In today’s globalized marketplace, multinational enterprises (MNEs) with operations in the UAE are being closely watched like never before in relation to inter-company dealings. Following the introduction of Corporate Tax in the UAE with effect from financial years commencing on or after 1 June 2023 and the consequent release of the Transfer Pricing Guide by Federal Tax Authority (FTA) in October 2023, transfer pricing has emerged as a key compliance and tax planning issue for organizations.
So, why is transfer pricing relevant here in the UAE today? It helps ensure that transactions between related parties occur at an arm’s length, prevents BEPS (base erosion and profit shifting), protects the local tax base, and ensures business avoids stiff financial penalties.
What is Transfer Pricing and Why is Transfer Pricing Important?
Transfer pricing is the pricing of goods, services, intangibles or financial transactions between entities under common ownership or control (related parties).
The core principle, called the Arm’s Length principle, assumes a controlled transaction should be valued and priced in terms comparable to transactions between independent, unrelated entities.
The significance of transfer pricing in a business context goes beyond just tax reporting:
- Ensure safeguard of the tax revenue of the UAE from profit shifting out to low-tax jurisdictions.
- Mitigates the risk of double taxation with Mutual Agreement Procedures (MAPs) and tax treaties.
- Improves transparency and group governance of multinationals
- Links operational reviews to reality in the marketplace
- Reduces both reputation and monetary risks of tax audits
Since its joining of the OECD/G20 inclusive framework on BEPS, the UAE has implemented the OECD Transfer Pricing guidelines as its reference framework in full, making compliance not optional but compulsory.
The Five OECD-Recognized Approaches
The five methods of transfer pricing are the same as those under the OECD guidelines, and are accepted by the UAE transfer pricing rules:
Comparable Uncontrolled Price (CUP) Method:
Compares the price arising in a controlled transaction with that in comparable uncontrolled transactions. Best when used to trade in commodities, finance products and very similar items.
Resale Price Method (RPM):
Described by applicants as being used for distributors. It decreases the resale price to an independent party by an applicable gross profit margin (resale price margin) from similar uncontrolled transactions.
Cost Plus Method (CPM):
Suitable for contract manufacturers, service providers or Research and Development contributors. Adds a mark-up on costs paid to suppliers of goods or services.
Transactional Net Margin Method (TNMM):
The Most Commonly Used method in the UAE. Compare net profit margins on sales (for example operating margins, or ROS, or the berry ratio) to a relevant base (sales, costs and assets) earned in similar uncontrolled transactions.
Profit Split Method (PSM):
In the case of very integrated transactions or in the presence of unique intangibles. Distributes the aggregate profit/loss among related entities according to their proportionate contributions.
The decision of the most suitable method for a transaction depends on the facts and circumstances. There is no hierarchy, but one method must be validly justified.
Importance of Transfer Pricing Documentation
In accordance with Article 55 of the UAE Corporate Tax Law, several taxpayers are to maintain:
- Local File: Specific details regarding related party transactions.
- Master File: Top level information on the business as well as transfer pricing policy of MNE Group.
- Country-by-Country Report (CbCR): Filed by MNE Groups with consolidated annual group revenue exceeding AED 3.15 billion.
Even where the taxpayer is not subject to Master/Local File, the principle of arm length pricing will still be considered, and that simultaneous documentation is always the best evidence in an FTA audit.
Advantages and Disadvantages of Transfer Pricing
Advantages of Transfer Pricing
- Allows for the optimization of taxes and is completely legal
- Enables objective assessment of the performance of business units
- Facilitates cash flow and working capital management in multiple jurisdictions
- Helps in strategy (make-vs-buy, location of intangibles, etc.)
- Reduces lower group tax bill when compliant
Disadvantages of Transfer Pricing
- High cost of compliance (benchmarking studies, documentation, audits)
- Risk of double taxation if Arm Length Principles are disagreed by countries
- Higher risk of audit and potential fines
- Complexity to choose and implement the proper one
- Continual need to update analyses as business models change
How CBM Consultants help with Transfer Pricing?
CBM Consultants assist companies in the UAE with Transfer Pricing to comply with Arm Length Principle and Corporate Tax. We assist clients in developing transfer pricing documentation, determining the most appropriate use of transfer pricing methods, studying intercompany transactions, and completing disclosure requirements. Our economic benchmarking, responsible for intercompany policies that are compliant and for optimizing intercompany pricing structures, assists you in minimizing tax risks while remaining transparent and prepared for an audit.
Penalties for Non-Compliance
There are penalties associated with non-compliance to Transfer Pricing regulation under the UAE Corporate Tax Law, which include:
- AED 50,000 to 200,000 for not complying with transfer pricing documentation requirements.
- Late submission penalties that include adjustments with interest.
Conclusion
As the UAE has quickly evolved into a world center of business and adopted OECD standards, transfer pricing is no longer simply a tax technicality. It is an integral part of a sustainable business strategy.
Those businesses that manage their transfer pricing proactively do more than minimize tax risks and penalties. They achieve greater insight into profit drivers, process efficiencies and value contributions by entity in multiple territories.
