What is Transfer Pricing?

With the introduction of Corporate Tax (CT) in the UAE, the concept of Transfer Pricing (TP) has received additional focus in the published UAE Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“UAE Corporate Tax Law”). For many locally owned businesses, this concept may be new, resulting in several questions and Transfer Pricing implementation considerations.  In this blog, Transfer Pricing and its considerations in the UAE will be discussed to provide further insights to businesses.

The standard definition of transfer pricing is most frequently understood as:

“The prices of goods and services sold or purchased between the entities with associated parties”.

Where a related party is an individual or entity that has a pre-existing relationship with a business through ownership, control, or kinship (in the case of natural persons).

Naturally related party transactions can provide scope for entities to artificially profit shift, therefore an emphasis on Transfer Pricing is naturally detailed with the UAE Corporate Tax introduction. The international tax justice network defines it as “a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens”.^[1]

Both definitions explain the notion of transfer pricing. However, it is useful to take one step back and supplement the definition. One should add that Transfer Pricing is

1. anti-abusive tax legislation developed to apply the “arm’s length” principle;
2. this states that the prices of goods and services charged between the associated parties should be the same as they would have been, had the parties to the transaction not been related to each other.

UAE Corporate Tax Law^[1] defines that “a transaction or arrangement between Related Parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realized if Persons who were not Related Parties had engaged in a similar transaction or arrangement under similar circumstances”.

The purpose of the arm’s length principle and the transfer pricing (“TP”) rules ensure that there is no transfer mispricing, because of abusive TP practices, where transfer prices are intentionally manipulated to achieve certain tax outcomes that benefit a group of associated entities.

Transfer Pricing is of critical importance for corporate tax purposes. Transfer prices directly affect the allocation of profits and losses to companies subject to corporate tax. Critically TP practices of taxpayers can therefore have a direct impact on a country’s tax revenue.

Where the corporate tax rates of the countries involved differ significantly, associated parties may have the incentive to determine their transfer prices in a way that allocates profits to the lower tax jurisdiction, reducing the overall (group) worldwide corporate tax liability. Even if a country has a low tax rate, in the absence of Transfer Pricing legislation, transfer mispricing may result in significant tax revenues being lost.

For example:

Company A, a tax resident in Bangladesh, that manufactures personal computers and electronic devices, where the corporate tax rate is 32.5% sells the manufactured products to its UAE Tax Resident-related entity Company B which pays 0% or 9% corporate tax for resale in UAE/third markets.

In this scenario, Company A would be motivated to sell the product at cost or with a low-profit margin to Company B, while Company B would be motivated to resell the product at the maximum possible margin and capture the higher share of profits so that both entities combined pay corporate tax at a minimal effective tax rate.    

Tax authorities of Bangladesh would be motivated to audit and adjust the corporate tax paid by Company A, therefore taxing a large part of the profits taxed in the UAE. If Company B paid corporate tax in the UAE, Company B would be interested in reducing the tax already paid in the UAE to eliminate and reduce the so-called “economic double taxation” through the corresponding Transfer Pricing adjustment. This is why countries with a corporate tax regime, in principle, should develop transfer pricing legislation and develop an administrative capacity to handle the adjustment requests.

Furthermore, since Accounting, legal, and corporate tax regulations and practices differ from country to country, it is of utmost importance to align to the Transfer Pricing legislation so that the corresponding TP adjustments follow at least the same principles and Transfer Pricing methodology.

Will It Impact A UAE-Based Business?

The short answer is Yes. UAE Corporate Tax Law specifies that UAE businesses qualifying related party transactions and transactions with connected persons (“intercompany transactions”) will need to comply with Transfer Pricing rules and documentation requirements with the envisaged disclosure form to be submitted with the Tax Return, while the master file and the local file need to be maintained and sent to the Tax Authorities upon request.

Furthermore, it is important to point out that both cross-border and domestic transactions and arrangements between Related Parties (including transactions undertaken by Free Zone entities) need to adhere to the arm’s length standard.

Who are the Related Parties?

According to the UAE Corporate Tax Law,^[1] a qualified related party is any of the following as:

• Two or more natural persons who are related within the fourth degree of kinship or affiliation, including by way of adoption or guardianship.
• A natural person and a juridical person where:
  • the natural person or one or more Related Parties of the natural person are shareholders in the juridical person, and the natural person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in the juridical person; or
  • the natural person, alone or together with its Related Parties, directly or indirectly Controls the juridical person.
• Two or more juridical persons where:
  • one juridical person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in the other juridical person;
  • one juridical person, alone or together with its Related Parties, directly or indirectly Controls the other juridical person; or
  • any Person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in or Controls such two or more juridical persons;
• A Person and its Permanent Establishment or Foreign Permanent Establishment.
• Two or more Persons that are partners in the same Unincorporated Partnership.
• A Person who is the trustee, founder, settlor, or beneficiary of a trust or foundation, and its Related Parties.

Furthermore, the UAE Corporate Tax Law defines “Control” as the ability of a Person, whether in their own right or by agreement or otherwise to influence another Person, including 

• The ability to exercise 50% (fifty percent) or more of the voting rights of another Person.
• The ability to determine the composition of 50% (fifty percent) or more of the Board of directors of another Person.
• The ability to receive 50% (fifty percent) or more of the profits of another Person.

The ability to determine, or exercise significant influence over, the conduct of the Business and affairs of another Person.

Who Are Connected Persons?

In the absence of personal income taxation in the UAE, individual owners of taxable businesses would be incentivized to erode the UAE corporate tax base by making excessive payments to themselves or persons connected with them.

That is why the Corporate Tax Law prescribed that the payments or benefits provided by a business (“Taxable Person”) to its “Connected Persons” will be deductible only if the business can demonstrate that the payment or benefit is in line with the “arm’s length principle” and that such expense corresponds with the “Market Value” (where reference was made to the arm’s length principle) of the service, benefit or otherwise provided by the Connected Person and is incurred wholly and exclusively for the Taxable Person’s business.

For UAE Corporate Tax Law a Connected Person of a Taxable Person is:

• An owner of the Taxable Person (or their Related Party) – owner here means any natural person who directly or indirectly owns an ownership interest in the Taxable Person or Controls such Taxable Person.
• A director or officer of the Taxable Person (or their Related Party),
• Where the Taxable Person is a partner in an Unincorporated Partnership, a Connected Person is any other partner in that same Unincorporated Partnership and any Person that is a Related Party of that partner.

However, the exception to the Connected Person rules applies if:

• A Taxable Person whose shares are traded on a Recognised Stock Exchange.
• A Taxable Person that is 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 at the suggestion of the Minister.

Extension to exempt entities

UAE Corporate Tax Law extends the application of the Transfer Pricing rules to situations when a Government Entity and a Government Controlled Entity conduct a Business or Business Activity, the transactions between the Business Activity and the exempted activities will be treated as intercompany transactions, and the arm’s length principle should be applied to determine the Taxable Income relating to the Business Activity.

Furthermore, the same will be applied to the transactions between the Extractive Business/Non-Extractive Natural Resource Business and any other Business of a Person as these will be considered Related Party transactions as well.

What Are The Compliance Obligations?

Transfer Pricing rules typically transfer the onus probandi (burden of proof) to the taxpayer. It is the duty of a taxpayer having intercompany transactions with a value above a certain threshold, during the relevant tax period to prepare Transfer Pricing documentation and prove that its intercompany transactions were performed at “arm’s length”.

UAE Corporate Tax Law specifies that Transfer Pricing documentation requirements could be consisted of :

• a disclosure form along with the Tax Return, containing information regarding the transactions and arrangements with Related Parties and Connected Persons;
• a Transfer Pricing master file and Transfer Pricing local file that must be maintained and that should be submitted within 30 days upon request of the Tax Authority.
• The Authority may also require any Taxable Person to submit (within 30 days) any information supporting the arm’s length nature of the transactions and arrangements with Related Parties and Connected Persons.

The threshold/exemption conditions have not yet been set and are likely to be mentioned under a separate decision of the Minister.

Furthermore, the above Transfer Pricing documentation requirements will not apply to a Taxable Person that would be eligible for Small Business Relief.    

Also, the arm’s length nature of the intercompany transactions will need to be supported using one of the internationally recognized Transfer Pricing methods, or a different method where the business can demonstrate that the specified methods cannot be reasonably applied.

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