Introduction – Chapter 10 – Transactions with Related Parties and Connected Persons under the UAE Corporate Tax Law
The term “Transfer Pricing” refers to the process of determining the price of an international transaction between two or more Related Parties. For example, when a subsidiary company sells goods, or provides services to its holding company or a sister company, the price charged by the holding company is called the Transfer Price. The Transfer Price is the arm’s length price charged between two Related Parties, as if such a transaction were being conducted between two independent parties. Further, multinational corporations often use Transfer Pricing to allocate profits between their domestic and international branches. So, transfer Pricing in UAE are introduced under the UAE Corporate Tax Law, and are effective for FY commencing on or after June 1, 2023.
Additionally, from a tax perspective, transfer pricing strategies can be beneficial for a business but manipulating Transfer Prices to avoid taxes is strongly discouraged by regulatory authorities.
EXAMPLE:
So, let us understand this with an example.
For instance, A sold goods at AED 12 to an independent party, but its value was AED 10. So here, A earned AED 2 profit, because A wants to make a profit, but when they earn a profit, they have to pay tax on this amount, let us say at 9%, which will be AED 0.18.
However, sometimes when the same transaction is done between two or more Related Parties, there can be instances of biases. In this case, the cost will remain the same, but instead of selling the goods at AED 12, they might sell it to them at AED 11, whereby the profit is reduced from AED 2 to AED 1 and when such profit is taxed at 9%, the tax liability would be 0.09.
So, the seller reduced their Taxable Income by entering a transaction with a Related Party for a lesser consideration (generally the Related Party is exempt from tax in such cases). Moreover, in such cases, the Transfer Pricing guidelines kick in, which provide that international transactions between related parties will be done at an arm’s-length price. If you intend to avail Transfer Pricing Services in UAE, CONTACT US TODAY
Transfer Pricing in UAE – Applicability under the UAE Corporate Tax Law
To avoid any potential bias in the price of an international transaction due to the close relationship between the parties, the law lays out the rules for conducting international transactions. The UAE Transfer Pricing Rules are applicable in respect of transactions between:
- Related Parties; and
- Connected Person
To prevent any kind of manipulation of the Taxable Income, Transfer Pricing Rules are provided under UAE Corporate Tax Law.
Note: The transfer pricing rules in the UAE are aligned with the OECD’s internationally accepted transfer pricing standards. It allows Taxable Persons to use relevant guidance while refering to the application of the provisions
Article 34 : Applicability of Arm’s Length Principle for transactions under the UAE Corporate Tax Law
Under the UAE Corporate Tax Law, the arrangements or transactions between Related Parties are required to meet the ‘arm’s length principle’ for ascertaining Taxable Income of a Taxable Person as incorporated in the UAE Corporate Tax Law.
Certain conditions can also be prescribed by the Federal Tax Authority in this regard.
How to determine if the transaction or arrangement meets the Arm’s Length Standard?
Clause 2 talks about the meaning of the “arm’s length principle”. To determine if the arrangement or transaction between the Related Parties meet the arm’s length principle, it is essential to see if the outcome of the arrangement or transactions is in consistent with the outcome whereof:
- A transaction takes place between independent parties or parties that are not Related Parties or Connected Persons and
- The transaction between independent parties was conducted under a similar arrangement or circumstances.
Transfer Pricing Methods to be used for determining Arm’s Length Price
The Transfer Pricing method to be used for ascertaining arm’s length price for the transactions or arrangements undertaken between Related Parties are as follows:
- The Comparable Uncontrolled Price Method or CUP method
- The Cost-Plus Method
- The Transactional Net Margin Method or TNMM Method
- The Transactional Profit Split Method or Profit Split Method
- The Resale Price Method
Note: The order of the methods does not indicate nor imply the hierarchy of methods to be used.
To determine an appropriate arm’s length price for each transaction or arrangement, it depends on the relevant facts and circumstances and differs for each transaction or arrangement.
Combination of Methods can be used: The parties can use any of the methods or a combination of the methods to arrive at the arm’s length price.
Application of any other method to determine Arm’s Length Price:
If there is a situation that none of the methods can be applied reasonably for ascertaining the arm’s length price in a transaction, then the Taxable Person can apply any other reasonable method to determine the same.
However, the Taxable Person has to show that none of the methods under the law can be reasonably applied to the arrangement or transaction in consideration, which is why it has had to resort to the application of another method that has not been prescribed under the UAE CT Law.
Factors for Choosing and Applying Transfer Pricing Method for determining Arm’s Length Price
There are certain factors that need to be considered for choosing and applying a Transfer Pricing method. They include:
- The terms of the contract relating to the arrangement or transaction
- The arrangement or transactions’ characteristics or features
- The economic situation when the arrangement or transaction was undertaken
- The functions performed, risk assumed, and the assets used or employed by the Related Parties
- The business strategy used by the Related Parties
Examination of Income and Expenditure by Federal Tax Authority to ensure compliance with Arm’s Length Principle
The Federal Tax Authority, while examining as to whether the income and expenditure from the arrangement or transactions entered into by Related Parties arrangement satisfy the arm’s length principle, will consider:
- The Transfer Pricing method used by the parties, and
- The factors for choosing and applying the Transfer Pricing method.
Note: Also, the application of the transfer pricing methods for an acceptable arm’s length price may be a range of results or indicators (rather than an absolute number).
While applying the transfer pricing method, there may be a situation where one has arrived at various arm’s length financial results or indicators, which are acceptable for establishing the arm’s length result. This is subject to any condition by the Authority.
Transfer Pricing Adjustments by the Federal Tax Authority when the Transaction violates the Arm’s Length Principle
If there is a situation that the result of an arrangement or transaction has failed to comply with the provisions of the arm’s length principle, then the Federal Tax Authority shall make adjustments to the Taxable Income to get the proper result as per the facts and circumstances of the arrangement or transactions.
Information relied on for making Adjustments: If an adjustment is made to the Taxable Income of the Taxable Person; then, the Authority will provide the information relied on to the Taxable Person.
Corresponding Adjustments to the Taxable Income of the Related Party: Further, if the adjustments are made to the Taxable Income of the Taxable Person, the Authority will have to make corresponding adjustments to the Taxable Income of the Related Party.
Adjustments by Foreign Competent Authority: In cases, where the adjustments are made by a foreign Competent Authority for meeting arm’s length Standard, then an application is to be made to the Federal Tax Authority by the Taxable Person for corresponding adjustments in the Taxable Income.
Want to calculate your Arm’s Length Price for an International Transaction under the UAE CT Law?
Article 35 – Related Parties and Control under Transfer Pricing in UAE
The Transfer Pricing Rules applies to transactions or arrangements between Related Parties or Connected Persons. The Related Parties or Connected Persons can be located in UAE or outside UAE. It can also be a UAE Mainland entity or a Free Zone Entity.
Who is a Related Party?
A Related Party is a person (individual or juridical person) that has a pre-existing relationship with another person. Additionally, under the UAE Corporate Tax Law, it refers to any of the following parties:
a) Two or more Natural Persons
- If two or more persons are related to each other within the four degrees of:
- affiliation or,
- kinship or,
- through guardianship or,
- through adoption.
b) Natural Person and Legal Person
A juridical and natural person are said to be Related Parties if:
- Ownership Interest: The natural person is a shareholder of the juridical person and has fifty percent (50%) or more ownership interest, whether directly or indirectly in it. The Natural Person can hold such interest alone or with Related Parties.
- Control: The natural person controls the juridical person, whether directly or indirectly. The Natural Person can Control the juridical person alone or with other Related Parties.
c) Two or more Juridical Persons
Additionally, two or more juridical persons are said to be Related Parties if:
-
- Ownership Interest: A juridical person has fifty percent (50%) or more ownership interest, whether directly or indirectly in the other juridical person. Additionally, the juridical person can hold such interest alone or with Related Parties.
- Control: The juridical person Controls the other juridical person. Also, it can be directly or indirectly. Further, the juridical person can Control alone or with Related Parties.
- Any Person who has Ownership Interest or Control: Any person has fifty percent (50%) or more ownership interest, whether directly or indirectly or Control over two or more juridical persons. Also, the person can hold such interest alone or with Related Parties.
d) Two or more persons are partners in the same Unincorporated Partnership,
e) A person and its PE (Permanent Establishment) or Foreign PE
f) A person is a founder, beneficiary, trustee, etc. of the trust or foundation and its Relating Parties
What is the degree of kinship and affiliation?
First-degree of kinship and affiliation
First-degree of kinship and affiliation includes a natural person’s:
- Parents
- Children
- Parents of the spouse
- Children of the spouse
Second-degree of kinship and affiliation
Second-degree of kinship and affiliation (in addition to the first degree) includes a natural person’s:
- Grandparents
- Grandchildren
- Siblings
- Grandparents of the spouse
- Grandchildren of the spouse
- Siblings of the spouse
Third-degree of kinship and affiliation
Third-degree of kinship and affiliation (in addition to the first and second degrees) includes a natural person’s:
- Great-grandparents
- Great-grandchildren
- Uncles
- Aunts
- Nieces
- Nephews
- Great-grandparents of the spouse
- Great-grandchildren of the spouse
- Uncles of the spouse
- Aunts of the spouse
- Nieces of the spouse
- Nephews of the spouse
Fourth-degree of kinship and affiliation
Fourth-degree of kinship and affiliation (in addition to the first, second, and third degrees) includes a natural person’s
- Great-great-grandparents
- Great-great-grandchildren
- Grand uncles
- Grand aunts
- Grandnieces
- Grandnephews
- First cousins
- Great-great-grandparents of the spouse
- Great-great-grandchildren of the spouse
- Grand uncles of the spouse
- Grand aunts of the spouse
- Grandnieces of the spouse
- Grandnephews of the spouse
- First cousins of the spouse
What is the meaning of Control under the UAE Corporate Tax Law?
Control refers to the capability to exert influence over another entity. Under the UAE Corporate Tax Law, ‘Control’ can be exerted by way of:
- Voting Rights: Having fifty percent (50%) or more voting rights in the entity
- Board of Directors: Ascertaining fifty percent (50%) or more the Board of Directors of another
- Profits: Receiving fifty percent (50%) or more profits of another
- Exert Influence: Exerting significant influence on the business and affairs of the person
Further, ‘Control’ can be by agreement or by own right or in any other way.
Article 36 – Payments to Connected Persons under the UAE Corporate Tax Law
Who is a Connected Person?
So, a Connected Person under the Law refers to a person who:
- Is the owner of the Taxable Person
- Is an officer or Director of the Taxable Person
- Is a Related Party to any of the above-mentioned Connected Persons
Owner: An ‘owner’ is a natural person having ownership interest in a Taxable Person or controls such Taxable Person, whether directly or indirectly. So, in a situation where the Taxable Person is a partner in an Unincorporated Partnership, the Connected Person shall be someone who:
- Is a partner in the same Unincorporated Partnership, and
- Is a Related Party to the partner of an Unincorporated Partnership
Treatment of Payments to Connected Persons
If a benefit or payment is provided to the Connected Person by the Taxable Person, it will be deductible only in the situation where it corresponds to the Market Value for the benefit provided and is sustained entirely and specifically for the business of the Taxable Person.
So, to ascertain if the payments are in consonance with the Market Value, the Federal Tax Authority will apply the relevant provisions of Article 34 to the Connected Person.
Non-Applicability of Article 36(1) i.e., provision for treatment of payments to Connected Persons
Further, the benefit or payment provided to the Connected Person by the Taxable Person will not be deductible where a Taxable Person:
- Has traded the shares in a Recognised Stock Exchange; or,
- Is under regulatory oversight by the Competent Authority of the State or
Sufficient oversight: It is on the basis that there should be sufficient oversight from independent parties. So, this is to ensure that the pricing of transactions between the Taxable Person and its Connected Persons should not be influenced by the relationships of the parties.
Further, the Cabinet may determine any other person who shall not be able to claim deduction on a benefit or payment made to a Connected Person.
Are you a Related Party or Connected Person under the UAE CT Law? Find out the tax implications of being a Related Party or a Connected person under the UAE CT Law.
