Transfer Pricing Compliance in the UAE

Transfer pricing refers to the pricing of transactions between related parties, such as a parent company and its subsidiaries, branches, or affiliates. These transactions can include the transfer of goods, services, intellectual property, loans, or royalties. Transfer pricing is critical for ensuring that prices charged in these transactions are set in a manner that reflects market value, i.e., at “arm’s length,” as if the transactions were between unrelated parties. This is a core principle of the OECD (Organisation for Economic Co-operation and Development) guidelines, which the UAE follows to prevent profit shifting and base erosion.

With the introduction of Corporate Tax (CT) in the UAE starting in 2023, transfer pricing compliance has become even more important for businesses engaged in cross-border transactions. Under the UAE’s new tax system, companies that are part of multinational groups must comply with strict transfer pricing documentation and reporting requirements to avoid penalties and ensure they are not engaged in aggressive tax avoidance or profit shifting.

Key Aspects of Transfer Pricing Compliance in the UAE

1. Legal Framework for Transfer Pricing in the UAE

The UAE Transfer Pricing Rules are primarily governed by the Federal Tax Authority (FTA) and are aligned with the OECD Transfer Pricing Guidelines. The introduction of the UAE Corporate Tax has formalized and expanded these rules, making transfer pricing compliance a critical issue for multinational companies operating in the UAE.

a. OECD Guidelines Alignment:

The UAE has largely aligned its transfer pricing rules with the OECD’s BEPS (Base Erosion and Profit Shifting)Action Plan, which aims to address practices that allow multinational enterprises (MNEs) to artificially shift profits to low or no-tax jurisdictions. This includes ensuring that transfer pricing arrangements reflect the economic reality of transactions and are not designed solely for tax avoidance.

b. UAE Corporate Tax Law (2023):

The introduction of corporate tax in the UAE, with a 9% tax rate on profits exceeding AED 375,000, makes transfer pricing documentation more essential. While the UAE was previously known for its tax-free environment, the implementation of corporate tax brings the necessity for MNEs to justify the arm’s length nature of their intercompany transactions. As a result, UAE tax law requires businesses to document and support their transfer pricing arrangements.

2. Who Must Comply with Transfer Pricing Rules in the UAE?

Under the UAE Corporate Tax Law and FTA regulations, the following businesses are required to comply with transfer pricing rules:

a. Multinational Enterprises (MNEs):

MNEs with entities in the UAE must comply with transfer pricing documentation requirements. This includes:

• A parent company and its UAE subsidiaries.
• UAE branches of foreign companies.
• Companies with related parties (e.g., joint ventures, affiliates) in other countries.

b. Threshold for Documentation:

• The threshold for compliance is generally based on revenue or other financial metrics, though specific guidelines will be provided by the FTA.
• Businesses with annual revenues over a certain threshold are typically required to prepare transfer pricing documentation. For example, companies with annual revenues exceeding AED 375,000 may need to submit transfer pricing reports.

3. Transfer Pricing Documentation Requirements

The UAE’s transfer pricing regulations require companies to maintain documentation that supports the pricing of intercompany transactions. This documentation should demonstrate that the transactions between related parties are conducted on an arm’s length basis (i.e., at market prices).

a. Master File and Local File:

The UAE’s transfer pricing rules require two main documents:

• Master File: This document provides a broad overview of the multinational group, including its organizational structure, business activities, financial results, and global transfer pricing policies. It also includes a detailed description of the group’s transfer pricing policies, including the allocation of profits and resources.
• Local File: The local file focuses specifically on the UAE entity’s operations, detailing the transactions conducted with related parties, the functions performed, risks assumed, and assets used. It should demonstrate that the pricing of these transactions is consistent with the arm’s length principle.

b. Transfer Pricing Report:

Companies in the UAE may need to prepare a detailed transfer pricing report to substantiate their pricing arrangements for intercompany transactions. This includes:

• The selection of the transfer pricing method (e.g., Comparable Uncontrolled Price (CUP), Cost Plus, Resale Price Method, or Transactional Net Margin Method).
• The financial analysis to show that the prices charged for goods, services, or intangibles are consistent with what independent third parties would charge in similar circumstances

c. Comparability Analysis:

The comparability analysis is a crucial part of transfer pricing compliance. It compares the terms and conditions of related-party transactions with those of independent parties, ensuring that the pricing used in intercompany transactions is consistent with market standards.

• Economic Analysis: This involves analyzing the functions performed, risks borne, and assets used by the entities involved in the transaction.
• Benchmarking: Benchmarking studies (using databases of comparable transactions) are often used to justify the arm’s length nature of the intercompany pricing.

d. Documentation Filing with the FTA:

The UAE requires transfer pricing documentation to be available on request by the Federal Tax Authority (FTA). However, there is no requirement to submit this documentation routinely unless specifically requested during a tax audit or investigation.

• In some cases, businesses may need to submit Country-by-Country Reports (CbCR) if their group meets the specific reporting thresholds.

4. Transfer Pricing Methods

The UAE adopts the OECD’s recommended transfer pricing methods, and businesses must select the method that best reflects the economic substance of their transactions. These methods include:

a. Comparable Uncontrolled Price (CUP) Method:

• This method compares the price charged in a controlled transaction (between related parties) with the price charged in an uncontrolled transaction (between unrelated parties) for the same or similar goods or services.

b. Cost Plus Method:

• This method calculates the cost of producing a good or service and then adds a markup to determine the price that should be charged in the related-party transaction.

c. Resale Price Method:

• This method works by determining the resale price charged by the reseller (the related party) and subtracting an appropriate gross profit margin to determine the transfer price.

d. Transactional Net Margin Method (TNMM):

• This method focuses on the operating margin of a controlled transaction compared to the margin earned by independent companies performing similar activities.

e. Profit Split Method:

• This method is used when transactions are highly integrated or when it’s difficult to compare them to external transactions. It splits the combined profits between related entities based on their contributions to the transaction.

5. Penalties for Non-Compliance

Failure to comply with UAE’s transfer pricing regulations can lead to significant penalties, including:

a. Fines:

• Penalties can be levied for not maintaining the required transfer pricing documentation or for failing to submit it when requested by the FTA. These fines can vary depending on the severity of the non-compliance.

b. Adjustments to Taxable Income:

• The FTA may challenge the transfer pricing practices of a business and adjust its taxable income. This could lead to higher tax liabilities if the FTA determines that the company has shifted profits unreasonably to reduce its tax burden.

c. Increased Risk of Audits:

• Businesses that fail to comply with transfer pricing documentation requirements are at risk of being subjected to more rigorous tax audits by the FTA.

6. Transfer Pricing in Cross-Border Transactions

Given that the UAE is a global business hub, many companies engage in cross-border transactions. These cross-border dealings must be carefully structured to comply with both UAE transfer pricing rules and the tax laws of the other jurisdictions involved.

a. Double Taxation and Treaties:

• The UAE has signed double tax treaties (DTTs) with many countries, which can impact the way transfer pricing is applied. These treaties can help businesses avoid double taxation on income that is subject to tax in both the UAE and other jurisdictions.
• Transfer pricing adjustments in one country may trigger tax disputes or additional tax liabilities in the other country, so it’s critical to have a global approach to transfer pricing compliance.

b. Country-by-Country Reporting (CbCR):

• Large multinational groups with global revenues above a certain threshold must comply with Country-by-Country Reporting (CbCR). This involves submitting a detailed report to the tax authorities, disclosing global allocation of income, taxes, and business activities across different countries.
• The UAE participates in the OECD’s Common Reporting Standard (CRS), which promotes tax transparency and combats tax evasion globally.

7. Transfer Pricing Disputes and Resolution

In the case of disputes over transfer pricing, businesses in the UAE may have the option to resolve them through:

a. Advance Pricing Agreements (APA):

• An APA is an agreement between a taxpayer and the tax authority that pre-approves the transfer pricing method for a specific set of transactions over a certain period. This provides certainty and helps prevent future disputes.

b. Dispute Resolution Mechanisms:

• In cases of disputes with the FTA, businesses may seek resolution through formal procedures, including administrative appeals or engaging with the Tax Dispute Resolution Committee (TDRC).