The Organisation for Economic Co-operation and Development (OECD), as a part of the base erosion and profit shifting (BEPS) project, released 15 action plans in 2015 to address tax challenges to ensure fair taxation based on economic activities and value creation.
On 16 May 2018, the United Arab Emirates (UAE) joined the OECD’s Inclusive Framework (IF), committing to adopting the key BEPS minimum standards in the short term:
When a transfer pricing adjustment is initiated, either by the FTA or the taxpayer, a corresponding adjustment can be made to the taxable income of the local related party. If the transfer pricing adjustment is initiated by a foreign tax authority, the taxable person has the option to request a corresponding adjustment from the FTA through MAP.
The UAE transfer pricing rules are not applicable to connected persons in the following scenarios:
Compliance with the UAE transfer pricing rules requires a free zone person to apply the arm’s length standard to a transaction involving related parties and connected persons, along with maintaining adequate transfer pricing documentation.
Meeting all the conditions outlined in the UAE Corporate Tax Law is imperative for Free Zone Persons to avail themselves of the 0% corporate tax rate, making the UAE transfer pricing rules a crucial aspect of eligibility.
A Tax Group is considered to be a single taxpayer for purposes of calculating taxable income under the UAE corporate tax law.
Transactions among entities within the same Tax Group are exempt from the application of the UAE transfer pricing rules, because they are consolidated for tax purposes. However, if a member of a Tax Group transacts with a related party outside its Tax Group, the transfer pricing rules will be applicable.
There are certain exemptions when transactions between members of a Tax Group are required to adhere to the arm’s length standards. They include:
If qualifying group conditions are not met or if qualifying group relief is not elected by the taxpayer, transfers are taxed at the normal tax rate prescribed under the Corporate Tax law, following the arm's length standard.
Qualifying group relief becomes void if within two years of such transfer:
Interest Deductions (Article 31)
Net interest expenditure is deductible, but only up to 30% of earnings before interest, tax, depreciation, and amortization (EBITDA).
No interest deduction will be allowed on loans from a related party for:
In line with the OECD transfer pricing guidelines, the UAT tranfer pricing rules introduced three-tiered documentation requirements, which includes a local file, a master file, and CbCR (subject to a threshold). In addition, taxpayers are required to submit a transfer pricing disclosure form providing details of their related-party transactions.
The transfer pricing documentation requirements are summarized below:
Exemptions:
Even if the prescribed threshold for maintenance of a local file and a master file is not met, taxpayers are still required to adhere to the arm’s length principles. Therefore, it is crucial for taxable persons to have sufficient documentation (transfer pricing policy) in place, outlining the nature of related-party transactions, functional analysis of the entities involved in the transactions, and methodology adopted to substantiate the arm’s length nature of the related-party transactions.
Inadequate documentation may lead to penalties, fines, and the risk of double taxation in multiple jurisdictions. It may also result in difficulties justifying the arm’s length nature of related-party transactions, potentially leading to adjustments in pricing strategies.
Further, taxpayers need to have formalized agreements defining the nature of a transaction, the terms of intercompany transactions, the roles and responsibilities of the parties involved in the transactions, and the pricing methodology.
It is equally important to review the existing legal structure and assess if any restructuring is warranted to reap the benefits available under the corporate tax/transfer pricing regime, keeping in mind the general anti-abuse rules (GAAR).
Finally, taxpayers should make sure the existing intercompany agreements are aligned with the actual substance of the transactions.
Ashish Athavale
Brian Conn
Mufaddal Safdari
Anshul Sharma
Manani Pratik
BDO in United Arab Emirates
On 16 May 2018, the United Arab Emirates (UAE) joined the OECD’s Inclusive Framework (IF), committing to adopting the key BEPS minimum standards in the short term:
- Action 5 - Measure against harmful tax practices
- Action 6 - Model provisions against treaty abuse
- Action 13 - Transfer pricing documentation and country-by-country reporting (CbCR)
- Action 14 - Enhancing dispute resolution mechanisms through the mutual agreement procedure (MAP)
Scope of Transfer Pricing Rules
The UAE transfer pricing rules are applicable to all transactions or arrangements between related parties and connected persons. This includes:- Cross-border transactions as well as domestic transactions, including those between Free Zone entities.
- Transactions between the mandated and non-mandated activity segment of the government entity.
- Exempt entities or entities that have elected small business relief are required to follow the arm’s-length standard for intercompany transactions or arrangements. However, they are not obligated to prepare and maintain a local file and a master file.
BDO Insight
While the UAE transfer pricing rules are broadly aligned with the OECD transfer pricing guidelines when it comes to related parties, including transactions with connected persons within the ambit of the transfer pricing regime is somewhat of an outlier move.The Arm’s Length Principle (Article 34)
Any transactions or arrangements between related parties or connected persons must follow the arm's length standard. A transaction or arrangement is considered to be arm’s length if the results of the transaction or arrangement are consistent with the results that would have been realized between unrelated parties engaged in a similar transaction or arrangement under similar circumstances.BDO Insight
The arm’s-length principle as defined in the transfer pricing rules is in line with the OECD transfer pricing guidelines. Further, the arm’s-length principle must be applied to all intercompany transactions, irrespective of thresholds or conditions.Transfer Pricing Adjustments (Article 34)
If a transaction or arrangement between related parties and connected persons does not meet the arm’s length standard, the FTA can adjust the taxable person’s taxable income or loss to align with the arm's length standard.When a transfer pricing adjustment is initiated, either by the FTA or the taxpayer, a corresponding adjustment can be made to the taxable income of the local related party. If the transfer pricing adjustment is initiated by a foreign tax authority, the taxable person has the option to request a corresponding adjustment from the FTA through MAP.
BDO Insight
The corresponding adjustment by the FTA based on an original adjustment initiated by a foreign tax authority ensures a more equitable tax framework. This reduces the risk of double taxation for companies operating in the UAE.Related Parties and Control (Article 35)
- The primary condition for the application of the UAE transfer pricing rules is to have a related-party relationship established between two or more entities or individuals. The term “related parties” includes both natural and juridical persons who have direct or indirect relationships through kinship, ownership, or control.
- The UAE Corporate Tax Law identifies the following individuals and legal entities as related parties:
- Fourth degree of kinship – Individuals related up to the fourth degree of kinship or affiliation, including through adoption or guardianship.
- Direct or indirect ownership and control - An individual or legal entity, along with its related parties, directly or indirectly own at least 50% of other legal entity or control such legal entity.
- Common ownership and control - A person (individual or legal entity) along with its related parties, directly or indirectly own at least 50% of such two or more legal entities or control such legal entities.
- A person and its domestic or foreign permanent establishment.
- Partners in the same unincorporated partnership, and the trustee, founder, settlor, or beneficiary of a trust or foundation, are also classified as related parties.
- Exercising 50% or more voting rights of the other person;
- The ability to appoint 50% or more of the board of directors of the other person;
- Being entitled to 50% or more of the profits of the other person;
- The ability to exercise significant influence over the conduct of a business of the other person.
- Debt-based influence: A loan from a person that constitutes 50% or more of the total capital of another person's business.
- Entitlement to profits: Royalty arrangement that entitles a party to 50% or more of the profits generated by another person from the use of such intangible property.
- Management Function: Ownership by a person is below 50%, but the key management functions of another person are performed by that person.
BDO Insight
The UAE Corporate Tax Law provides a broader definition of related parties than the OECD transfer pricing guidelines. It is essential for taxpayers to accurately identify these relationships to determine if they fall under the definition of related parties and connected persons.Payments to Connected Person (Article 36)
The following persons are considered connected persons:- The owner of a taxable person
- A director or officer of a taxable person, i.e., the key managerial personnel (KMP), such as directors, CEOs, CFOs, and heads of departments.
- Related parties of the above individuals, including any relatives of the owner or KMPs.
The UAE transfer pricing rules are not applicable to connected persons in the following scenarios:
- If the shares are traded on a recognised stock exchange.
- If the taxable person is subject to the regulatory oversight of a competent authority in the UAE.
- Any other person as may be determined in a decision issued by the Cabinet Minister.
BDO Insight
Any compensation paid to KMPs may fall under the ambit of the transfer pricing regime. The onus rests on the taxable person to document the basis for arriving at the compensation paid to KMPs, including any external benchmarking, to support the same.Interplay between Corporate Tax and Transfer Pricing
Free Zone Persons (Article 18)
The UAE Corporate Tax law allows Qualifying Free Zone Persons (QFZP) to avail themselves of a 0% corporate tax rate on qualifying income, provided they meet specified criteria, including adherence to the arm’s length standard.Compliance with the UAE transfer pricing rules requires a free zone person to apply the arm’s length standard to a transaction involving related parties and connected persons, along with maintaining adequate transfer pricing documentation.
Meeting all the conditions outlined in the UAE Corporate Tax Law is imperative for Free Zone Persons to avail themselves of the 0% corporate tax rate, making the UAE transfer pricing rules a crucial aspect of eligibility.
BDO Insight
One of the conditions to avail freezone relief is compliance with the TP Rules. Failure to meet TP compliance requirement may result in the loss of free zone status for the current year and the subsequent four years.Tax Grouping (Article 42)
UAE resident juridical persons have an option to form a Tax Group, if the parent company (a UAE resident) holds at least 95% of the share capital and voting rights of its UAE-resident subsidiaries.A Tax Group is considered to be a single taxpayer for purposes of calculating taxable income under the UAE corporate tax law.
Transactions among entities within the same Tax Group are exempt from the application of the UAE transfer pricing rules, because they are consolidated for tax purposes. However, if a member of a Tax Group transacts with a related party outside its Tax Group, the transfer pricing rules will be applicable.
There are certain exemptions when transactions between members of a Tax Group are required to adhere to the arm’s length standards. They include:
- If the member of the Tax Group has unutilised pre-grouping tax losses
- If a member of the Tax Group is eligible to claim a foreign tax credit (FTC)
- A member of the Tax Group benefits from any specified incentives
- A member of the Tax Group has unutilised carried forward pre-grouping net interest expenditure
BDO Insight
Forming a Tax Group may result in relaxed transfer pricing obligations.Transfer of Assets or Liabilities within Qualifying Group (Article 26)
The UAE Corporate Tax law allows the formation of a “qualifying group”, subject to specific conditions. Within a qualifying group, transfers or restructuring of assets/liabilities among members are valued at net book value to prevent taxable gain or loss.If qualifying group conditions are not met or if qualifying group relief is not elected by the taxpayer, transfers are taxed at the normal tax rate prescribed under the Corporate Tax law, following the arm's length standard.
Qualifying group relief becomes void if within two years of such transfer:
- There is a subsequent transfer of the asset or liability outside of the qualifying group; or
- The transferor or transferee ceases to be a member of the samequalifying group.
BDO Insight
Determining eligibility under a qualifying group could offer some easing regarding meeting transfer pricing obligations in certain cases, subject to meeting the relevant requirements.Interest Deductions (Article 31)
Net interest expenditure is deductible, but only up to 30% of earnings before interest, tax, depreciation, and amortization (EBITDA).
No interest deduction will be allowed on loans from a related party for:
- Distribution of a dividend or profit to a related party.
- Redemption, repurchase, reduction, or return of share capital to a related party.
- Capital contribution to a related party.
- Acquisition of an ownership interest in a person who is or becomes a related party following the acquisition.
BDO Insight
Incurring a higher interest rate on loans from related parties could be questioned from a UAE transfer pricing perspective.Transitional Rules (Article 61)
The UAE Corporate Tax Law introduced transitional rules that require that the opening balance sheet for corporate tax purposes will be the closing balance sheet for the year prior to the first tax period. These rules also require that the opening balance sheet must be prepared taking into consideration the arm’s length standard. This may have an impact on the transfer pricing arrangements and necessary adjustments in the closing balance sheet may have to be made.BDO Insight
It is relevant for the taxpayer to understand how these adjustments will be carried out in the books of accounts and how they will be disclosed in the financial statements; accordingly, to determine impact of CT in the first tax period.TP Documentation and Compliance Requirements
Taxpayers in the UAE must maintain contemporaneous transfer pricing documentation to ensure compliance with the UAE transfer pricing rules. The FTA expects transfer pricing documentation to be maintained either at the time of the transaction or when the tax return for that period is submitted.In line with the OECD transfer pricing guidelines, the UAT tranfer pricing rules introduced three-tiered documentation requirements, which includes a local file, a master file, and CbCR (subject to a threshold). In addition, taxpayers are required to submit a transfer pricing disclosure form providing details of their related-party transactions.
The transfer pricing documentation requirements are summarized below:
Exemptions:
- The requirement to maintain a master file applies only to UAE-based groups that have business establishments outside the UAE. However, UAE-based groups that have a domestic presence are still required to prepare and maintain a local file.
- Taxpayers that do not meet the threshold conditions are not obligated to maintain either a master file or a local file.
- Exempt entities and entities availing themselves of small business relief are not required to maintain a local file or a master file. However, they still need to adhere to the arm’s length standards.
BDO Insight
The transfer pricing rules require taxable persons to prepare and maintain a master file and a local file, subject to meeting threshold requirements, to provide the FTA with a clear understanding of their transactions with related parties and connected persons.Even if the prescribed threshold for maintenance of a local file and a master file is not met, taxpayers are still required to adhere to the arm’s length principles. Therefore, it is crucial for taxable persons to have sufficient documentation (transfer pricing policy) in place, outlining the nature of related-party transactions, functional analysis of the entities involved in the transactions, and methodology adopted to substantiate the arm’s length nature of the related-party transactions.
Inadequate documentation may lead to penalties, fines, and the risk of double taxation in multiple jurisdictions. It may also result in difficulties justifying the arm’s length nature of related-party transactions, potentially leading to adjustments in pricing strategies.
Further, taxpayers need to have formalized agreements defining the nature of a transaction, the terms of intercompany transactions, the roles and responsibilities of the parties involved in the transactions, and the pricing methodology.
Challenges During Transfer Pricing Audits
Some of the key challenges taxpayers may face during a transfer pricing audit are highlighted below:- For intragroup services transactions, a detailed analysis is required explaining the nature of the intragroup services provided, the allocation key used, whether such services are rendered, any benefit received, and the rationale for the mark-up applied, as these kinds of services may be a significant target for the tax authorities during an audit.
- A closer look is required for the outstanding balances receivable from related parties, which are not recovered during the normal course of business. These may be treated as a deemed loan advanced to the related parties and notional interest may be charged.
- Understanding the indirect tax implications (VAT, Customs, etc.) of transfer pricing adjustments is crucial. Any true-up or true-down adjustment can result in an excess or shortfall in customs duties, which may in turn require amendments in relevant filings or application to the relevant tax authority.
- Special consideration is needed when the taxable person incurs losses while the group is profitable. It is essential to analyze whether the losses are on account of related-party transactions or due to external factors outside the control of the entities involved in the transaction.
Way Forward
Taxpayers should review their existing transfer pricing policies and verify that they align with the UAE transfer pricing rules. If taxpayers do not have a formal transfer pricing policy in place, they should consider maintaining such policies to mitigate transfer pricing-related penalties and litigation risk at a later stage.It is equally important to review the existing legal structure and assess if any restructuring is warranted to reap the benefits available under the corporate tax/transfer pricing regime, keeping in mind the general anti-abuse rules (GAAR).
Finally, taxpayers should make sure the existing intercompany agreements are aligned with the actual substance of the transactions.
Ashish Athavale
Brian Conn
Mufaddal Safdari
Anshul Sharma
Manani Pratik
BDO in United Arab Emirates