Corporate Tax (CT) implementation in UAE was announced on 31st January 2022 by the Ministry of Finance and it was confirmed that one of the mechanisms substantiating the new tax law would be the introduction of Transfer Pricing (TP), based on the Organisation for Economic Co-operation and Development (OECD) principles.
The transactions and entities that would come under the scope of transfer pricing are to be announced in due course along with the reporting and compliance requirements.
What is transfer pricing (TP)?
TP is an intra-company market mechanism used for accounting and taxation purposes and allows for internal pricing transactions within businesses and between subsidiary companies operating under common ownership and control. The TP practice involves both domestic and cross-border transactions. For taxation purposes, the transfer price is essentially at an ‘open market’ or ‘arm’s length value for preventing tax evasion.
What is the role of OECD in transfer pricing (TP)?
OECD has been striving for the prevention of tax avoidance through its ‘Base Erosion and Profit Shifting’ (‘BEPS’) action plan for several years by establishing measures to prevent multinational businesses from evading tax by artificially shifting profits to different low or no-tax jurisdictions.
The UAE, in line with most of the developed countries, has stood by the BEPS program and the adoption of the OECD rules for TP has been a logical move as part of the introduction of CT.
What is OECD’s guidance on transfer pricing?
The essence of OECD transfer pricing guidance revolves around the ‘arm’s length principle that represents an international consensus on the valuation of cross-border transactions between associated enterprises as per OECD. Under prevailing market conditions, a value is stated to be equivalent to arm’s length if it is the same as the price that would be paid between two unrelated entities without any influence over each other.
Detailed guidance is provided by OECD on measures to test, analyze and compare the transfer price for establishing the arm’s length valuation. The prescribed formats for documentation purposes are also provided by the OECD and include Master file, Local file and Country by Country Report (CbCR).
Valuation of TP can be quite complex and needs sufficient data that influences the price to be gathered from both external and internal sources. There are five methods advocated by OECD to determine the arm’s length price.
Which UAE business will be affected?
Theoretically, all businesses will be within the scope of the transfer pricing rules however, in practice, the major effects of the TP regime will be felt by the multinational companies that are involved in transferring goods or services between group establishments. These businesses, in all likelihood, will be required to maintain the records stipulated by the OECD including the preparation of additional annual reports demanded by the FTA.
One-time transactions e.g. sale of high-value assets may also come under the TP rules and may need to be critically reviewed for evaluating TP implications even if the businesses generally don’t undertake intra-group transactions that come under the TP rules.
Family businesses in the UAE providing financial support to each other may be under greater scrutiny and may need to review their TP policies and adapt some of their practices to comply with the TP regulations.
Free zone businesses may need to take into account certain TP considerations and may need to make some additional assessments accordingly. The applicability of the arm’s length principle to such free zone businesses would need to be analyzed once the detailed TP rules are available to satisfactorily address situations where the Free Zones based companies carry out business with mainland UAE entities.
How should UAE businesses get prepared for the transfer pricing (TP) regime?
It is believed that most of the businesses in the UAE have already carried out a high-level impact assessment of the forthcoming TP regime and identified transactions to be affected by it.
Once the detailed TP requirements are issued by the FTA, businesses must undertake an optimization exercise to align existing TP policies with the OECD guidelines followed by implementation of the revised TP policies, as appropriate, by amending policy documents and contracts.
Upon successful implementation, businesses must focus on the compliance aspect and prepare the TP Master file/ Local files/ returns, wherever applicable.
The proposed UAE CT regime has kept a provision for TP for ensuring that the price of a transaction is not influenced by the relationship factor between the parties involved.