prescribed by the Authority.
  • Article 61 - Transitional Rule: The opening balance sheet referred to in Clause 1 of this Article shall be prepared, taking into consideration the arm's length principle in accordance with Article 34 of the Decree-Law.
  • Fines and penalties shall be prescribed for contravention under the law.

Our Comments

The introduction of TP in the CT law would significantly impact businesses in the region. The companies that are not familiar with such compliances would need to gear up and start evaluating the implications, including the following:

  • Examining the group shareholding structure in light of the requirement of Article 35 of the Decree.
  • Analyzing terms of existing intra-group transactions/ arrangements and checking if any changes are required to align with the arm's length standard.
  • Analyzing how provisions related to a payment to connected persons could potentially impact the company.
  • Alignment of existing TP policies and documentation with the newly introduced TP rules.
  • Whether the free zone companies are meeting the arm's length criteria to be treated as a qualifying free zone company.

Furthermore, with respect to noncompliance with TPD requirements or non-submission of such information, no specific penalties have yet been prescribed or set out in law.

Considering the timeframe left to prepare for implementing TP rules, companies should start assessing the above impact on their business.

Tax Street July 2023