What is Transfer Pricing?
Corporate tax transfer pricing involves the pricing of transactions between related parties or connected individuals. The terms and conditions of these transactions are influenced by the relationship between the parties involved. In contrast to independent parties, who determine prices through market forces, related parties can establish prices that may not accurately represent the true market value. This can consequently impact the reported profits across various jurisdictions. To prevent the exploitation of tax liabilities through such non-arm's length pricing, the Arm’s Length Principle is applied, which necessitates that transactions between Related Parties be conducted at a fair market value, comparable to those between independent parties.
Corporate tax transfer pricing refers to the practice of setting prices for transactions between related entities within a multinational corporation. This ensures that goods, services, and intellectual property are exchanged at market rates, complying with the arm's length principle. Proper transfer pricing is crucial for accurate profit allocation across different tax jurisdictions, preventing tax evasion and ensuring fair taxation. Regulations and documentation requirements help maintain transparency and compliance with international and local tax laws.
Scope of Transfer Pricing
Corporate tax Transfer Pricing applies to a wide range of transactions between Related Parties or Connected Persons. These transactions may include:
- Trade of Services: Transactions involving the provision of services.
- Tangible Goods: The sale or transfer of physical products.
- Intangibles: Transfers involving intellectual property or other non-physical assets.
- Financial Transactions: Loans, guarantees, or other financial arrangements.
- Permanent Establishments (PE): Certain transactions involving a Permanent Establishment.
The provisions under the Corporate Tax Law and Ministerial Decision No. 97 of 2023 ensure that Related Parties set the terms of these Controlled Transactions in a manner consistent with how independent parties would operate under comparable circumstances.
How Transfer Pricing Works in UAE?
Corporate tax transfer pricing is a method used by companies to set prices for goods, services, or intellectual property exchanged between divisions within the same company or between related entities under common control. The main objective is to ensure that transactions reflect market conditions as if they were conducted between unrelated parties, adhering to the "arm's length principle."
Here’s how transfer pricing works:
- Determination of Transfer Prices: Companies establish transfer prices using various methodologies such as the Comparable Uncontrolled Price (CUP) method, Cost Plus Method, Resale Price method, Transactional Net Margin Method (TNMM), and the Profit Split method. These methodologies aim to replicate the pricing that would occur between independent enterprises.
- Documentation and Compliance: Firms must document their transfer pricing practices and provide justification for the chosen methods. This documentation is crucial for compliance with international and local tax regulations and for defending against audits by tax authorities.
- Tax Implications: Transfer pricing affects the allocation of income and expenses among different jurisdictions, impacting the overall tax liability of multinational companies. By setting appropriate transfer prices, companies can manage their tax exposure while complying with regulatory requirements.
- Regular Review and Adjustment: Due to changes in market conditions, regulatory updates, and business operations, companies need to regularly review and adjust their transfer pricing policy to remain compliant and competitive.
Transfer pricing is essential for effective tax planning, performance measurement, and regulatory compliance within multinational corporations.
Key points in the UAE Transfer Pricing Guide
Burden of Proof
In the UAE, it’s up to you, the taxpayer, to prove that your transfer prices align with what unrelated parties would charge. This means you’ll need to keep solid records to back up your pricing strategies and show that your transactions with related companies are fair.
Transfer Pricing Documentation
The UAE expects multinational companies to keep detailed transfer pricing documentation requirements which usually include:
- Master File: This gives a broad look at your company’s global operations, its structure, pricing policies, and major transactions.
- Local File: This file zeroes in on the specific transactions between the UAE branch and its related parties, detailing the pricing methods and comparisons.
- CbCR (Country-by-Country Reporting): This means you’ll need to share some financial details for each country you operate in, so tax authorities can see how you distribute income and what taxes you pay.
Transfer Pricing Disclosure Form
When filing your corporate tax return, the UAE’s Federal Tax Authority (FTA) asks for a TP Disclosure Form. This form includes:
- Information on transactions with related parties
- The pricing methods you used
- Comparisons with other transactions to show fair pricing
Arm’s Length Principle & Application
Arm’s Length Principle
The Arm’s Length Principle, set forth in Article 34 of the UAE Corporate Tax Law, requires transactions and agreements involving Related Parties or Connected Persons to be priced as if they were conducted between independent parties under similar conditions. This principle guarantees that the pricing of these transactions accurately represents what two unrelated entities would have agreed upon, taking into account the available conditions and evidence.
The Arm's Length Principle applies regardless of whether there is a formal pricing arrangement or legal agreement among Related Parties. This means that if a property is transferred or a service is provided without proper remuneration or below market value, the transaction needs to be carefully assessed to determine if it had taken place between independent parties and at what price.
The principle considers Related Parties and Connected Persons, such as members of a corporate group, as independent entities. This approach emphasizes evaluating whether the conditions of Controlled Transactions differ from those observed in Comparable Uncontrolled Transactions. This comparison, referred to as a "comparability analysis," is essential in the application of the Arm's Length Principle.
Application of the Arm’s Length Principle
This section outlines the three essential stages of implementing the Arm's Length Principle for Controlled Transactions:
Step 1: Identify Related Parties, Connected Persons, Relevant Transactions, and Perform a Comparability Analysis
Identify Related Parties and Connected Persons:
- Related Parties: Entities that exert control over one another or are under common control, encompassing parent companies, subsidiaries, and affiliates.
- Connected Persons: Individuals or entities with substantial control over the business, such as major shareholders, directors, or family members of key personnel.
Identify Relevant Transactions and Arrangements:
- Transactions: Any monetary transactions occurring between parties with a close relationship, encompassing sales, services, loans, and leases.
- Arrangements: Contracts or arrangements, whether formal or informal, that affect the terms and conditions of transactions.
Perform a Comparability Analysis:
- Functional Analysis: Examine the functions performed, assets used, and risks assumed by each party in the transaction.
- Economic Analysis: Assess the economic conditions, market conditions, and business strategies that influence the transaction.
- Comparability Factors: Consider factors such as the characteristics of the goods or services, contractual terms, economic circumstances, and business strategies.
Step 2: Selection of the Most Appropriate Transfer Pricing Method
- Comparable Uncontrolled Price (CUP) Method: Compares the price charged in a controlled transaction to the price charged in a comparable uncontrolled transaction.
- Resale Price Method: Determines the arm’s length price by subtracting an appropriate gross margin from the resale price of a product sold to an independent party.
- Cost Plus Method: Adds an appropriate markup to the costs incurred by the supplier in a controlled transaction to determine the arm’s length price.
- Transactional Net Margin Method (TNMM): Examines the net profit margin relative to an appropriate base (e.g., costs, sales) that a taxpayer realizes from a controlled transaction.
- Profit Split Method: Divides the combined profits from controlled transactions among the related parties based on their relative contributions.
Step 3: Determination of the Arm’s Length Price
- Gather Data: Collect data on comparable uncontrolled transactions, including internal and external comparables.
- Adjustments: Make necessary adjustments to account for differences between the controlled and uncontrolled transactions to ensure comparability.
- Calculate the Arm’s Length Range: Determine a range of acceptable prices or profit margins that reflect what independent entities would have agreed upon under similar circumstances.
- Select the Arm’s Length Price: Choose the most appropriate point within the arm’s length range, often the median or mean, to set the transfer price.
- Documentation: Maintain thorough documentation to support the transfer pricing analysis and the determination of the arm’s length price. This includes details of the comparability analysis, selection of the transfer pricing method, and any adjustments made.
Transactions with Related Parties and Connected Persons under the UAE Corporate Tax Law
Related Parties and Control under Transfer Pricing in UAE
Related Parties in the context of UAE Corporate Tax Law refer to entities or individuals that have the ability to directly or indirectly influence each other's business decisions. This influence often stems from control, ownership, or significant involvement in each other's operations. Understanding the concept of Related Parties is crucial in determining the application of transfer pricing rules to ensure transactions are conducted at arm’s length prices.
Who is a Related Party?
In UAE Corporate Tax Law, a Related Party includes various scenarios:
- Two or more Natural Persons: Related if they share a familial or close personal relationship.
- Natural Person and Legal Person: Related if there is substantial ownership or control between them.
- Two or more Juridical Persons: Related if there is significant ownership or control between these entities, such as parent-subsidiary relationships.
- Two or more persons are partners in the same Unincorporated Partnership: Related if they jointly control the partnership's operations.
- A person and its PE (Permanent Establishment) or Foreign PE: Related if there is control or significant influence over the PE's operations.
- A person (founder, beneficiary, trustee, etc.), of the trust or foundation and its Relating Parties: Related if there is control or substantial influence over the trust or foundation and its beneficiaries or trustees.
Understanding these definitions is crucial for compliance with UAE Corporate Tax Law, ensuring fair taxation practices and preventing tax avoidance through improper transfer pricing practices.
Trusted Corporate Tax Advisor in UAE
Reyson Badger is a prominent firm providing complete corporate tax services in UAE. Their team of expert tax consultants specializes in UAE corporate tax transfer pricing methods, offering extensive knowledge and experience to assist businesses effectively. They excel in guiding clients through complex calculations and strategic tax planning, ensuring compliance and optimizing tax strategies.
For further inquiries or assistance regarding transfer pricing and other corporate tax matters, Reyson Badger stands ready to provide personalized advisory services customized to meet business needs.