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We are excited to share the latest edition of the Law Update, beautifully and appropriately titled “Sustainable Horizons: The Saudi Arabian Vision.” Giving special honor to the Kingdom’s 2030 vision, this update focuses on a collection of both informative and inspiring articles.
For those in construction, you can learn about how the tendering environment impacts risk-pricing for contractors, the updates on the legal framework of the construction industry and how contractors can protect themselves against financial difficulties.
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With the introduction of the corporate income tax from 1 June 2023, transfer pricing (“TP”) rules will be in place in the United Arab Emirates (“UAE”) for the first time. This will have a significant impact on groups of companies operating in the UAE. In this article we will discuss key features of the expected UAE TP legislation and how business can prepare.
The Organisation for Economic Co-operation and Development (“OECD”) is an international organisation that has played a key role in shaping the global tax agenda. The recent projects of the OECD include the Base Erosion Profit Shifting Project (“BEPS”), as well as the work related to Pillar I and Pillar II aiming to tackle tax avoidance and to address the tax challenges arising from the digitalization of the global economy. Member countries of the Inclusive Framework on BEPS (including the UAE since May 2018) committed to implement the BEPS minimum standards. Against this backdrop, the UAE introduced Economic Substance Requirements (“ESR”) regulations and Country-by-Country (“CbCR”) reporting requirements in April 2019.
On 31 January 2022, the UAE Ministry of Finance (“MoF”) announced that corporate tax regime will be introduced in the UAE applicable for financial years starting on or after 1 June 2023. The proposed corporate tax regime will be based on international best practices and aims to cement the UAE’s position as a leading global hub for business. As the proposed corporate tax regime will be based on the best international practices, it will include TP rules and documentation requirements in line with the OECD TP Guidelines.
Subsequently, the MoF issued a public consultation on 19 May 2022 providing further details on the transfer pricing rules. It is expected that the MoF will be releasing the corporate tax legislation before the end of the year.
Transfer pricing deals with all aspects of intra-group arrangements between members of a multinational group. Intra-group dealings have significantly increased as a result of globalisation and the digitalization of the economy. Multinational groups undertake intra-group transactions for several reasons, including operational efficiencies, market penetration, etc. Generally, these transactions can be in the form of supply of tangible goods, provision of services, transfer or use of intellectual property as well as financial transactions (i.e. loans, guarantees, etc.).
Therefore, the pricing of intra-group arrangements can impact the profitability of the members of a multinational group. To illustrate this point, let us take the example of a group that produces and sells car parts with operations in the United States (“US”) and the UAE. The US company manufactures the car parts and sells these to a related company in the UAE, which distributes the car parts to local customers.
As the UAE company and the US company are related, the US company may charge a lower price to the UAE company given that there is no corporate tax in the UAE and the tax rate in the US is high. This price would not reflect the price that would be charged by the parties had they not be related.
Accordingly, the taxable income of the US group company would be reduced (less income=less profits) and the taxable income of the UAE company would be increased (lower expenses=more profits). In such case, the net tax impact is positive for the group (in comparison to a price that the US company would have charged if the company in the UAE was an independent party). This artificial allocation of income from the US to the UAE may reduce the overall tax burden for the group, however will impact the revenues of the tax authorities. In this example, US tax authorities would collect less taxes from what they could.
As intra-group arrangements consist a significant part of the global trade, this can have a serious impact on the revenues of the tax authorities. In light of this issue, tax authorities around the world have introduced guidance/ rules to prevent businesses from using transfer pricing as a tool to reduce tax liability.
Tax authorities commonly rely to the TP guidelines issued by the OECD. The OECD has provided specific guidance on the valuation of intra-group arrangements for tax purposes. The latest version was issued in January 2022. The UAE would follow the guidance from the OECD TP Guidelines in line with best international tax practices.
Transfer pricing relates to dealings between members of a multinational group (i.e. “related parties”). The definition of “related parties” is important as it determines whether the parties are considered affiliated and consequently whether any transactions among them will fall within the scope of the TP rules.
In the public consultation document, the definition of “related parties” is similar to definitions that we typically encounter in other corporate tax regimes. “Related parties” can be considered entities or individuals that are related through ownership, control or kinship (in the case of natural persons). Specifically, relationship through ownership, requires that one party owns 50% or greater share in another party. Control is a more general term than ownership and requires that one party exercises control over the other (e.g. management control). Relationship can also exist through kinship, where individuals are related to the fourth degree of kinship including by birth, marriage, adoption or guardianship. From the above, it can be easily understood that related parties may be easily identified on the basis of ownership or kinship, however it may not be as straightforward in the case of control.
The future UAE corporate tax regime will also include the concept of “connected” persons, which is not commonly seen in other jurisdictions. Specifically, persons (or any related persons to them) that own, control or manage a business that is within the scope of the UAE corporate tax regime will be considered as “connected”. With the introduction of this concept, the UAE corporate tax regime aims to prevent the corporate tax base from being eroded as a result of excessive payments made to business owners or persons connected with them. As an example, a business will need to prove that salaries paid to its directors are in line with the provision of the TP regulations to enable it to obtain a tax deduction for such expenses.
This concept will also impact family businesses as the way they currently operate (e.g. a family owns or controls several businesses in the UAE) may be considered as base erosion or profit shifting under the proposed corporate tax regime.
The OECD TP Guidelines adopt the “arm’s length principle” that represents an international consensus on the valuation of intra-group transactions for tax purposes. Based on this principle, transactions between related parties should be conducted as if these parties were independent.
Practically, this means that intra-group transactions should be priced at the market rate.
The OECD TP Guidelines provide specific guidance on the methods that can be utilised to assess the arm’s length nature of the intra-group arrangements. The contractual terms of the transaction, the activities performed by the parties involved, the characteristics of the property transferred/ services provided, the relevant economic circumstances and the business strategies followed by the parties involved are some of the key factors to consider in relation to the pricing intra-group arrangements.
As indicated in the consultation document, the UAE business would follow the OECD guidance to demonstrate compliance with the arm’s length principle.
Based on the public consultation document, the corporate tax regime in the UAE will adopt a three-tiered approach to transfer pricing documentation in line with the OECD TP Guidelines. The three-tiered TP documentation includes the following: (i) Master file; (ii) Local file; and CbCR. These documents include qualitative and quantitative information in a standardised format in order to assist the tax authorities to assess the intra-group dealings of the taxpayers.
Businesses will need to prepare and maintain a Master file and Local file when certain materiality thresholds are met. The relevant deadlines and thresholds, whether the filing will be mandatory and the applicable penalties have not been provided yet.
In addition, businesses will be required to submit a disclosure containing information regarding their transactions with “related parties” and “connected persons”. It should be noted that similar TP documentation requirements have been recently introduced in other countries in the Gulf, such as Saudi Arabia and Qatar.
The Master file should provide an overview of the multinational group business, including the nature of its global business operations, its overall transfer pricing policies, and its global allocation of income and economic activity.
The Local file will support the Master file and provide more detailed information relating to specific intra-group transactions. It focuses on information relevant to the intra-group transactions that the local entity undertakes and evaluates the arm’s length nature of these transactions.
The CbC Report contains aggregated information on a jurisdictional basis of a multinational group’s revenues, profits, taxes, stated capital, accumulated earnings, employees and assets. The CbCR also provides information on the locations and business activities of a group’s global operations.
Businesses will need to document all the transactions with “related parties” and “connected persons”. This disclosure will likely include information such as names of related parties, nature of transactions, volume, transfer pricing approach considered, etc. However, details of the exact content of the disclosure have not been yet provided.
The introduction of the TP rules in the UAE is a significant development and will require UAE companies to comply with the TP documentation requirements for the first time. It is likely that the TP regime in the UAE will cover all types of intra-group transactions (i.e. tangible goods, services, intangibles, financial transactions), including cross border as well as domestic transactions. All companies operating in the UAE, should assess their current TP policies and the impact of the TP rules on their businesses. Specifically, business should aim to:
Business should also review their operating models to mitigate any relevant tax and TP risks. Businesses in the UAE have a unique opportunity to implement tax and TP efficient structures in line with commercial reality and best international TP practices. There is time to act, but as this exercise will require effort and time, we would urge businesses to start the process sooner, rather than later.
If you need assistance or advice with transfer pricing or any other tax matter, please contact our regional tax team.
Partner, Head of Taxations.email@example.com
Transfer Pricing Advisori.firstname.lastname@example.org
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