What is Transfer Pricing?
Since the implementation of UAE Corporate Tax (CT) for the UAE, The notion of Transfer Pricing (TP) has been given more attention in the Ministry of Finance (MoF) released Questions and Answers along with the public Consultation documents. In the case of many locally-owned companies, this idea may be a new concept, resulting in a variety of issues as well as Transfer Pricing implementation issues. The topic of this article is theTranfer Pricing as well as its implications within The UAE will be addressed to give further insight to business owners.
The standard definition of transfer pricing is often referred to as:
“the prices of goods and services sold or purchased between the entities with associated parties.”
A related party refers to an individual or entity with a prior relationship with a company through control, ownership, or kinship.
Naturally, related party transactions allow entities to manipulate profit shifts, so a greater emphasis on transfer Pricing is a natural part of UAE Corporate Tax reform. The world’s tax justice network defines Transfer Pricing as “a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens.”
Both definitions offer the reasoning behind the concept of transfer price. But it’s helpful to step back and add a description. One could clarify that Transfer Pricing refers to the following:
- A tax law to prevent abuse was enacted to implement the “arm’s length” principle.
- It is a requirement that the price of the goods and services that are charged between the parties involved should be precisely the same as they would be should the parties to each transaction been connected to one another.
The goal of the arm’s-length concept and transfer pricing (“TP”) regulations is to ensure that there are no instances of pricing mismatch in transfers resulting from fraudulent transfer Pricing methods. In which transfer prices are deliberately altered to obtain certain tax benefits that favor a set of related entities.
The Transfer Pricing issue is vital importance to corporate taxation. Transfer prices directly impact the distribution of losses and profits for companies that are that are subject to corporate tax. The Transfer Pricing practices of taxpayers could have an impact now on the tax revenues of a nation.
Suppose the tax rates for corporations of the countries concerned differ substantially. In that case, related parties may have a strong incentive to set their transfer prices in a manner that distributes profits to the less tax jurisdiction, thus reducing the total (group) global tax burden on corporations. Even when a country has a meager tax rate but needs to be governed by Transfer Pricing legislation, mispricing transfers may cause significant tax revenue to be wasted.
Company A, which is tax resident of Bangladesh, manufactures electronic devices and personal computers and electronic devices, in which the corporate tax rate is 32.5 percent. It sells the goods to its UAE-related tax-resident company Company B which pays 0 percent or corporate tax of 9% for the resales in third markets and UAE.
In this case, Company A will be able to offer the product at a price or with a lower profit cost to company B. In contrast, Company B will be driven to sell the product with the highest possible profit and to take the more significant portion of the gains to make both companies pay corporate tax at a low amount.
Tax authorities in Bangladesh will be motivated to audit and modify the tax on corporate income paid by company A, thereby taxing a substantial portion of the profits that the UAE taxes. If the company B had paid corporation tax within the UAE and the company B is likely to be looking to lower the tax paid by the UAE to reduce and eliminate the phenomenon known as “economic double taxation” through the transfer Pricing adjustment. This is the reason why countries that have an established corporate tax system in general, must adopt legislation regarding transfer pricing and specify an administrative capacity to deal with adjustments requests.
Additionally, as legal, accounting and corporate tax rules and procedures differ between countries It is of the utmost importance to be aligned with the Transfer Pricing law to ensure that the appropriate TP adjustments adhere to the exact guidelines and the Transfer Pricing method.
Will It Impact A UAE-Based Business?
The simple answer is yes. The official MoF documents ( Press release and Public Consultation) clarify that UAE businesses must be in compliance with Transfer Pricing regulations and the requirements for documentation in accordance with the Transfer Pricing Guidelines.
As part in the Corporation Tax introduction as part of the Corporate Tax introduction, the UAE will implement Transfer Pricing regulations. That means that all transactions between related parties and persons who are connected (“intercompany operations”) will have to conform to the applicable TP regulations under the principle of arm’s length outlined in the OECD Guidelines on Transfer Pricing. Guidelines.
Who are the Related Parties?
In accordance with the UAE Corporate Tax Consultation Document 22 (“Consultation Paper”) A related party is an individual an entity with an existing connection to a business by ownership or control or kinship (in instances of natural people).
The document also lists these relationships in the form of connected parties:
- Two or more people who are related by the fourth degree or affiliation such as marriage, birth, or adoption;
- A person as well as a legal person when either alone or in conjunction with a related person directly or indirectly holds more than 50% percent of an entity legal in nature;
- One or more legal bodies in which one legal entity on its own or with a related entity directly or indirectly, holds at least a 50% percentage of or controls another legal entity.
- A legal entity or two, if an individual taxpayer, or in conjunction with a related person who directly or indirectly, owns 50 percent of each or is the sole owner;
- A taxpayer and its branch or permanent establishment
- Members of the same partnership that is not incorporated; and
- Non-exempt & exempt business activities of the same individual
Who Are Connected Persons?
Consultation Paper Consultation Paper stresses that in the absence of taxation on personal income in the UAE, individuals who own tax-deductible companies would be encouraged to reduce the UAE corporate tax base through excessive payments to themselves and others associated with them.
So, benefits or payments offered by a company for their “Connected Persons” will be tax-deductible only if the company can prove that the price is under the “arm’s length principle” and that the cost is incurred solely & exclusively to serve tax payer’s work.
Connected Persons differ as Related Parties. A person is considered as being connected to a business in the scope of the UAE Corporate Tax regime it is:
- A person who either directly or indirectly owns ownership of, or control over the tax-paying person;
- Director or Officer of the tax-paying person;
- A person who is related to the director, owner, and Officer of the tax-paying person in an extent of the 4th degree of family kinship, for example, through marriage, birth, or adoption;
- When the person who is taxable has a partnership in a partnership that is not incorporated or any other partner of the same alliance is also taxable.
- The term “related party” refers to a Related Party of any of the above.
What Are The Compliance Obligations?
TP rules usually place the onus probandi (burden of evidence) onto the taxpayer. Any taxpayer with intercompany transactions exceeding a certain threshold during the applicable tax year must create the Transfer Pricing documents & show that it’s dealing with intercompany counterparts “arm’s length.”
The number of transactions between companies still needs to be established, and it is anticipated to be clarified after the implementation by the UAE Corporate Tax Legislation. This Consultation Paper does specify the necessary TP documentation to consist of a local file along with a Master file (according according to the formats and content required in OECD BEPS Act 13 as well as in accordance to World’s Best practices).
Additionally, the arm’s-length nature of the transactions should be confirmed using any of the internationally accepted TP methods or a different approach when the business is able to prove that the method specified can’t be applied in a fair manner.
If the requirements are met, companies must complete and submit a transfer Pricing disclosure form with details about their transactions with intercompany entities. It remains to be determined what this TP disclosure form will need to be filed simultaneously with when filing the tax return (i.e., at least (9) months from the expiration of the applicable fiscal period) or in a different timeframe.