UAE Corporate Tax: Companies need to keep close check on expenses in new regime

As the corporate tax is calculated on net taxable income (i.e., revenue less expenses), the UAE entities are up for a detailed scrutiny about their expenses. Until now, expenses were not of a significant concern simply because the UAE entities were not taxed.

With UAE being home to multinational corporations (MNCs), the scrutiny of intra-group services will also entail a ‘transfer pricing analysis’ to pre-empt profits shifting from the UAE to other jurisdictions.

Two-fold test

The transfer pricing analysis is not just about benchmarking the adequacy of the expense quantum. Both the OECD Transfer Pricing guidelines and the UN’s transfer pricing guidelines have proposed a two-fold test to establish the arm’s length nature of intra-group services.

The first test requires determining if a service has been rendered. It requires to determine if the intra-group services:

a) provide the UAE entities with economic and commercial benefit (‘Benefits Test’);

b) are not services that the UAE entity is already performing for itself (‘Duplicate service test’); and

c) are not shareholder services

If the first test is satisfied - i.e., the intra-group service has indeed been rendered - the second test requires to determine if the charge for such service is at arm’s length by ensuring:

a) that the cost base is appropriate to the services;

b) that the mark-up is arm’s length; and

c) that the allocation keys commensurate with the services

Failure of first test could result in disallowance or a reduction of the expenses towards intra-group services.

Benefits Test

The benefit test must demonstrate that the intra-group services have provided economic or commercial value to the UAE entity. However, the services may or may not give any immediate value to the UAE entity.

For example, a shared-services department may supply accounting services to group companies, which provide an immediate benefit to the group companies. A recharge of centralised R&D costs may not bring any immediate benefit to the group companies but will still pass the benefits test.

It Is also required to demonstrate that the intra-group services have not been forced on the UAE subsidiary. In other words, an independent entity in similar circumstances would have paid for such services. The intra-group services could be in the nature of common centralised services, or a specific service provided to a particular group company alone.

Duplicate Service Test

The intra-group services received by a UAE entity could be treated as a duplication of service if IT has already incurred costs for the same activity. However, the duplication test is subjective and needs to be tested meticulously.

For example, a UAE entity engages a local law firm to counter an IPR infringement and incurs the necessary legal costs. At the same time, the UAE entity takes a second opinion from the corporate group’s legal counsel on the same issue. In such a case, there is no duplication as obtaining a second legal opinion is usual justified measure.

Duplication may not also arise even if the intra-group service has the same name as those performed by the UAE entity, e.g., marketing activities. the strategic marketing functions such as branding, corporate websites etc. may be performed by the parent company and charged to its group companies.

The local subsidiaries may also simultaneously perform marketing functions such as marketing analysis, participation in exhibitions etc. As the nature of intra-group marketing services are different, it should not be treated as a duplication of services.

Shareholder services

When a parent company charges a cost to its UAE subsidiary, it is important to discern whether the parent company has performed a role of a service provider, or has merely transferred costs of shareholder’s services. The latter is not available as an expense deduction.

If a parent company chooses to supervise its investments in a UAE subsidiary by deputing an employee, the cost of the deputed employee cannot be charged to the subsidiary. Similarly, the costs of a supervisory board to supervise and protect global investments cannot be claimed as an expense of intra-group services.

Road ahead

The intra-group services can no longer be claimed as an expense under an umbrella description such as ‘management fee’. It will also not be sufficient to prove that the expense is at arm’s length in terms of its value. UAE-based entities will be required to demonstrate that the intra-group services inter-alia meet the benefits test and duplication tests.