UAE corporate tax: Transfer pricing benchmarking helps set fair market prices

Transfer price refers to the prices of goods and services charged on transactions between the related parties and with the connected persons (owner, director, officer, or 4th degree of kinship of owner, director, officer of taxable person). like A Ltd and B Ltd are owned by Mr X, and the price charged by A Ltd to B Ltd, or vice versa on the sales of goods and services between them refers to the transfer price.

The key risk associated with the transactions between related parties, and with the connected persons is that the owner or the person in control can manage the transaction price between the related parties; or connected parties, which will help them to shift their taxable profits from high tax jurisdiction to the low tax jurisdiction; or reduce their taxable profits in the same tax jurisdiction which will ultimately help them to pay the lesser tax.

For example, A Ltd is in the United Kingdom (UK) where the corporate tax rate is 19 per cent, and B Ltd is in the United Arab Emirates (UAE) where the announced corporate rate is 9 per cent. If we are further assuming that B Ltd has given a loan of Dh20,000,000 to A Ltd at higher interest rates of 10 per cent instead of 5 per cent which is the market rate. Mr. X being a common owner, has controlled the transaction, which resulted in the tax savings of Dh100,000, and it has been shown in the accompanying table:

From the illustration, it is evident that through the controlled transaction, interest expense has been overbooked by Dh1 million (Dh20m*10 per cent-Dh20m*5 per cent) as compared to the fair market rate, which eroded the profit of Dh1 million from the high tax UK jurisdiction to the low tax UAE jurisdiction, and it helped them to evade tax of Dh100,000. This tax evasion through the controlled transaction has increased the profit of the entities by Dh100,000 (Dh13,350-Dh13,250), and it has be summarised as [{20m (loan amount)}*{(10 per cent (inflated rate)-5 per cent(market rate)}*{(19 per cent (UK tax rate)-9 per cent(UAE tax rate)}].

The other situation may be where the connected person of the entity is taking benefits or salaries which are not as per the market rates, and due to these non-arm length benefits, the taxable profits of the company will be reduced which will result in tax savings to the entity. Like a B Ltd is giving extraordinary salaries and benefits to one of its officers.

To control such situations, transfer pricing rules have been introduced in the UAE corporate tax law (the law) to ensure that the price of a transaction is not influenced by the relationship between the parties involved, and to achieve this outcome, the UAE has applied the internationally recognized “arm’s length” principle to the transactions and arrangements between related parties and with connected persons.

In the article 34 of the law, it has been given that while determining taxable income, transactions and arrangements between related parties must meet the arm’s length standard. 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.

In the law, it has been mentioned that all related parties’ transactions must comply with transfer pricing rules and the arm’s length principle as set out in the OECD transfer pricing guidelines. In the OECD guidelines following five methods have been proposed to assess the arm-length price:

Traditional transaction methods (recommended methods), which include:

Comparable uncontrolled price method

Resale price method

Cost plus method

Transactional profit methods (alternative methods), and it comprises:

Transactional net margin method

Transactional profit split method

The taxable person may apply any transfer pricing method, provided that they can demonstrate that none of the listed methods can reasonably be applied to determine an arm’s length result. Additionally, any such alternative transfer pricing method used must help to identity the arm’s length price, and the choice and application of method depends upon the various factors like contractual terms, economic situation, nature of business, nature of transactions, assets employed, risk taken etc.

If the transactions between the related parties, and with the connected persons are not at arm’s length price, then the Federal Tax Authority (FTA) will assess the arm-length price and make an adjustment to arrive at the taxable profits of the taxable person as per fair market value.

The businesses are proposed to have a proper benchmarking study and apply the arm-length price accordingly to avoid any future complications.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official opinion of the Khaleej Times but an opinion of the writer. For any queries/clarifications, please write to the writer at mahar@kresscooper.com

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