− How current legislation deals with this controversial topic −
A. What is Transfer Pricing?
Generally speaking, “Transfer Pricing” is the internal process of accounting of a large company dealing with buying and selling goods within the company. For this purpose, branches or sub-divisions of the company sell and buy goods to certain prices that are most beneficial to them.
The process can be best described by the following example:
If one sub-division of a company is specialized in product designs and the other sub-division is specialized in assembly of the final product, the first can sell their designs to the second or any other company for that matter.
Usually, the first sub-division will sell their designs to the second one at a normal market price. However, the first sub-division could also sell their product to the second sub-division to a smaller price.
That would minimize their sales because of the smaller price on one hand. On the other hand, the second sub-divisions profits would be higher, as they would achieve a more competitive price for their sold goods. The lost revenue of one sub-division would therefore be regained by the surplus in sales of the other sub-division, which means that the company as a whole will not be financially affected.
If these basic principles are applied in a tax-context, the importance of “Transfer Pricing” to a company becomes evident: While lost revenue on one side is balanced out by higher sales on the other side, if the income is taxable in different countries, it may make a significant impact on a company’s net-income by shifting the loss of income to the high-taxation country and the surplus of income to the low-taxation country.
Depending on the Tax Legislation of the countries the company is operating in, the topic of “Transfer Pricing” can be a difficult and pricy endeavor, if done wrong.
B. Transfer Pricing in the UAE – An Overview
Tax authorities all over the world have been aware of this, which is why regulations have also been implemented in the UAE (Federal Decree-Law No. 47 of 2022), effective June 1st, 2023. The general consensus is, that companies should buy and sell goods “within the company” to the same price as they would “outside the company”, as companies should not be able to cheat themselves a tax relief. In order to hold companies accountable for this, the law sets a few criteria to determine the exact activities that fall under the mentioned category.
I. Related Parties and Connected Persons
The UAE law defines “Related Parties” as natural persons up to the 4th degree of kinship or affiliation (including adoption and guardianship), as well as a natural or juridical person owning at least 50% of the company or in control thereof. “Related Parties” are also a person and its “Permanent Establishment”, two or more Partners in the same “Unincorporated Partnership” or a trustee, founder, settler or beneficiary of a trust/foundation and their “Related Parties”.
“Connected Persons” are owners or directors/officers of the respective taxable person, as well as related parties of the owners/directors and/or officers.
II. The Arm’s Length Principle
According to the UAE law, the price of trading shall be determined by the “Arm’s Length Principle”. The “Arm’s Length” standard is met if the company does not achieve a different outcome by trading with “Related Parties” in comparison to trading with “Unrelated Parties”. To ensure that, the UAE law defines a few transfer pricing methods:
a) The comparable uncontrolled price method;
b) The resale price method;
c) The cost-plus method;
d) The transactional net margin method and
e) The transactional profit split method.
These methods should be applied. However, other methods may be applied if it is demonstrated that neither of the above is applicable and if taking into consideration the provisions set out in section 34 (5) of Federal Decree-Law No. 47 of 2022.
C. The execution of Transfer Pricing regulations
“Transfer Pricing” regulations in the above-mentioned law apply to all taxable persons in the UAE, including Free Zone entities, that are trading within the company. Therefore, a few standards regarding compliances have to be met:
Together with the tax return of the fiscal year, a “Transfer Pricing Disclosure Form” will have to be filled out. However, the contents thereof are not public knowledge yet. It is to be expected, that the taxable person will have to disclose their activities and habits correlating to “Transfer Pricing”.
In addition to that, the taxable person will also have to maintain a so called “Group Master File” as well as a “Local Country File”. These files will have to meet certain standards, the contents of which are yet to be specified. It is likely, that the “Local Country File” would require information such as an overview over transactions made, as well as an economic and functional analysis, while the “Group Master File” would require information on the group as a whole, such as structure, supply chains, tax rulings of other countries, etc.
Not further specified, but still important for multinational groups is the “Country by Country Report” (CbCR) dealing with business activity across boarders and the legal assessments of other countries.
Businesses may apply for “Advanced Pricing Agreements” (“APAs” = bilateral agreement between one or more taxpayers and one or more tax authorities determining the procedures of “Transfer Pricing” beforehand) in order to avoid disputes with the corresponding tax authority.
Taxpayers also need to keep in mind, that non-compliance or a lack of cooperation will most likely invoke penalties amongst other consequences.
UAE’s “Transfer Pricing” regulations broadly match international standards, following OECD’s plan to stop tax-avoidance. Therefore, the legislation generally hinders companies from using “Transfer Pricing” as a method to minimize their tax burden.
However, a diligent approach may still help achieving a desirable outcome, e.g., by finding the right “Transfer Pricing” method or applying for APAs.
It is recommended, that businesses are well advised on this topic and start making precautions by identifying related parties/connected persons and understanding their “Transfer Pricing” compliance obligations. A “Transfer Pricing” policy (Policy on how transactions between related parties are handled) should be set up or modified professionally to fit the regulations.
As one may have noticed, the topic of “Transfer Pricing” is very individual and bears high risks, which is why a professional consultation is recommended.
We at Meyer-Reumann & Partners are specialized in individual consultation and dedicated to help you achieve the outcomes you desire from a legal perspective.