What is Transfer Pricing?
Since the implementation of UAE Corporate Tax (CT) for the UAE, The notion of transfer Pricing (TP) has been given greater attention in the Ministry of Finance (MoF) released Questions and Answers as well as the Public Consultation documents. In the case of many locally-owned firms, this concept may be new, resulting in various concerns about Transfer Pricing implementation issues. The topic of this article is transfer Pricing, along with its aspects within The UAE will be addressed to give further insight for businesses.
The standard definition of the term “transfer pricing” is commonly referred to as:
“the prices of goods and services sold or purchased between the entities with associated parties.”
A related party is an entity or person who has a prior relationship with a company through control, ownership or the kinship (in cases of natural people).
Naturally, related party transactions give entities the opportunity to shift profits artificially so a greater emphasis on transfer Pricing is a natural part of UAE Corporate Tax reform. The tax justice network in the world defines Transfer Pricing in terms of “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 that transfer prices are a way to make money. It is, however, beneficial to go back and add a description. It is essential to include that Transfer Pricing means:
- 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 charged by the respective parties must be precisely the same as they would be should the parties to this transaction have never been connected.
The goal of the arm’s-length concept and transfer pricing (“TP”) guidelines is to ensure that there isn’t any pricing mismatch in transfers as the result of fraudulent transfer Pricing methods, in which transfer prices are deliberately altered to gain certain tax advantages which benefit several affiliated entities.
The Transfer Pricing issue is of crucial importance to corporate taxation. Transfer prices directly impact the distribution of loss and profits to corporations that are subject to corporate tax. Notably, the practices of Transfer Pricing taxpayers have, therefore, an impact directly on a country’s tax revenues.
Suppose the tax rates for corporations of the countries concerned differ substantially. In that case, related parties may be enticed to establish their transfer rates to allocate profits to the tax-free area, reducing the total (group) global tax burden for corporations. Even if a nation has an extremely low tax rate but isn’t governed by Transfer Pricing laws, mispricing of transfers may result in substantial tax revenue being taken away.
Company A, a tax resident of Bangladesh, manufactures electronic devices and personal computers and electronic devices, which are taxed at a rate of 32.5 percent. It sells the goods to its UAE Tax resident related company Company B which pays 0 percent or corporate tax of 9% for the resales in third markets and UAE.
In this scenario, company A will be driven to sell the product for price or with a lower profit cost to company B. In contrast, Company B will be forced to sell the product with the greatest possible profit margin and take the more significant part of the profits to make both companies pay corporate tax at a low efficient tax rate.
Tax authorities in Bangladesh will be motivated to review and alter the tax on corporate income paid by company A, thereby taxing a substantial portion of the earnings taxed within the UAE. Suppose company B had paid taxes on corporate income in the UAE in the UAE. In that case, company B is likely to be keen to reduce the tax already paid in the UAE to reduce and eliminate the phenomenon known as “double economic taxation” through the transfer pricing adjustment. That is why countries with corporate tax systems, in general, need to adopt legislation regarding transfer pricing and create an administrative capacity to deal with adjustment requests.
Additionally, as the accounting, legal and corporate tax rules and tax practices vary between countries and from country to country, it is of paramount importance to conform to the Transfer Pricing laws 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 short answer is. The MoF documents ( Press release and Public Consultation) stipulate that UAE businesses must comply with Transfer Pricing regulations and the requirements for documentation under the Transfer Pricing Guidelines.
As part of the corporate Tax introduction as part of the Corporate Tax introduction, the UAE will implement Transfer Pricing regulations. That means that qualified transactions with related parties and those with persons who are connected (“intercompany transaction”) will have to conform to the applicable TP regulations in accordance with the arm’s length principle outlined in the OECD Guidelines on Transfer Pricing. Guidelines.
Who are the Related Parties?
Under the UAE Corporate Tax Consultation Document 22 (“Consultation Paper”), A related person is an individual or entity that has already established a relationship with a company through ownership or control (in cases of natural individuals).
The document also lists these relationships in the form of connected parties:
- A minimum of two or more persons who are related by the fourth degree, affiliation, or kinship, for example, through marriage, birth, or adoption;
- A person and a legal person, when alone or in conjunction with a related person, directly or indirectly holds at least 50% percentage of or controls this legal entity.
- One or more legal bodies, where one legal entity on its own or in conjunction with a related entity directly or indirectly, owns at least a 50% percentage of or controls each legal entity
- More than two legal entities, if an individual taxpayer, or together with a partner directly or indirectly, owns 50 percent of each;
- A taxpayer and its branch or permanent establishment
- The partners in the same partnership that is not incorporated; and
- Non-exempt and exempt business activities of the same individual (for example , an exempt-free zone-based business).
Who Are Connected Persons?
Consultation Paper Consultation Paper stresses that in the absence of taxation on personal income in the UAE, the owners of tax-exempt businesses will be encouraged to decrease the UAE corporate tax base through excessive payments to themselves and others associated with them.
Thus, any benefits or payments given by a business towards their “Connected Persons” will be tax-deductible only if the company can show that the use or payment conforms to what is known as the “arm’s length principle” and that the cost is incurred entirely and solely to serve tax payer’s work.
Connected Persons are distinct as Related Parties. A person is considered as being ‘connected’ to a company that falls in the scope of the UAE Corporate Tax regime it is:
- A person who directly or indirectly holds an ownership control or interest in the tax-paying person;
- Director or Officer of a taxable person;
- A person who is related to a director, owner, or another officer tax-paying person in four degrees of affinity or kinship such as through marriage, birth, or adoption;
- When the taxable person has a partnership in a partnership that is not incorporated, any other partner in the same collaboration 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. The taxpayer is responsible for intercompany transactions of an amount greater than a specific threshold in the relevant tax period to complete the TP documents and show that the transactions between its companies were conducted at “arm’s length.”
The amount of transactions between companies has yet to be defined & is anticipated to be clarified by the UAE Corporate Tax Legislation. This Consultation Paper does specify the mandatory TP documentation that will consist of a local file as well as a Master File (according according to the formats and content required in OECD BEPS Act 13 as well as in accordance the World’s Best practices).
Additionally, the arm’s-length nature of the transactions must be confirmed using one of the internationally recognized TP methods or a different approach if the company can prove that the method specified can’t be used reasonably.
If the requirements are met, companies are required to complete and submit the transfer Pricing disclosure form with information about their intercompany transactions. It is still being determined how it is necessary to raise the TP disclosure form will need to be filed simultaneously with your tax returns (i.e. at least (9) months from the expiration of the applicable fiscal period) or with a different deadline.