The United Arab Emirates has introduced transfer pricing rules as part of the new corporate tax law that are effective from 1 June 2023. This article provides a high-level overview of what this will mean for UAE businesses.
Some taxpayers may not be familiar with the concepts behind transfer pricing, so we will start with an overview of the UAE transfer pricing rules. In brief, the transfer pricing provisions in the tax decree-law establish a framework to ensure that transactions between related parties or payments to persons connected to the business are at “arm’s length” or “open market” value. They lay down the acceptable methods to determine and establish that an arm’s length valuation has been applied, and set out the compliance requirements. The rules are closely aligned with the OECD transfer pricing guidelines.
Transfer pricing rules are essential to the proper working of the corporate tax, as it is a mechanism that prevents taxpayers distorting or reducing a business’s profits to avoid tax.
Taxpayers that do not enter into transactions with related parties and do make payments to connected persons will not be affected by the transfer pricing rules. It is also possible that certain categories of taxpayer may be excluded from the rules or have reduced compliance obligations. The full scope will be confirmed by Cabinet Decision, in due course.
Related Parties and Connected Persons
As mentioned above, the transfer pricing rules apply to related parties and connected persons. The corporate tax decree-law includes detailed definitions of these terms. Broadly speaking, related parties of an individual refer to the individual’s relatives as well as companies in which the individual, alone or together with their related parties, has a controlling interest (typically 50% or more of the shares of the company). For companies, “related party” means other companies in which the company, alone or together with its related parties, have a controlling ownership interest (again, typically 50% or more of the shares of the company), or that are under greater than 50% common ownership.
The term connected persons refers to the owner of the business, a director or officer of the business or
a related party of either of the above.
Calculating arm’s length value
The essence of an arm’s length value is that a transaction should be valued as if it had been carried out between unrelated parties, each acting in his own best interest. The valuation should not be affected by one party’s influence over the other.
The corporate tax decree-law confirms that the following transfer pricing methods are approved for use when calculating the arm’s length value:
- The comparable uncontrolled price method
- The resale price method
- The cost plus method
- The transactional net margin method
- The transactional profit split method
The named methods are well established methods, which are consistent with the OECD transfer pricing guidelines. Standard practices are normally followed when carrying out a valuation using these methods, and this is an area in which taxpayers may need the assistance of a transfer pricing specialist. It’s worth noting that the decree-law also allows the use of an alternative method if it can be shown that none of the listed methods can be reasonably applied.
Transfer pricing reporting and recordkeeping
The decree-law provides a broad guide to the transfer pricing documentation a taxpayer may be required to keep, and a Cabinet Decision will be issued in due course to clarify which taxpayers will be affected by the documentation and reporting requirements.
The list of documents in the decree-law includes a master file and a local file, both of which are standard OECD documents. The decree-law provides that these documents should be kept in a form specified by the FTA, but it seems likely the format will be very similar or the same as called for in the OECD guidance.
Generally, the master file will contain information on the global business operations of the group to which the taxable person belongs, and should include information such as:
- Group structure
- Description of the group business
- Intangibles of the group
- Intercompany financing arrangements
- Financial and tax position of the group
The local file usually includes:
- Information on the taxable person such as organisational chart, business strategy, etc.
- Documentation on material local transactions subject to transfer pricing rules
These documents do not have to be submitted to the FTA as part of the normal reporting process but the FTA can request them at any time. If a request is made, the taxpayer will have 30 days to produce the files.
In addition to the requirement to maintain a master file and a local file, the decree-law also refers to the possibility that a notice or decision might be issued that requires a taxpayer to file a transfer pricing disclosure at the time the tax return is filed. At this stage, there is no indication of whether any such notice or decision might be issued and whether it will apply generally or only to certain taxpayers.
BDO Insight
The introduction of transfer pricing rules will create a new challenge for UAE taxpayers. It is an essential part of the new tax system and it will affect a wide cross section of UAE businesses. Any business that has transactions with group companies, whether in the UAE or in other jurisdictions, and any owner or director that receives payments for the business will need to consider whether they can meet the transfer pricing conditions. The consequences of not meeting the conditions are considerable: ultimately profits might be adjusted, and additional tax might be payable. As a consequence, penalties might also be due.
The transfer pricing rules are specifically referred to in the provisions for free zone companies: A free zone company cannot be treated as a qualifying free zone company if, among other things, it does not meet the transfer pricing conditions. This needs to be borne in mind when free zone companies are preparing for corporate tax.
The documentation and reporting requirements will also create a significant compliance burden for some taxpayers, and these requirements should not be taken lightly. Master files and local files are complex documents that cannot be assembled correctly without an investment of time and effort. If there is also an annual reporting requirement alongside the tax return, it will also require care and time, and once again, penalties are likely to be payable if there are errors or lack of compliance.
Ashish Athavale
Brian Conn
Mufaddal Safdari
BDO in United Arab Emirates