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UAE Corporate Tax: Transfer Pricing

Tyne Hugo Senior Associate tyne.hugo@bsabh.com
Tyne Hugo Senior Associate tyne.hugo@bsabh.com

When the Ministry of Finance (MOF) announced the implementation of corporate tax it announced that it would be following the Organization for Economic Co-Operation and Development (OECD) model. By doing so, it would also introduce a well-established principle of corporate taxation, namely the principle of transfer pricing. Transfer pricing will see a greater scrutiny placed on transactions and financial support between related companies (even if they are in Freezones). 

This article will briefly and simply consider the concept of transfer pricing.

What is transfer pricing and who does it affect?
The concept of transfer pricing focuses specifically on business transactions between related companies, common within the region, particularly between multinational companies and in some cases large family-owned businesses within the UAE that are able to control a certain market. 

Ultimately the concept prevents a business from paying less tax by exploiting a tax loophole and charging a related business a far lower or far higher fee for a transaction, thus skewing the amount of taxable income and declaring income to be much lower than what it actually is in practice. 

A simple example of this would be if Business A and Business B are owned by the same person or company. Business A is within the UAE, whereas Business B is in another country and provides management services to Business A. Business A makes AED10,000,000 in taxable income. To reduce this, Business B charges Business A a management fee of AED8,000,000 (when the actual fee would be much less) thus reducing the taxable income to only AED2,000,000 from what should have been a far higher taxable income. 

It is not only applicable to services but will equally apply to goods transferred between related entities as well.

OECD Guidelines
Although we will have to wait to see exactly what the corporate tax legislation dictates once it is finalized, as mentioned above, the MOF announced it would align itself with OECD principles. 

The OECD utilizes the “arm’s length principle” when considering transfer pricing. What this means, simply, is that any transactions between related enterprises are on the same terms as they would be if the enterprises were unrelated. Accordingly, no special treatment is given by one enterprise to the other.

The OECD provides detailed guidance on how a valuation is to be determined but in essence, five methods are used, namely the:

1) Comparable uncontrolled price method
2) Resale price method
3) Cost plus method
4) Profit split method
5) Transactional Net Margin Method.

The OECD further requires certain key documentation to be maintained by companies, the most relevant of which is a Master File and a Local File.

The Master File covers the group of related companies as a whole, while the local file focusses specifically on the company within the local jurisdiction (in this case the UAE).

What can companies do to prepare?
Until the actual legislation is finalized, it is not advisable for multinational companies to make major sweeping changes until they know exactly what to change. What companies can do, is consider the OECD concepts and principles and then self-evaluate their current position and how they operate, particularly with regards to their transfer pricing policy, to ensure they are prepared for when the legislation comes out and to properly comply with it. Failure to property prepare can lead to non-compliance with the legislation and risk the penalties that will undoubtedly be applied in such cases.

Furthermore, related companies can also register for Tax Groups provided they meet the criteria so that the whole group can be taxed rather than each entity individually. Tax Groups are not entirely new as they were introduced the with the VAT legislation, however their use may increase even more once corporate tax is implemented.

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