What is Transfer Pricing?
In the wake of the implementation of UAE Corporate Tax (CT) for the UAE, The idea of transfer Pricing (TP) is receiving greater attention in the Ministry of Finance (MoF) released Questions and Answers as well as the Public Consultation documents. In the case of many locally-owned companies, this idea could be completely new, leading to numerous issues and Transfer Pricing considerations for implementation. The topic of this article is transfer Pricing, as well as its implications for UAE, which will be discussed. UAE will be reviewed to provide more information to business owners.
The most common definition of transfer pricing is commonly referred to as:
“the prices of goods and services sold or purchased between the entities with associated parties.”
A related party is an entity or person with a prior relationship with a company through control, ownership, or kinship (in instances of natural people).
Naturally, related party transactions may allow entities to manipulate profit. Therefore, a strong emphasis on transfer Pricing is evident in an introduction to the UAE corporate tax introduction. The world’s tax justice network defines Transfer Pricing as “a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens.”
Both definitions explain that transfer prices are a way to make money. But it’s helpful to go back and expand the definition. One could include that Transfer Pricing means:
- A tax law to prevent abuse was enacted to enforce the “arm’s length” principle.
- It is a requirement that the price of the goods and services charged by the respective parties must be precisely the same as they would be should the parties involved in this transaction have never been connected.
The goal of the arm’s-length concept and transfer pricing (“TP”) guidelines is to ensure that there are no instances of pricing mismatch in transfers due to improper transfer Pricing methods. In which the prices of transfers are deliberately manipulated to gain certain tax advantages which benefit several related entities.
Transfer pricing is of crucial importance to corporate taxation. Transfer Pricing directly impacts the distribution of losses and profits for companies subject to corporate tax. Notably, the practices of Transfer Pricing taxpayers have an immediate impact on the tax revenues of a nation.
Suppose the tax rates for corporations of the respective countries differ significantly. In that case, the associated parties might be motivated to establish their transfer rates to allocate profits to the tax-free jurisdiction, thus reducing the total (group) global corporate tax burden. Even when a country has lower tax rates and is not governed by Transfer Pricing laws, transfer mispricing could result in substantial tax revenue being removed.
For instance:
Company A, a tax resident of Bangladesh, manufactures electronic and personal computers in a country taxed at a rate of 32.5 percent. The company sells its manufactured items to the UAE-related tax-resident business Company B, which pays 0 percent or the corporate tax rate of 9% for the resale of its products in third markets and the UAE.
In this scenario, company A will likely be driven to sell the product for price or with a lower profit cost to company B. Company B is in a position to resell the product with the highest possible margin and to take home the more significant portion of the profits, to make both companies pay corporate taxes at a lower amount.
Tax authorities in Bangladesh are likely to audit and modify the tax on corporate income paid by company A, thereby taxing a substantial portion of the profits that the UAE taxes. Suppose company B had paid taxes on corporate income in the UAE.
In that case, company B is likely to be keen to reduce the tax paid by the UAE to avoid and lessen the phenomenon known as “double economic taxation” through the transfer pricing adjustment. That’s why countries with corporate tax systems, in general, must develop transfer pricing laws and establish an administrative capacity to manage the request for adjustment.
Additionally, accounting, as well as legal and corporate tax laws and practices, vary from one country to the next and from country to country. It is essential to be aligned with the Transfer Pricing law to ensure that the appropriate TP adjustments are based on the same rules and principles as the Transfer Pricing procedure.
Will It Impact A UAE-Based Business?
The simple answer is yes. The documents published by the MoF documents ( Press release and Public Consultation) clarify that UAE companies must adhere to Transfer Pricing regulations and documentation requirements based on the Transfer Pricing Guidelines.
In the context of the Corporation Tax introduction as part of the Corporate Tax introduction, the UAE will implement Transfer Pricing rules. That means that all transactions between related parties and persons who are connected (“intercompany transaction”) will have to comply with applicable TP requirements according to the principle of arm’s length outlined in the OECD Transfer Pricing Guidelines.
Who are the Related Parties?
As per the UAE Corporate Tax Consultation Document [22 (“Consultation Paper”), A related person is an individual an entity with an existing connection to a business by control, ownership, or family kinship (in cases of natural individuals).
The document also lists these relationships in the form of connected parties:
- A minimum of two or more persons who are related with the 4th degree of kinship or affiliation, for example, through marriage, birth, or adoption;
- When alone or in conjunction with a partner, a person, or a legal entity, the individual directly or indirectly holds more than 50% of this legal entity.
- One or more legal bodies, where one legal entity on its own or in conjunction with a related entity directly or indirectly, holds at least a 50% percentage of or controls each legal entity
- More than two legal entities, if the taxpayer, either alone or in conjunction with a related person directly or indirectly, holds at least 50% of each or is the sole owner;
- A taxpayer and its branch or permanent establishment
- Members of the same unincorporated partnership and
- Non-exempt and exempt business activities of the same individual (for instance, an exempt-free zone-based business).
Who Are Connected Persons?
Consultation Paper Consultation Paper stresses that in the absence of taxation on personal income in the UAE, individuals who own tax-deductible companies would be encouraged to reduce the UAE corporate tax base through excessive payments to themselves or those associated with them.
So, benefits or payments given by a company for the “Connected Persons” will be tax-deductible only if the company can show that the benefit or payment conforms to “arm’s length” or the “arm’s length principle” and the expense is entirely and solely for the benefit of your business.
Connected Persons differ as Related Parties. A person is considered as being connected to a business in the scope of the UAE Corporate Tax regime it is:
- An individual who either directly or indirectly owns an ownership control or interest in the tax-paying person;
- An officer or director of a taxable person;
- An individual who is related to the director, owner, or another officer tax-paying person in an extent of the 4th degree of family kinships such as through marriage, birth, or adoption;
- If the tax-paying person is a member of an unincorporated partnership or any otheras a partner of the same partnership and
- A Related Party of any of the above.
What Are The Compliance Obligations?
TP rules usually place the onus probandi (burden of evidence) on the taxpayer. The taxpayer is responsible for intercompany transactions with an amount greater than a specific threshold in the applicable tax year to create the TP documents and show that the transactions between its companies were carried out at an “arm’s length.”
The value of intercompany transactions has yet to be defined and is expected to be clarified following the implementation of UAE Corporate Tax Legislation. Consultation Paper Consultation Paper does specify the mandatory TP documentation that will comprise a Local File along with a Master file (according to the formatting and content required in OECD BEPS Act 13 as well as following the World’s Best practices).
Additionally, the arm’s-length nature of intercompany transactions must be confirmed using any of the internationally accepted TP methods or another approach when the business can prove that the specified method can’t be used reasonably.
If the requirements are met, companies must complete and submit a transfer Pricing disclosure form with information about their intercompany transactions. It is unclear how it is necessary to submit the TP disclosure form will need to be filed simultaneously with when filing the tax return (i.e., at least (9) months from the date of expiration of the relevant period of tax) or by an earlier date.