Understanding Intra-Group Services under the UAE’s Corporate Tax Law

Introduction

A group of companies is a set of businesses that are connected as part of one larger organisation. Let’s imagine a family conglomerate that owns a set of small businesses, including a factory, a chain of stores, and a delivery service. Since all these small businesses are owned by the same family, together they would be considered a group of companies. According to the UAE’s Cabinet Resolution No. 44 of 2020, companies are considered a "Group" if they are connected through “ownership or control” and are required to prepare Consolidated Financial Statements either for the purposes of preparing financial reports or if any of the companies in the group are publicly traded.

Now, it is likely that one of the companies in this group might require another company within the group to provide a service. The service provider in this situation may charge an amount that is not determined by the dynamics of the market forces but rather by the influence of the owners. This may result in non-arm’s length pricing of the transactions to alter the profits and thus optimising tax liabilities. This is where transfer pricing comes into play. Transfer pricing refers to the pricing of transactions between related entities and connected persons within a group. For example, the factory in the family conglomerate might need its delivery service to transport the factory’s products. When these kinds of intra-group services are provided, it’s important to ensure that the prices charged for these services, i.e., the transfer pricing, is done at arm’s length, , according to Article 34 of the UAE’s Corporate Tax Law, must be followed to ensure that transactions and arrangements between which related parties are priced as if the transactions had occurred between unrelated parties under similar circumstances.

In this blog, we will explore what qualifies as intra-group services and the importance of the arm’s length principle when such services are provided, as detailed in the UAE Federal Tax Authority’s Transfer Pricing Guide published in October 2023. We will also understand the benefits of availing such services within a group of companies and the documentation required under the UAE’s Corporate Tax Law.

What are Intra-Group Services?

The first step in determining whether intra-group services have actually been provided is to assess whether the service has added value to the recipient. The intra-group services must pass the “Benefit Test,” which has three key conditions:

1.?????? The services should offer commercial or economic value to the recipient.

2.?????? The recipient should be willing to pay for the service, even if it is provided by an independent party or done in-house.

3.?????? The service must genuinely be needed and not just performed out of convenience.

The following services are not considered intra-group services:

a)?????? Shareholder Activities: Sometimes a parent company might perform activities for its group members that those members don’t really need or wouldn’t pay for if they were independent. These activities might be done because the parent company owns the other companies or to meet certain regulatory requirements. Since these activities are based on ownership or compliance, they aren’t true intra-group services and shouldn’t be charged to the other group members.

b)????? Duplication of Services: This happens when a service is offered to a group company that has already paid for similar services, either from an independent party or in-house. However, if the duplication is done to reduce the risk of wrong business decisions or is temporary, it might still be justified.

c)?????? Incidental Benefits: Sometimes, when an intra-group service is provided to certain members of a group, other members might indirectly benefit from it. For instance, if one group member uses insights from a study conducted on structural changes within the group to gain a corporate advantage, this is considered an incidental benefit. Such benefits do not qualify as true intra-group services because they are not specifically provided to or intended for the benefiting entity.

In a Multinational Enterprise (MNE) group, there can be several layers of management overseeing different aspects of the business. These layers might include global leadership teams managing the overall strategy, regional teams focusing on specific geographic areas, and local teams handling country-specific operations. To allocate the costs of these global and regional leadership teams across all countries of operation, the MNE group must ensure that the allocation passes the benefits test. If a cost allocation does not meet the benefits test, it may need to be adjusted when determining the taxable income according to corporate tax laws. Additionally, care should be taken to avoid duplication of costs due to multiple layers of management.

Centralised services, such as IT, human resources, financial services, and legal support, are typically considered intra-group services, as companies would be willing to pay for these kinds of services to independent parties or perform them in-house.

Whenever intra-group services are provided, the following documentation needs to be prepared and maintained so that they can be produced to FTA on request:

a) A clear explanation of the intra-group services provided

b) The identity of the beneficiaries

c) A summary of the benefits received

d) The approach (direct or indirect) used to determine charges

e) The reason behind choosing allocation keys

f) Support for any markup applied

g) The relationship between the underlying costs and the services provided

Benefits of using Intra-Group Services

The benefits of using intra-group services can be enormous for a group of companies, some of which have been described here:

1.?????? Cost Efficiency: By centralising services within the group, companies can achieve cost savings. For example, instead of each company in the group having its own service provider, they can share resources that might reduce costs for the entire group. This is especially important when it comes to bulk purchasing and avoiding duplicate services across the group.

2.?????? Flexibility and Agility: When services are provided within the group, it’s easier to move resources around and respond quickly to changes in demand. For example, if one company suddenly needs more resources, another company in the group can easily step in to help, ensuring the group remains agile and responsive to market changes.

3.?????? Specialisation and Expertise: Companies within the group can access specialised skills and knowledge that might not be available elsewhere. For example, one company might have expertise in a particular area that can be shared with the rest of the group, improving the overall quality of services.

4.?????? Enhanced Coordination and Control: Centralising services within the group makes it easier to manage and control operations. This ensures that all companies in the group are aligned and working towards the same goals.

Arm’s Length Charge for Intra-Group Services

To determine the arm’s length charge for intra-group services, it's essential to assess the transaction from both the service provider's and the recipient's perspectives. This includes evaluating the service's value to the recipient and comparing it to what an independent company would pay in similar circumstances. The following Transfer Pricing methods are most commonly used for intra-group services:

a)?????? Comparable Uncontrolled Price Method (CUP)

b)????? Cost-based Method (Cost plus method)

c)?????? Transactional Net Margin Method using Cost-Based PLI (TNMM)

MNEs can use direct or indirect charge methods to determine the arm's length charge. The direct charge method is effective when services provided to related parties are also offered to independent parties in a comparable and significant manner. However, if services to independent parties are occasional or if services are centrally managed for multiple entities, the indirect charge method, involving cost allocation and apportionment, needs to be implemented. In these cases, determining the correct cost base is essential as has been detailed in the FTA’s Transfer Pricing Guide. To reduce the compliance burden on taxable persons, a simplified cost-plus 5% markup for low-value-adding services may be used. Appropriate documentation should be maintained to support the classification of these services as low-value-adding intra-group services.

Conclusion

Intra-group services within a corporate group, particularly under the UAE’s Corporate Tax Law, require meticulous attention to transfer pricing regulations for compliance. The arm’s length principle for intra-group services is essential, not only for regulatory compliance but also for preventing profit shifting and ensuring that transactions are conducted as they would be between independent entities. This is especially true for MNEs. According to the OECD’s estimates, USD 100-240 billion ( 4% -10% of global corporate income tax revenue) is lost annually through base erosion and profit shifting (BEPS). Regulations on the arm’s length principle for transactions and arrangements between two related parties at arm’s length serve as a critical tool used by tax authorities to prevent such profit shifting internationally.

Applying the arm’s length principle for intra-group services may include identifying the need for the services, determining the functions performed, assets employed, and risks assumed in performing the services, selecting the comparable, choosing the appropriate transfer pricing methods, determining the correct cost base for services provided, and maintaining comprehensive documentation to demonstrate that the charges are consistent with those that would be agreed upon between unrelated parties. The application of the arm’s length principle for intra-group services can be complex, especially for companies operating in multiple jurisdictions or dealing with varied management layers within a multinational enterprise (MNE). Accurately determining the correct charges, meeting the benefits test, and ensuring compliance with the law are essential factors for groups of companies to consider in order to navigate these challenges effectively.

Find out how AKW Consultants can help you implement the arm's length principle for your intra-group services, streamline your transfer pricing processes, optimise tax requirements, and ensure full compliance with the UAE’s Corporate Tax Law and other related regulations. ?