1) Introduction
Transfer Pricing whilst would have been a global phenomenon for more than 4 decades, countries forming part of GCC had been out of its purview until late 2018 when Kingdom of Saudi Arabia (KSA) formally introduced a detailed Transfer Pricing Regulations with United Arab Emirates (UAE) becoming the second country to adopt a detailed provision very recently.
The journey of UAE towards becoming a tax compliant jurisdiction started in 2016 when law establishing “Federal Tax Authority (FTA)” was issued which then evolved over introduction of VAT Law in 2018. Post this, UAE became signatory to BEPS inclusive framework and thereafter began what the region saw series of changes and updates on the tax and regulatory environment in UAE. Post the announcement of Corporate Tax Law in January 2022, the final version of the Law was made available in late 2022 (9th December 2022) – popularly known as UAE CT Law and the idea and approach of FTA became more crystalized which contained provisions on Arm’s Length Price & Transfer Pricing Documentation. The UAE CT Law become applicable from 1st June 2023, and in this chapter, we intend to discuss few of the aspects of Transfer Pricing Regulations as they stand for the businesses operating in UAE.
While Indian professionals have been dealing with the subject for more than 2 decades now since its introduction is April 2001. Indian tax authorities used the transfer pricing provisions to an extent for making some high pitch assessments and adjustments which eventually led to litigation, but most of the issues have now settled. Let’s see how the UAE journey spans out.
Given the above basics, let’s deep dive into the UAE TP under the UAE CT Law.
Key highlights / framework of the UAE TP Regulations
- Overarching principle governing most of the provisions of UAE TP will be based on OECD Transfer Pricing Guidelines (OECD TPG) – conceived from the intent and communication of Federal Tax Authority (FTA) and Ministry of Finance (MOF)
- Regulations are applicable to businesses involved in transactions with Related Parties and Connected Persons (‘CP/RP’) (as against being limited to “associated enterprises” globally and in India). Currently there are no deeming provisions for determination of “associated enterprises” like in case of Section 92A (2) under the Indian Income Tax Act, 1961 (‘ITA’)
- The regulations apply to transactions as well as “arrangements” which implies that even if there is no commercial outflow involved in a particular support or services extended by one RP/CP to other and same may not be forming part of the books of account, it still falls within the ambit of transfer pricing. Currently there are no provisions of “deemed” international transactions like in case of 92B (2) of ITA, besides the broader coverage as described above
- In terms of methods of transfer pricing, UAE TP Regulations adopt the methods prescribed under OECD including the provision for “other method”.
- Additionally, transfer pricing regulations also apply to transactions between a UAE permanent establishment and its non-resident Related Party.
- Taxpayer can avail for arm’s length range in determination of ALP.
- Provisions for “corresponding” adjustment also prevail under the framework of the UAE TP regulations.
- W.r.t Compliance – both disclosures and documentation are applicable, with certain thresholds (explained in tabular format below)
- There are provisions for Advance Pricing Agreement, while the operational rules thereto are yet to be published. KSA, however, (within GCC) has recently implemented an APA regime effective from 1st January 2024.
- There are no separate provisions for Penalties under the UAE CT Law, but the ones prescribed under the Tax Procedure Law would be applicable in cases of non-compliances.
Till date of this article there is only limited documents & legislation (or literature thereof) available as official documents and position of the FTA on the subject and further detailed guidance are expected to be published soon. Hence, information in here is based on the same besides drawing inferences from OECD framework as the FTA has indicated that UAE TP Regulations will be largely based on OECD Transfer Pricing
The key TP provisions under the UAE CT Law are discussed in detail in the ensuing paragraphs:
Each of these provisions and related updates available on the subject until the date of article are explained in the ensuing paragraphs.
2. Article 34
Arm’s Length Principle (including the methods and other aspects of UAE TP Regulations)
The provisions of Transfer Pricing and intent of introducing them was first communicated through a set of FAQs on the “Corporate Tax” which were published by FTA on the subject. Question 96 of the FAQs addressed:
What are transfer pricing rules? Transfer pricing rules seek to ensure that transactions between Related Parties are carried out on arm’s length terms, as if the transaction was carried out between independent parties. To prevent the manipulation of taxable income, various articles in the Corporate Tax Law require that the consideration of transactions with Related Parties and Connected Persons needs to be determined by reference to their “Market Value”.
Thereafter the final provisions under the UAE CT Law, under provisions of Article 34, elaborates follows:
“In determining Taxable Income, transactions and arrangements between Related Parties must meet arm’s length standard…”
What is arm’s length standard?
“… If results of the transaction of 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”.
Comparability Analysis to be carried out keeping in mind the following factors (emerging from the OECD TPG and broadly similar to Indian provisions as well) Factors (Clause 5 of Article 34) determining the choice and application of method must be made having regard to:
- contractual terms
- characteristics of the transaction
- economic circumstances
- functions performed, assets employed, and risks assumed (FAR)
- business strategies employed by the related parties.
Whilst, other factors assume importance, in this article we have elaborated on FAR analysis as FAR analysis is the heart of determining ALP as it not only tries to help understand where and how the value is created but also helps in identification of which is the tested entity (i.e., simpler entity) and in-turn help in comparability criteria.
Refer the brief table below for understanding:
With the e-commerce business prevailing and borderless businesses flourishing there is one more factor that has gained importance in the above analysis, i.e., “Market” whereby significant value of the entire supply chain could be said to be derived. As the consumers of goods or services if belong / reside into a particular jurisdiction, the right to tax the fair share of profit is that of the jurisdiction where these customers are based, and hence global trend is noticing a “FARM” analysis which is an extension of “FAR” analysis.
Having understood the approach to determine the comparability, one also needs to capture the methods available to demonstrate the ALP. Like India and taking guidance from OECD, UAE TP Regulations have also provided for the standard 5 methods and other method.
Tabulated below are the methods and their understanding along with an example:
There exists a provision to even adopt combination above methods to substantiate ALP.
3. Article 35
Related Parties & Control
Related party covers within its ambit the following:
- Kinship (upto fourth degree i.e., great-great-grandparents, great-great-grandchildren, nephew, and niece)
- A Natural or Juridical Person who has directly or indirectly a relationship through ownership, rights in share of profits, control overboard of director for 50% or more another judicial person. Control will also deem to be exercised in cases where significant influence on the conduct of business and affairs of another person.
- A Permanent establishment or branch, and
● Partners in the same unincorporated partnerships
● A trustee, founder, settlor or beneficiary of a trust or foundation.
Let’s understand this with the help of examples.
4. Article 36
Connected Persons (and payments thereto)
Connected person has wider definition than related parties mentioned above. A person shall be known as connected person if it is:
- An owner of the Taxable Person.
- A director or officer[1] of the Taxable Person.
- A Related Party of any of such owner / director / officer.
- An owner of the Taxable Person is any natural person who directly or indirectly owns an ownership interest in the Taxable Person or Controls such Taxable Person.
- Where the Taxable Person is a partner in an Unincorporated Partnership, a Connected Person is any other partner in that same Unincorporated Partnership, and any Person that is a Related Party of that partner.
As mentioned above, ALP principle must be observed while transacting with RP/CP. In other words, amount paid to “Connected Persons” will be allowed as deduction while computing the taxable income only if the same is found to be in line with “market value” and in case there is any excessive payment, the same is disallowed.
The largest impact of this provision will be felt in case of “Managerial Remuneration” paid to Key Managerial Person (‘KMP’) and Local sponsors . Determining “market value” is not only challenging but also a subjective exercise and hence it would be imperative for the businesses to build up complete / robust documentation around the same. Some of the factors that would be useful to demonstrate their contribution and build up a narrative of ALP:
There are certain exceptions to this principle whereby transactions by the below person with connected person shall be out of purview of connected person:
a. Benefit (derived)
b. Corresponds to market price.
c. Wholly and exclusively for business
d. Not linked / contingent on financial results of the business or paid as part of profit (dividend or the like)
e. Nature of Payment should be either of the following (EG May 2023):
Provision of services
-
-
- Salary
- Wages
- Non-deductible if in the nature of dividend, profit distribution or benefit of similar nature (Article 33 of CT Law)
- Dividend also includes, “…any payment or benefit which in substance or effect constitutes distribution of profits made or provided… or any transactions or arrangements with a Related Party or Connected Person that does not comply with Article 34.”
- The rationale of such a provision is keeping in mind that this payment is not used as a provision to manipulate profits. Since, natural person in their personal capacity will not be subject to tax, hence some check and balance in the system is required. Benefit or otherwise provided by the Connected Person and is incurred wholly and exclusively for the purposes of the Taxable Person’s Business. In other words, a deduction would be denied on any portion in excess of “Market Value”.
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f. Guidance as to the maximum allowability / cap on similar nature of payments can be obtained from:
UAE Federal Law no. (32) of 2021 on Commercial Companies Article 171, Article 104 of this law (not the UAE CT Law referred elsewhere in this chapter)
g. OECD TPG – Para 2.181 (indirect inference can be drawn) – preparation of JD and CV with experience and contribution to the business and operations.
h. Other method – by use of quotations / job offer letter with similar skill sets?
i. HR Consulting firm research / industry report?j. Glassdoor or similar other online secondary source?
k. Indirect benchmarking by use of TNMM?
There are certain exceptions to this principle whereby transactions by the below person with connected person shall be out of purview of connected person:
- Taxable person whose share are traded on recognised stock exchange.Taxable person is subject to regulatory oversight by authority in UAE.
- Any other person as decided by the government.
5. Article 55
Transfer Pricing Documentation (Disclosure along with Local File & Master File)
5.1 Disclosure form
Whilst the content (form / format) of Disclosure form is awaited, cue from global jurisdiction can be considered as reference point for the taxpayers to determine the expectations that this could cover:
• Name and address of the RP / CP• Relationship – Related Party or Connected Person
• Nature and type of transaction (entered into with RP/CP) in the reporting period.
• Total Value of the transaction entered into with each of the RP/CP in the reporting period.
• ALP of the transaction entered into with each of the RP/CP in the reporting period.
• Method used for justification of the ALP.
• Any other
5.2 The content of three tier documentation, can be illustrated as:
Its important to note that FTA intends to provide a detailed guidance on the content or coverage of Master File and Local file through separate literature on the subject, soon. The above table is based on the understanding of the content drawn up from references in OECD TPG.
5.1 Disclosure form
UAE doesn’t have mandatory filing of company financials and with the dynamics of “free-zone” and “mainland”, practically there are more than 40 regulators and their set of different regulations, especially governing the companies operating out of each of these free-zones. Considering this, it will be interesting to see how comparable data of the relevant region are available or used. Given the status of affairs, it will be imperative to use larger comparable dataset like GCC, Middle East, MENA, East Europe and few other select countries. Some of the global databases that could be relevant for the purpose of conducting an external benchmarking (besides a possibility of using an internal comparable data point available within the purview of the taxpayer or the group at large) analysis could include the following depending on the transaction under purview and method to be used (only an illustrative list):
• Bloomberg
• Standard & Poor’s
• Orbis / TP Catalyst by Moody’s Analytics (Bureau van Dijk)
• Dun & Bradstreet
• ktMine
• RoyaltyRange / Royaltystat / RoyaltySource
•Thomson Reuters
5.4 List of transactions (generally)
Coverage of the transactions that can be contemplated keeping in mind the common business practices followed in UAE.
• Transactions between mainland businesses, free zones, and exempt persons that are not tax neutral.
• In relation to goods: Purchase, sale, and transfer of goods related to manufacturing and distribution activities, including raw materials, and finished goods.
• In relation to services: Provision and receipt of various services, such as IT, sales and marketing, engineering, R&D, finance, accounting, legal, managerial, and procurement.
• In relation to tangible property: Purchase, sale, transfer, and lease of tangible property.
• In relation to intangible property (IP): Royalties and license fees for the use of intangible assets.
• In relation to Finance transaction: Issuance, investment, and transfer of equity and preference shares, as well as hybrid instruments such as CCDs, CCPs, OCDs, and OCPs, Intra-group loans and guarantees.
• Other transactions with connected persons: Payments to owners, shareholders, directors, officers, partners, and their relatives, such as remuneration, rent, dividends, and interest on loans.
• Business Restructurings and Reorganizations: Transfer of shares, tangible and intangible assets, business combinations, changes in contractual terms, parties, and characterization.
• Intra-group Services (IGS) and Cost Contribution Arrangements (CCAs)
6. Other Key Elements of UAE TP Regulations
6.1 Applicability to Free zone
FAQ 115
“What is a Qualifying Free Zone Person?
Further Article 18 – Qualifying Free Zone Person of the UAE CT Law
1. A Qualifying Free Zone Person is a Free Zone Person that meets all of the following conditions:
a. Maintains adequate substance in the State.
b. Derives Qualifying Income as specified in a decision issued by the Cabinet at the suggestion of the Minister.
c. Has not elected to be subject to Corporate Tax under Article 19 of this Decree-Law.
d. Complies with Articles 34 and 55 of this Decree-Law.
e. Meets any other conditions as may be prescribed by the Minister.”
Hence, even a Free-zone person needs to comply and adhere to transfer pricing provisions for itself to be eligible for claiming the benefit of the free-zone person which would enable it to claim the 0% tax rate under the UAE CT Law.
6.2 Retrospective application under Transitional Provisions
Besides, India witnessing many clarifications introduced in the IT Act which are made applicable “retrospectively”, UAE CT law also provides for such a provision. As a part of transitional rules, kindly refer the following provision and the clarification issued in the Explanatory Guide (of May 2023)
Article 61 – Transitional Rules
2. The opening balance sheet referred to in Clause 1 of this Article shall be prepared taking into consideration the arm’s length principle in accordance with Article 34 of this Decree-Law…”
Further, EG May 2023, provides as follows:
“This requirement is intended to prevent non-arm’s length transactions and arrangements entered into prior to the introduction of Corporate Tax from impacting the calculation of Taxable Income”.
7. Some provisions that may help the adoption of the Transfer Pricing Regulations smooth:
7.1 Arm’s Length Range: The regulations provide for use of range but the same hasn’t been defined as yet, so going by OECD TPG, it could be “arithmetic mean”, i.e., 25th to 75th percentile (as opposed to adopted in India, which is 35th to 65th percentile)
7.2 Safe-Harbour Prescribing a threshold for transactions which don’t have reliable external comparable available, viz. managerial remuneration. Or type of transaction which are significant in the region such a provision could ease the compliance burden to a great extent.
7.3 Detailed guidance As the TP regulations are fairly new, it would be useful to provide some guidance along with case studies. Basis the recent awareness sessions conducted by MOF the same are expected.
7.4 Use of Multi-year Data In today’s scenario, business environment is dynamic and volatile to a great extent and hence provisions as to the number of years that can be used for the purpose of benchmarking / comparability will be useful. Similarly, whether documentation is required to be prepared every year or once in 2/3 year could also be help taxpayers assess their compliance requirements.
7.5 Source / Database Considering the limitation highlighted above, it could be useful for the FTA to propose database or set of countries that can be considered as reliable for the purpose of external benchmarking analysis, especially till the time, UAE market matures with respect to the availability of sufficient data. Similar approach was adopted by Sri Lanka when transfer pricing provisions were made applicable therein, the authorities stated acceptance of Indian database and comparable therein.
7.6 Period of Local file (whether required to be prepared / updated every year)
Some of the countries encourage preparation of Local file once every 3 years to reduce the burden of the compliance on the business, unless there is changes in the facts or transactions between the RP/CPs. It may be important for the FTA to consider such a provision given the global best practices.
7.7 Intangible assets With growing globalization, there is also an increasing need to focus on intangible assets like IP in nature of trade name, brand name, patent, etc and royalty payments thereto will have some peculiarities and it can be easier for the taxpayers to adopt the methodology with help of some guidance on this aspect from FTA.
7.8 Cost allocation/ Sharing agreements Be it India or Middle East, a lot of global conglomerates believe in synergising the efforts at common location or participation of various group company to achieving a common objective. Hence these kinds of arrangements are common. To help taxpayer adopt an acceptable approach some guidance from FTA could be helpful.
8. Conclusion & Way Forward
At the end this Article, we would like to quote, Shri Nanabhoy ‘Nani’ Ardeshir Palkhivala, commonly refer (renowned tax lawyer):
“Tax evasion is reprehensible: it is social injustice by the evader to his fellow citizens. Arbitrary or excessive taxation is equally reprehensible: it is social injustice by the government to the people”.
Considering that UAE is witnessing a new chapter in its evolution and hence preparedness by business is utmost important and time to act is now…!!
Transfer pricing is a reality now, gearing up is required. Documentation is the key – most companies fail to maintain and produce documents which costs heavy adjustment and penalties when FTA analyses the completeness of the compliances.
• Taking corrective action may be necessary, rather than waiting for the last moment.
• Redesigning inter-company/inter-unit pricing policies, wherever required
• Documenting inter-company/intra-company pricing policies
• Use of other method and a corroborative approach may be helpful.
• Focus should be contemporaneous, and emphasis should be given to “substance” as opposed to “form”.
