Transfer Pricing

Introduction of Corporate Tax

The Federal Decree-Law No. (47) of 2022 on the Taxation of Corporations and Businesses - issued 3 October 2022 (Effective 15 days after publishing in the Official Gazette), provides the legislative basis for the introduction and implementation of a federal corporate tax in the UAE and is effective for financial years starting on or after June 1, 2023.

Does a Taxable Person need to maintain a ‘local file’ for Corporate Tax?

As per Article 55(2) of the UAE Corporate Tax Decree-Law if a Taxable Person’s transactions with its Related Parties and Connected Persons for a Tax Period meet the conditions prescribed by the Minister, the Taxable Person must maintain both a master file and a local file in the form prescribed by the Authority.

Transfer Pricing Overview

Transfer Pricing Methods

The arm’s length result of a transaction or arrangement between Related Parties must be determined by applying one or a combination of the following transfer pricing methods:

Comparable Uncontrolled Price (CUP) Method The CUP Method is a transfer pricing method comparing the price of the property or services transferred in the Controlled Transaction with the price charged in comparable transactions in similar property or services in similar circumstances.
Resale Price Method (RPM) This method analyzes the price of a product that a related sales company charges to an unrelated customer, i.e. the resale price, to determine an arm’s length gross margin that the sales company retains to cover its sales, general and administrative expenses and still make an appropriate profit. The remainder of the product’s price is regarded as the arm’s length price for the transactions between the sales company and a Related Party.
Cost Plus Method (CPM) This method evaluates the arm’s length nature of an intercompany charge for tangible property or services by reference to the Gross Profit Markup on costs incurred by the supplier of the property or services. It compares the Gross Profit Markup earned by the Tested Party with the Gross Profit Markups earned by comparable companies.
Transactional Net Margin Method (TNMM) This Method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a Controlled Transaction. This is compared to the net profit margins earned in Comparable Uncontrolled Transactions.
Transactional Profit Split Method (TPS) This method seeks to eliminate the effect on profits of non-arm’s length conditions made or imposed in Controlled Transactions by determining the division of profits that independent enterprises would have expected to realize from engaging in the transactions.

Overview of Statutory Rules/Regulations/Circulars

Arm’s length principle (OECD)

The most important and enduring feature of the transfer pricing regulations is the notion of the "arm's length principle," which is the idea that, for tax purposes, a transfer price is to be determined or evaluated by comparing it to the price that would be paid in an identical (or, in practice, comparable) transaction were that transaction entered into between unrelated parties dealing at arm's length; i.e., an arm's length price.

The international standard that OECD member countries have agreed should be used for determining transfer prices for tax purposes. It is set forth in Article 9 of the OECD Model Tax Convention as follows:

where “conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”.

In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm's length result).

UAE Corporate Tax Decree-Law requires the Taxable Persons to comply with the Transfer Pricing regulations in particular the following:

Article 20 – General Rules for Determining Taxable Income

1. The Taxable Income of each Taxable Person shall be determined separately, on the basis of adequate, standalone financial statements prepared for financial reporting purposes in accordance with accounting standards accepted in the State.

2. The Taxable Income for a Tax Period shall be the Accounting Income, defined as “The accounting net profit or loss for the relevant Tax Period as per the financial statements prepared in accordance with the provisions of Article 20 (General Rules for Determining Taxable Income) of this Decree-Law” for that period, and to the extent applicable, adjusted for the following:

Any unrealised gain or loss under Clause 3 of this Article.
Exempt Income as specified in Chapter Seven of this Decree-Law.
Reliefs as specified in Chapter Eight of this Decree-Law.
Deductions as specified in Chapter Nine of this Decree-Law.
Transactions with Related Parties and Connected Persons as specified in Chapter Ten of this Decree-Law.
Tax Loss relief as specified in Chapter Eleven of this Decree-Law.
Any incentives or special reliefs for a Qualifying Business Activity as specified in a decision issued by the Cabinet at the suggestion of the Minister.
Any income or expenditure that has not otherwise been taken into account in determining the Taxable Income under the provisions of this Decree-Law as may be specified in a decision issued by the Cabinet at the suggestion of the Minister.
Any other adjustments as may be specified by the Minister.

Article 34 – Arm’s Length Principle

In determining Taxable Income, transactions and arrangements between Related Parties must meet the arm’s length standard.
A transaction or arrangement between Related Parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realised if Persons who were not Related Parties had engaged in a similar transaction or arrangement under similar circumstances.
The arm’s length result of a transaction or arrangement between Related Parties must be determined by applying one or a combination of the following transfer pricing methods:
- The comparable uncontrolled price method.
- The resale price method.
- The cost-plus method.
- The transactional net margin method.
- The transactional profit split method.
The choice and application of a transfer pricing method or combination of transfer pricing methods must be made having regard to the most reliable transfer pricing method and taking into account following factors:
- The contractual terms of the transaction or arrangement.
- The characteristics of the transaction or arrangement.
- The economic circumstances in which the transaction or arrangement is conducted.
- The functions performed, assets employed, and risks assumed by the Related Parties entering into the transaction or arrangement.
- The business strategies employed by the Related Parties entering into the transaction or arrangement.
The Authority’s examination as to whether income and expenditures resulting from the Taxable Person’s relevant transactions or arrangements meet the arm’s length standard shall be based on the transfer pricing method used by the Taxable Person provided such transfer pricing method is appropriate
Application of the selected transfer pricing method or combination of transfer pricing methods may result in an arm’s length range of financial results or indicators acceptable for establishing the arm’s length result of a transaction or arrangement between Related Parties.
Where the result of the transaction or arrangement between Related Parties does not fall within the arm’s length range, the Authority shall adjust the Taxable Income to achieve the arm’s length result that best reflects the facts and circumstances of the transaction or arrangement.
Where the Authority makes an adjustment to the Taxable Income the Authority shall rely on information that can or will be made available to the Taxable Person.
Where the Authority or a Taxable Person adjusts the Taxable Income for a transaction or arrangement to meet the arm’s length standard, the Authority shall make a corresponding adjustment to the Taxable Income of the Related Party that is party to the relevant transaction or arrangement.

Article 35 – Related Parties and Control

“Related Parties” means any of the following:

Two or more natural persons who are related within the fourth degree of kinship or affiliation, including by way of adoption or guardianship.
A natural person and a juridical person where:

1) the natural person or one or more Related Parties of the natural person are shareholders in the juridical person, and the natural person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in the juridical person; or

2) the natural person, alone or together with its Related Parties, directly or indirectly Controls the juridical person.

Any Person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in or Controls such two or more juridical persons.

“Control” means the ability of a Person, whether in their own right or by agreement or otherwise to influence another Person, including:

The ability to exercise 50% (fifty percent) or more of the voting rights of another Person.
The ability to determine the composition of 50% (fifty percent) or more of the Board of directors of another Person.
The ability to receive 50% (fifty percent) or more of the profits of another Person.
The ability to determine, or exercise significant influence over, the conduct of the Business and affairs of another Person.

Article 36 – Payments to Connected Persons

A payment or benefit provided by a Taxable Person to its Connected Person shall be deductible only if and to the extent the payment or benefit corresponds with the Market Value of the service, benefit or otherwise provided by the Connected Person and is incurred wholly and exclusively for the purposes of the Taxable Person’s Business.

A Person shall be considered a Connected Person of a Taxable Person if that Person is:

An owner of the Taxable Person.
A director or officer of the Taxable Person.
A Related Party of any of the Persons i.e Owner, Director or 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.

To determine that a payment or benefit provided by the Taxable Person corresponds with the Market Value of the service or otherwise provided by the Connected Person in exchange, the arm’s length provisions shall apply.

Article 55 – Transfer Pricing Documentation

The Authority may, by notice or through a decision issued by the Authority, require a Taxable Person to file together with their Tax Return a disclosure containing information regarding the Taxable Person’s transactions and arrangements with its Related Parties and Connected Persons in the form prescribed by the Authority.
If a Taxable Person’s transactions with its Related Parties and Connected Persons for a Tax Period meet the conditions prescribed by the Minister, the Taxable Person must maintain both a master file and a local file in the form prescribed by the Authority.
The documentation under Clause 2 of this Article must be submitted to the Authority within (30) thirty days following a request by the Authority, or by any such other later date as directed by the Authority.
Upon request by the Authority, a Taxable Person shall provide the Authority with any information to support the arm’s length nature of the Taxable Person’s transactions or arrangements with its Related Parties and Connected Persons, within (30) thirty days following the request by the Authority, or by any such other later date as directed by the Authority.