Transfer Pricing Principles and Fundamentals
Overview
This section aims to provide an understanding of Transfer Pricing, emphasizing the application of the Arm’s Length Principle in the UAE and specifying the individuals and transactions falling under its purview.
What is Transfer Pricing?
Transfer Pricing is primarily a tax concept with broader implications for accounting and risk management. It involves pricing transactions or agreements among Related Parties or Connected Persons, influenced by their relationship. These transactions encompass services, tangible goods, intangibles, financial dealings, and certain Permanent Establishment (PE)-related transactions.
When independent parties engage in transactions, market forces and negotiations typically determine their commercial and financial terms. In contrast, transactions between Related Parties or Connected Persons may not face the same external market pressures, allowing for non-arms length pricing. This can be used to manipulate reported profits and optimize tax liabilities. The globally recognized standard for pricing such transactions is the Arm’s Length Principle, mandating that Controlled Transactions mirror open market values between independent parties.
To address this, the Corporate Tax Law and Ministerial Decision No. 97 of 2023 were introduced to ensure that ‘Related Parties’ and ‘Connected Persons’ set the conditions of their Controlled Transactions akin to those between independent parties in comparable circumstances.
The Arm’s Length Principle
In Article 34 of the Corporate Tax Law in the UAE, the Arm’s Length Principle dictates that transactions between Related Parties or Connected Persons should be priced as if conducted between independent entities in similar circumstances. The key consideration is what price independent parties would agree upon, based on direct or indirect evidence of their typical behavior.
The absence of a formal pricing arrangement does not negate its existence. The Arm’s Length Principle should be applied in cases where the property is transferred or services are provided without a formal agreement, remuneration, or at a rate below Market Value.
This principle treats Related Parties and Connected Persons, including members of a Group, as separate entities rather than integral parts of a single business. The focus is on the nature of Controlled Transactions and whether their conditions differ from Comparable Uncontrolled Transactions. This comparative analysis, known as a “comparability analysis,” is integral to applying the Arm’s Length Principle.
In essence, the Corporate Tax Law mandates Related Parties or Connected Persons to earn their “fair share” of profits by aligning with the Arm’s Length Principle. Following its application, each entity within the Group should record operating profits based on their functions, assets, risks, and contributions to the value chain.
Disclaimer: The information provided here pertains to sections 4.1, 4.2, and 4.3 extracted from the Transfer Pricing Guide, Corporate Tax Guide (CTGTP1) released in October 2023. It does not encompass the entirety of the guide and is intended solely for reference purposes. Readers are advised to consult the complete guide for a comprehensive understanding of the subject matter.
Summary
The Corporate Tax Guide (CTGTP1) provides an overview of Transfer Pricing Principles in the UAE, emphasizing the Arm’s Length Principle. Transfer Pricing involves pricing transactions among Related Parties, ensuring they mirror open market values. The Arm’s Length Principle, outlined in Article 34 of the Corporate Tax Law, treats Related Parties as separate entities, requiring a comparative analysis to align conditions with Comparable Uncontrolled Transactions.
This principle aims to prevent profit manipulation and tax optimization by mandating fair profit sharing within the Group based on functions, assets, risks, and contributions. However, Transfer Pricing provisions apply only to Related Parties or Connected Persons, exempting certain entities from maintaining Transfer Pricing Documentation.
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This article was published on 18 January 2024.
