Domestic transfer pricing impact startups, family businesses and SMEs

With Corporate Tax on the anvil in the UAE, transfer pricing discussions are gaining traction amongst the business community. Transfer pricing is generally applicable on international transactions. Such a generic understanding should not blindside and mislead the UAE businesses which are not engaged in international transactions.

UAE tax laws will contain unique provisions of ‘domestic transfer pricing’. Family businesses, single-owner companies, partnerships and startups need to pay a closer attention to its implications on their operations.

Concept of ‘Connected Persons’

UAE corporate tax regime is expected to introduce a concept of ‘connected persons’. ‘Connected persons’ would have a very wide coverage compared to ‘related parties’ as traditionally understood in taxation.

‘Connected person’ in relation to a company includes: (a) an individual who directly or indirectly has an ownership interest in, or controls, the company; (b) a director or officer of the company; (c) an individual related to such owner, director or officer to the fourth degree of kinship or affiliation, including by birth, marriage, adoption or guardianship.

The percentage of ownership could be irrelevant to be treated as a connected person. Any direct or indirect shareholder could be treated as a connected person. Similarly, the relatives would be covered not vis-à-vis the owners alone but also for the directors and the officers.

Domestic Transfer Pricing

All transactions between a company and its ‘connected persons’ will need to comply with transfer pricing rules and the arm’s length principles.

The arm’s length principles require that the company must demonstrate that the transaction between connected persons is consistent with similar transactions between independent third parties i.e. persons that are not related to each other. The study of such unrelated transactions is referred to as ‘benchmarking’.

As UAE currently does not impose any tax on an individual’s income, the transfer pricing would apply even if both the company and its ‘connected persons’ are based in the UAE.

The domestic transfer pricing aims to pre-empt tax evasions i.e. transferring a company’s taxable profits to its owners, partners, senior management or their relatives. Considering the growth of the business environment in the UAE, especially the family businesses, the application of domestic transfer pricing could pose significant challenge and consequent implications.

Challenges in domestic transfer pricing

Identifying and maintaining the records of the transactions with the owners, directors, officers and their extended relatives would be a demanding task. For a publicly listed company, such requirements could become humongous.

UAE has a thriving environment for start-ups and SMEs. Many senior professionals opt to leave their jobs to start their own ventures in the UAE. The remunerations that such professionals command from unrelated employers would be much more than the entire profits of their start-ups in the initial years. The time that such professionals invest in their own ventures may be much more that the working hours of a job. For large scale businesses, the salaries of the owners/officers could vary considerably amongst the businesses of similar size of operations. The arm’s length principles on owners’ salaries and perquisites will require careful attention to details.

For the family businesses, the tax challenges are multipronged. The benchmarking of salaries to the owners is in itself a challenge. It is common to engage family members and relatives at various positions in the organisation. To demonstrate arm’s length principle, the businesses could also be required to demonstrate that an individual’s qualifications & experience is appropriate to the job positions and consequent remuneration.

It needs to be seen if the tax laws would require a company to demonstrate what a ‘connected person’ could have otherwise earned from an unrelated party, or what that company would have paid to an unrelated/un-connected person. One could also contend that, by treating family businesses as a group, benchmarking could be done by averaging how much salary an owner draws as a percentage of gross revenues.

Responsibility of the Businesses

The onus to satisfy the arm’s length principle would be on the company/taxpayer. Benchmarking would be an annual compliance requirement. It could not be left on an off chance of being detected by the tax authorities and be dealt at that time if it so comes.

Just like all tax domains, transfer pricing is a vast field for study and specialisation. The understanding of tax nuances would help in optimising tax implications. All businesses, whether small or big, need to proactively engage with experienced tax professionals to manage the upcoming tax compliances for their businesses.

Pankaj S. Jain is the managing director of AskPankaj Tax Advisors. For feedback and queries, you may write to info@AskPankaj.com. Views expressed are his own and do not reflect the newspaper’s policy.

• Dubai