What is Transfer Pricing?
In the wake of 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. This concept may be new for many local-owned firms, resulting in many concerns about Transfer Pricing implementation issues. This blog will discuss transfer Pricing as well as its aspects for 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 with an existing connection with a business by control, ownership, or family kinship (in instances of natural people).
Naturally, related-party transactions may allow entities to shift profits artificially. Therefore, a focus on transfer Pricing is a natural part of this UAE Corporate Tax proposal. 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 justify that transfer prices are a way to make money. It is, however, beneficial to go back and add a description. One could clarify that Transfer Pricing refers to the following:
- A tax law designed to prevent abuse was enacted to enforce”arm’s length” principle “arm’s length” principle.
- That means that the costs of the goods and services that the respective parties charge must be the same as they would be where the parties involved in each transaction are connected.
The goal of the arm’s-length concept and transfer pricing (“TP”) regulations is to ensure that there isn’t any price mispricing of transfers. That can be due to abusive transfer Pricing methods, in which transfers prices are manipulated to obtain certain tax benefits that favor a set of affiliated entities.
Transfer pricing is of crucial importance to corporate taxation. Transfer prices directly impact the distribution of loss and profits to corporations subject to corporate Tax. Notably, the practices of Transfer Pricing taxpayers have an immediate impact on the tax revenues of a nation.
When the corporate tax rates of the countries concerned differ significantly, the associated parties may have a strong incentive to set their transfer prices so that they can allocate profits to the tax-free area, which reduces the total (group) global tax burden for corporations. Even when a country has lower tax rates and is not 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 in a country taxed at a rate of 32.5 percent. The company sells its manufactured items to the 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 the cost or at a low-profit percentage to Company B. Company B will be forced to sell the product with the highest possible profit margin and take the more significant part of the profits to make both companies pay corporate taxes at a lower efficient tax rate.
Tax authorities in Bangladesh are likely to audit and modify the Tax on corporate income paid by company A, thereby taxing a significant portion of the profits that the UAE taxes. Suppose company B was to pay taxes on corporate income in the UAE. In that case, company B is likely to be keen to reduce the Tax paid by the UAE to reduce and eliminate the phenomenon known as “economic double taxation” through the Transfer Pricing adjustment. That is why countries with corporate tax systems need to create legislation on transfer pricing and establish an administrative capacity to deal with the request for adjustment.
Additionally, as the accounting, legal and corporate tax rules and procedures differ from one country to the next and from country to country, it is of paramount importance to be aligned with the Transfer Pricing law to ensure that the adjustments to TP are based on the same guidelines and the Transfer Pricing procedure.
Will It Impact A UAE-Based Business?
The short answer is. The documents published by the MoF documents ( Press release and Public Consultation) clarify that UAE businesses must comply with Transfer Pricing regulations and requirements for documentation under the Transfer Pricing Guidelines.
As part of the corporate Tax introduction, The UAE will implement Transfer Pricing rules, which means that qualified transactions with related parties and those that involve connected individuals (“intercompany transaction”) will have to comply with applicable TP regulations under the principle of arm’s length as laid out 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 an entity with an existing relationship with a company through ownership or control or kinship (in cases of natural individuals).
The document also lists some of the relationships listed as related parties:
- A minimum of two or more persons connected with the 4th degree of kinship, affiliation, or kinship, for example, through marriage, birth, or adoption;
- A person or legal entity in which, either alone or in conjunction with a closely related person, the individual directly or indirectly holds at least 50% part of or controls an entity legal in nature;
- One or more legal bodies, where one legal entity or with a connected party directly or indirectly owns more than 50% of or controls another legal entity.
- A legal entity or two, if the taxpayer, either alone or in conjunction with a related person who directly or indirectly, owns at least 50% of each;
- A taxpayer and its branch or permanent establishment
- Members of the same partnership that is not incorporated; and
- Non-exempt and exempt business activities of the same individual (for instance, an exempt-free zone company).
Who Are Connected Persons?
Consultation Paper Consultation Paper stresses that in the absence of taxation on personal income in the UAE, the owners of companies that are tax deductible would be encouraged to decrease the UAE corporate tax base through excessive payments to themselves and others who are associated with them.
So, benefits or payments given by a business for the “Connected Persons” will be tax-deductible only if the company can show that the use or cost conforms to”arm’s length” or the “arm’s length principle” and the expense is solely and exclusively to serve tax payer’s work.
Connected Persons differ in comparison to Related Parties. A person is regarded 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 taxable person
- An officer or director of the tax-paying 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;
- If the tax-paying 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 generally place the onus probandi (burden of the proof) onto the taxpayer. Any taxpayer with intercompany transactions with an amount greater than a specific threshold during the applicable tax year must create documentation for TP and demonstrate that its dealings with its intercompany counterparts were conducted at “arm’s length.”
The number of transactions between companies has yet to be established & is expected to be clarified following the implementation of UAE Corporate Tax Legislation. Consultation Paper Consultation Paper specifies the mandatory TP documentation consisting of a local file and a Master file (according to the formats and content required in OECD BEPS’s Action 13 and under the World’s Best practices).
Additionally, the arm’s-length nature of the transactions should be backed by one of the internationally recognized TP methods or another method when the business can prove that the specified methods cannot be applied fairly.
If the requirements are met, companies must complete and submit a transfer Pricing disclosure form containing information about their intercompany transactions. It is unclear how it is necessary to raise the TP disclosure form that has to be filed in conjunction with your tax returns (i.e., in the first 9 (9) months from the date of expiration of the relevant period of Tax) or with a different deadline.