What is Transfer Pricing?
Since the implementation of UAE Corporate Tax (CT) within the UAE, The notion of transfer Pricing (TP) is receiving more attention in the Ministry of Finance (MoF) released Questions and Answers along with the public Consultation documents.
This idea could be new for many local-owned companies, leading to numerous concerns and Transfer Pricing considerations for implementation. The topic of this article is Transfer Pricing, and its implications within The UAE will be reviewed to provide more information for businesses.
The standard definition of the term “transfer pricing” is commonly referred to as:
“the prices of goods and services sold or purchased between the entities with associated parties.”
When a related party refers to an entity or person who has a prior connection with a business by control, ownership, or family kinship (in instances of natural people).
Naturally, related-party transactions may allow entities to shift profits artificially. Therefore, this UAE corporate tax introduction strongly emphasizes transfer pricing.
The world’s tax justice network defines Transfer Pricing as “a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens.”
Both definitions explain that transfer prices are a way to make money. But it’s helpful to go back and expand the definition. It is essential to clarify that Transfer Pricing refers to the following:
- A tax law to prevent abuse was enacted to implement the “arm’s length” principle.
- It is a requirement that the price of the goods and services that the respective parties charge must be precisely the same as they would have been being the parties involved in each transaction were connected.
The goal of the arm’s-length rule and the Transfer Pricing (“TP”) regulations is to ensure that there isn’t any price mispricing of transfers, which can be due to fraudulent transfer Pricing methods, in which the prices of transfers are deliberately manipulated to obtain certain tax benefits which benefit several related entities.
Transfer pricing is of crucial importance to corporate taxation. Transfer prices directly impact the distribution of losses and profits for companies that are who are taxed by the corporate tax. The Transfer Pricing practices of taxpayers could have an immediate impact on the tax revenues of a nation.
When the corporate tax rates of the countries concerned differ substantially, related parties might be motivated to establish their transfer rates so that they can allocate profits to the less tax jurisdiction, thus reducing the total (group) global tax burden for corporations.
Even when a country has lower tax rates and is not governed by Transfer Pricing laws, transfer mispricing can take away significant tax revenue.
Company A, a tax resident of Bangladesh, manufactures electronic devices and personal computers in a country taxed at a rate of 32.5 percent. It sells its items to the UAE-related tax-resident company Company B which pays 0 percent or 9% corporate tax on the resale of its products in third markets and UAE.
In this scenario, company A will be driven to offer the product at a price or with a lower profit percentage to Company B. In contrast; Company B will be in a position to resell the product with the highest possible profit margin and take the more significant part of the profits to ensure that both entities pay corporate taxes at a lower efficient tax rate.
Tax authorities in Bangladesh are likely to audit and modify the tax on corporate income paid by company A, thereby taxing a substantial portion of the profits that the UAE taxes. Suppose company B was to pay taxes on corporate income in the UAE.
In that case, company B is likely to be keen to reduce the tax paid by the UAE to reduce and eliminate the phenomenon known as “economic double taxation” through the Transfer Pricing adjustment. That’s why countries with corporate tax systems should create transfer pricing laws and an administrative capacity to deal with the request for adjustment.
Additionally, as accounting and legal tax laws and practices vary from country to country, It is of the utmost importance to be aligned with the Transfer Pricing law to ensure that the adjustments to TP are based on the same rules and principles as the Transfer Pricing method.
Will It Impact A UAE-Based Business?
The simple answer is yes. The official MoF documents ( Press release and Public Consultation) stipulate that UAE businesses must adhere to Transfer Pricing rules and the requirements for documentation by the Transfer Pricing Guidelines.
As part in the Corporation Tax introduction as part of the Corporate Tax introduction, the UAE will implement Transfer Pricing rules, which means that all transactions with related parties and those that involve connected individuals (“intercompany transaction”) will have to conform to the applicable TP requirements according to the principle of arm’s length that is outlined in the OECD Transfer Pricing Guidelines.
Who are the Related Parties?
In accordance with the UAE Corporate Tax Consultation Document [2(the (“Consultation Paper”), A related person is an individual or an entity with already established a connection to a business by control, ownership, or family kinship (in cases of natural people).
The document also lists these relationships in the form of related parties:
- Two or more people connected with the 4th degree of kinship, affiliation, or kinships such as marriage, birth, or adoption;
- When alone or in conjunction with a partner, a person, or a legal entity, the individual directly or indirectly holds more than 50% of this legal entity.
- A legal entity or two in which one legal entity or in conjunction with a related entity directly or indirectly, has more than 50% part in or controls each legal entity
- More than two legal entities, if an individual taxpayer or together with a partner who directly or indirectly owns 50 percent of each;
- A taxpayer, its branch, or permanent establishment
- The partners in the same unincorporated partnership and
- Business activities that are exempt and non-exempt of the same individual (for instance, an exempt-free zone-based business).
Who Are Connected Persons?
Consultation Paper Consultation Paper stresses that in the absence of taxation on personal income in the UAE, individuals who own tax-deductible companies would be encouraged to reduce the UAE corporate tax base through excessive payments to themselves and others who are associated with them.
So, benefits or payments offered by a company for the “Connected Persons” will be tax-deductible only if the company can prove that the benefit or payment conforms to”arm’s length” or the “arm’s length principle” and that the cost is incurred entirely and solely for the benefit of your business.
Connected Persons differ as Related Parties. A person is regarded as being ‘connected’ to a business in the scope of the UAE Corporate Tax regime it is:
- A person who directly or indirectly holds an ownership control or interest in the taxable person
- Director or Officer of a taxable person;
- An individual who is related to the director, owner, and Officer of the tax-paying person in four degrees of affinity or kinship, such as through marriage, birth, or adoption;
- If the tax-paying person is a member of an unincorporated partnership or any other as a partner of the same partnership and
- The term “related party” refers to a Related Party of any of the above.
What Are The Compliance Obligations?
TP rules usually shift the burden of proof (burden of evidence) on the taxpayer. It is the responsibility of any taxpayer who has intercompany transactions that have more than a certain threshold, in the applicable tax year, to create documents for TP and demonstrate that the intercompany transactions were conducted at “arm’s length”.
The value of intercompany transactions has yet to be defined and is anticipated to be clarified following the implementation of UAE Corporate Tax Legislation. This Consultation Paper specifies the mandatory TP documentation consisting of a local file and a Master File (according to the formats and content required in OECD BEPS’s Action 13 and by the World’s Best practices).
Additionally, the arm’s-length nature of the transactions must be confirmed using one of the internationally recognized TP methods or another approach when the business can prove that the method specified can’t be used reasonably.
If the requirements are met, companies must complete and submit the transfer Pricing disclosure form with details about their transactions with inter-company entities. It needs to be clarified how this TP disclosure form has to be filed simultaneously with your tax returns (i.e., in the first (9) months from the expiration of the applicable period of tax) or with an earlier date.