Transfer pricing compliance appears to be an enigma for many business owners.
It refers to the pricing of transactions between ‘related parties’ or ‘connected persons’. There is a presumption that the relationship between such parties could influence the transaction value and thus obtain a tax advantage.
The tax advantage for international transactions is generally the tax rate arbitrage between two different jurisdictions. Even where both parties are located in the UAE and subject to UAE corporate tax laws, the tax advantage could still be obtained in varied scenarios.
One of the transacting parties could be exempt from tax, enjoying the preferential tax rate of 0 per cent as a qualifying free zone person, enjoy Small Business Relief, or not have taxable income above the Dh375,000 threshold.
To demonstrate the relationship has not unduly influenced the transaction, the transfer price should be at ‘arm’s length’. As per Federal Tax Authority’s (FTA) guide, the arm’s length principle requires that the related-party transactions should be at a price which two independent parties would have agreed in similar circumstances.
Transfer pricing compliance has two elements:
- Ensuring the transactions are at arm’s length.
- Maintaining transfer pricing documentation to demonstrate compliance with the arm’s length principle.
Transfer pricing documentation
Among the five main transfer pricing documentation, the important three are:
- ‘Transfer Pricing disclosure form’ detailing the transactions with related parties/connecter person. It would be mandatory to submit this along with the annual tax return for related-party transactions above a materiality threshold.
- ‘Master File’ providing a high-level overview of the corporate group’s business and allocation of income and economic activity among group companies.
- ‘Local File’ detailing information on operations of the UAE entity or entities, and demonstrating that the transactions with related parties are at arm’s length.
Maintaining a master file and a local file is mandatory for two categories of taxpayers namely; (i) taxpayers that are a part of a multinational group having consolidated group revenue of Dh3.15 billion or above, and (ii) taxpayers having an annual revenue of at least Dh200 million.
Exceptions and compliance costs
The ministerial decision provides that a local file should include transactions between two UAE-based related parties if they are subject to different corporate tax rates. For example, one company is taxable at 9 per cent and another is eligible for preferential 0 per cent tax rate for free zones.
As a corollary, the local file need not include transactions between two UAE-based related parties if both are subject to same tax rate. Many corporate groups have UAE companies all of whom are taxable at 9 per cent.
Such groups are struggling to figure out if they have to ensure that the related party transactions are at arm’s length even if there is no obligation to include such transactions in the local file. If yes, how would the company demonstrate in the future that the transactions were at arm’s length in absence of a local file?
Let us take a scenario where two UAE based group companies are not only subject to same tax rate say, 9 per cent, but also liable to pay tax – that is having taxable income above the Dh375,000 threshold without availing any other tax relief.
In such a scenario, there is no risk of obtaining undue tax advantage and determining the arm’s length price may not result in any additional tax payments for the corporate group. However, the group would have to spend significant costs and time for benchmarking analysis and determining the arm’s length prices for each transaction category.
Under UAE VAT laws, transactions between related parties are automatically acceptable as at arm's length (i.e., at market value) if the recipient company is eligible to recover 100 per cent input credit on the same. Such a beneficial provision has helped companies in saving costs and time otherwise required for determining arm’s length price for a sizeable portion of inter-company transactions.
The business community would significantly benefit if a similar provision could be provided for UAE corporate tax. Companies should evaluate the exact requirements for benchmarking analysis before committing themselves to significant costs of transfer pricing compliance.