Exploring Transfer Pricing: Key FAQs for Companies in the U.A.E.

Question #1. What is transfer pricing and how is it applicable to the U.A.E. companies?

The recently introduced regulations on the corporate income tax in the U.A.E. require that the companies, which are subject to the corporate tax, should prepare and present to the tax authorities specific documentation on their transactions with the related parties. By Article 55 para 2 of the Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses, the companies should maintain both master and local files.?

Thus the UAE tax authorities introduce so-called transfer pricing regulations, which have been implemented in over 60 countries globally. The pioneer in these regulations was the US government, which first introduced the transfer pricing regulations back in 1994. In 1996 the OECD issued the first transfer pricing guidelines, which were further expanded in 1996 and 2010. The OECD guidelines have been formally adopted by many European Union countries, 19 of 20 members of G20 and many other countries.

Transfer pricing (TP) legislation around the world has a single key objective: to ensure that the tax base is properly calculated when the parties can manipulate transaction prices. In particular, to ensure that the related parties do not agree on such terms and conditions that lead to tax avoidance, e.g. by shifting transactional profits to a jurisdiction with a lower tax burden.

TP rules are established and commonly used to set the rules of the game. The core base of TP regulation is the arm’s length principle, which means the results of the transaction or arrangement are consistent with those that would have been realised between unrelated parties in a similar transaction or arrangement under similar circumstances.

The key definitions under any TP regulations usually include:

• related parties (usually the parties that have an impact on one another) (see Question #3 below),
• controlled transactions (or simply transactions between the related parties, which are subject to TP control by local tax authorities),
• TP methods (a way of confirming that prices are arm’s length) (see Question?#4 below),
• TP documentation (compliance documents to be submitted to the tax authorities) (see Question?#2 below).

The breach of the TP rules may lead to additional tax and penalties for underpayment of taxes, as the tax authorities will have the right to adjust the prices in controlled transactions and calculate the taxable income as if the parties contracted based on the arm’s length principal. The amount of additional tax is usually significant, TP audit and related communication with the tax authorities is time-consuming and complicated due to many uncertainties and details of each particular case.?

Therefore, it is strongly recommended to prepare price justification / TP compliance documents in advance and, ideally, to include TP planning and control in the company's business processes.

Question #2. What transfer pricing documentation should the U.A.E. companies maintain and what are the contents of the TP documentation?

Under Article 55 of the Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses, transfer pricing documentation is “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”. A Taxable Person should maintain both a master file and a local file, again, “in the form prescribed by Authority”.?

At the moment, the U.A.E. regulations do not provide any explanations on what exactly should master file and local file contain. Still, as the rules are based on OECD TP Guidelines, we can assume that the contents can be similar.

The master file should contain standardised information relevant to all MNE (multinational enterprise) group members. In particular, an overview of the MNE group business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity to assist tax administrations in evaluating the presence of significant TP risk during the analysed financial year and so forth.?

Clause 5.19 of the OECD TP Guidelines describes the master file as a “blueprint” of the MNE group. Its contents can be grouped into five categories (Annex I to Chapter V of the OECD TP Guidelines):?

• the MNE group’s organisational structure;?
• a description of the MNE’s business or businesses (e.g. supply chain for the group’s main products/services, main geographic markets, a brief functional analysis describing principal contributions to value creation, important business restructuring transactions during the analysed period);?
• the MNE’s intangibles, IA (intangible assets), including the overall MNE’s strategy for the development, ownership and exploitation of intangibles, list of? groups of IA and location of main R&D facilities and R&D management;?
• the MNE’s intercompany financial activities (e.g. description of how the group is financed, including important arrangements with unrelated or/and related entities which, inter alia, provide a central financing function of the group);?
• the MNE’s financial and tax positions (the MNE’s annual consolidated financial statement for the fiscal year, and tax rulings and agreements, if any).

The Local file contains information about the specific material transaction(s) of the local taxpayer. According to Clause 5.22 and Annex II to Chapter V of the OECD TP Guidelines, such information can be divided into three main sections and should include the following:

1. local entity:

• a. the management structure of the local entity, a local organisation chart, and a description of the individuals to whom local management reports (and their location);
• b. a detailed description of the business and business strategy pursued by the local entity including an indication of whether the local entity has been involved in or affected by business restructurings or intangibles transfers in the analysed or past year;
• c. key competitors.

2. controlled transactions:

• a description of the material controlled transactions, the context in which such transactions take place, related companies involved and the value of such transactions (i.e. payments and receipts);
• copies of all material intercompany agreements (related to the analysed transaction) concluded by the local entity;
• a detailed comparability and functional analysis (see Question?#6 below) of the taxpayer and relevant associated enterprises concerning each documented category of controlled transactions;
• an indication of the most appropriate TP method for each analysed transaction and the reasons for selecting that method;
• selection of the tested party, if applicable, and an explanation of the reasons for this selection;
• a summary of the important assumptions made in applying the TP methodology;
• a list and description of selected comparable uncontrolled transactions (internal or external), if any, and their financial indicators relied on in the TP analysis, including a description of the comparable search methodology and the source of such information;
• any comparability adjustments performed – if applicable;
• conclusion whether the analysed transactions were priced on an arm’s length basis based on the application of the selected TP method;
• summary of financial information used in applying the TP methodology;
• copy of existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and which are related to controlled transactions described above – if applicable.

3. financial information

• annual local entity financial accounts for the fiscal year concerned;
• information and allocation schedules showing how the financial data used in applying the TP method may be tied to the annual financial statements.
• summary schedules of relevant financial data for comparables used in the analysis and the sources from which that data was obtained.

Question #3. What are the related parties under the U.A.E. tax regulations?

When analyzing international transfer pricing (TP) practice, parent companies, subsidiaries, associate firms, JVs, or other entities that can significantly influence, manage/ control the transaction terms can be treated as related parties. Related parties include not only parties within the same corporate group but also those, which have a link of direct or indirect control, incl. control over the board of directors.

According to the Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses (Art.?35), a related party relationship in the U.A.E. includes an ownership interest of ≥ 50% in a legal entity (LE), namely:

1. Individuals who are related within the fourth degree of kinship or affiliation, incl. by way of adoption or guardianship.
2. Individuals and LEs (incl. the participation of individual’s related parties): (1) with at least 50% share of direct or indirect participation, (2) with direct or indirect control of an individual over the LE.
3. Legal entities (all shares incl. with the participation of its related parties): (1) direct or indirect interest of at least 50% of one legal entity in another, (2) direct or indirect control of one LE over another, (3) direct or indirect participation of one person in two or more LEs with an interest of ≥ 50% or control over them.
4. A person and its permanent establishment.
5. Partners in a joint partnership without forming a legal entity,
6. Persons who are trustees, founders or beneficiaries of a trust or foundation, and their related parties.

Question #4. What transfer pricing methods are used to prove that the transactions between the related parties are on an arm’s length basis?

According to the OECD TP Guidelines, the commercial and financial transactions between related parties must comply with the arm's length principle.?

To ensure your organization's profits from intercompany transactions are on an arm’s length basis, you can apply several TP methods to determine arm’s length transfer prices for such transactions.?

The TP methods defined in OECD TP Guidelines:

1. Comparable uncontrolled price method (CUP)
2. Resale price method (RP)
3. Cost plus method (СР)
4. Transactional net margin method (TNMМ)
5. Transactional profit split method (PS).

The first three of them are the traditional methods, while the others – are the cost-benefit-based analysis methods. The Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses (art.?34) provides the same TP methods list. Below we provide some details on each of them.

CUP method is applied to determine whether the price used in a controlled transaction corresponds to market prices, if there is at least one comparable transaction involving identical (or homogeneous) goods (work and services) on the relevant market and if there is enough information on such a transaction.

RP method is based on a comparison of the gross profit margin received by a person in the subsequent sale (resale) of goods purchased by him in the analyzed transaction, with the market gross profit margin range.

CP method is based on a comparison of the gross margin on costs of the party to the analyzed transaction, with the market range of gross margin on fees in comparable transactions.

TNMM analyzes profitability at the operating profit level, which is less affected by differences in transaction terms and more resistant to minor functional differences between controlled and market transactions compared to the gross profitability used under the RP and CP methods.

PS method consists in comparing the actual allocation between the parties of the total profit received from the transaction with the allocation of profit between the parties to comparable transactions.

To obtain the most reliable results of the market price level, a taxpayer can apply the combination of TP methods.

Question #5. What is the benchmarking study?

According to Article 34 of the Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses, a transaction between related parties must meet the arm’s length principle. To verify that an analyzed transaction corresponds to this principle, special research, so-called comparability analysis, should be performed.

Currently, the U.A.E. regulations do not provide for the definition of the comparability analysis or how to perform it. However, as the U.A.E regulations are broadly in line with the OECD TP guidelines, the provisions of the latter can be used for interpretation.?

Under the OECD TP Guidelines, the comparability analysis is an analysis of whether the conditions of transactions between related parties differ from the conditions that would be obtained in comparable uncontrolled transactions. The parties to comparable uncontrolled transactions with functional and risk profiles similar to a taxpayer’s, are called “comparables”. These comparables can be divided into two groups:?

• internal comparable (between a party to the controlled transaction and an independent party);
• external comparable (between two independent enterprises).?

The identification of external comparables is called benchmarking study and can be performed in two ways:

1. Addictive approach – involves compiling a list of third parties believed to perform potentially comparable transactions (e.g., a taxpayer’s competitors); further, the information is collected on transactions concluded by these third parties to confirm whether they are acceptable comparables, based on the pre-determined comparability criteria. The main obstacle to this approach is that there may be not enough information on potential comparables, for example, no financial data available.?
2. Deductive approach – used more frequently and starts with a wide set of companies that operate in the same sector of activity, perform similar broad functions and do not present different economic characteristics. The list is then refined using selection criteria and publicly available information (e.g. from databases, Internet sites, etc.). In practice, the “deductive” approach typically starts with a search on a database.?

The deductive approach is more reproducible and transparent and is used more frequently. At the same time, the quality of the outcome of this approach depends on the quality of the search tools on which it relies.?

Questions #6. What is the TP functional analysis??

Functional analysis is aimed at identifying the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to the controlled transactions.

Functional analysis is crucial to the overall TP analysis and is the basis for the choice of the TP method and the tested party. The Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses (Article 34) outlines the principle but provides no further explanation.

Under Clause 1.51 of the OECD TP Guidelines, the functional analysis is necessary to delineate the controlled transaction and determine comparability between controlled and uncontrolled transactions or entities because in transactions between two independent enterprises compensation usually reflects the functions that each enterprise performs (considering account assets used and risks assumed).

The functional analysis focuses on what the parties do and the benefits they provide. These include decision-making (incl. decisions about business strategy and risks). Therefore, it may be helpful to understand the structure and organisation of the MNE group and the interdependence of the functions inside the group.

As a process, functional analysis is the collection and structuring of information about the actual segregation of functions, risks and assets between the parties to a transaction.?

Functional analysis is a link between several stages of the analysis of controlled transactions: preliminary analysis, data collection and the analysis of the transfer price itself and the conclusion regarding its compliance with the arm’s length level.

At ADE Professional Solutions, we have over a decade of experience, specialising in addressing a wide range of transfer pricing challenges across various industries and jurisdictions. We are well-equipped to provide expert assistance and answer any additional questions you may have.