United Arab Emirates or UAE or Emirates is the federation of seven Emirates, including Abu Dhabi, Dubai, Sharjah, Ajman, Umm Al-Quwain, Fujairah, and Ras Al Khaimah. Though taxation in UAE was initially restricted to corporate taxes levied on foreign banks and oil companies, the companies will have to follow the transfer pricing rules and documentation procedures as mentioned and mandated in the OECD (Organisation for Economic Co-operation and Development) Transfer Pricing Guidelines.
What is Transfer Pricing?
Transfer pricing can be explained as the price paid for the transfer of goods and services from one unit of an organization to another unit of the same organization situated in a different country. Suppose company X, headed by Mr. Alex and headquartered in the USA, produces biscuits. The company has operations in the UK, Dubai, and India. Now the UK Company is in short supply of a particular flavoring agent used in the biscuit that is available at the Dubai Office in surplus. Now the UK Company asks the Dubai Office to send ten units of the flavoring agent to the UK. Usually, company X being the mother company, would guide the Dubai Office to parcel the ten units of flavoring agent to the UK office and make adjustments in the stock ledger of both companies.
The monetary considerations, in lieu of such a transaction, have a huge probability of being influenced by Mr. Alex or his team at the headquarters. For example, He can say that instead of Dh100, charge Dh80 since this is an internal transfer. There can be a probability of tax evasion too. How? Well, suppose the UK imposes an import tax on the flavouring agent in case the UK company ordered it in the normal UK Market. This internal transfer helps the UK company save on such import tax because the transfer is happening internally from a sister concern of the same company.
In order to avoid such price alterations and tax evasion among related companies or companies under the same operations, the policy of transfer pricing has been implemented by the OECD. The same transfer pricing mechanism would now be applicable for companies operating within UAE or with operations involving any company in Dubai. Transfer pricing can be explained as the due consideration that has to be paid by the companies to avail of a product or service from another company, though both companies might be related. So, under the influence of transfer pricing the UK company needs to pay due consideration for the flavouring agent to the Dubai Company.
Transfer pricing is also helpful in managing situations where a related person to the entities might take benefits, either in kind or salaries, that are much higher than the existing salary or perquisites applicable in the market, for e.g., extraordinary salaries are being paid to some employee or expat diplomat working in some other location. This might be in favour of an individual’s gain; however, this would erode the profitability of the organisation and thus might not be in favour of the shareholders of the company at large. Therefore, Transfer pricing is mandated to take care and control over any of the above financial irregularities that might happen due to multiple location operations of the organisation.
Methods of Calculating Transfer Pricing
While the concept of transfer pricing has been an acceptable feature globally, in all kinds of cross border operations of organisations, UAE had a different way of looking at corporate taxes. In the UAE, only foreign banks and oil companies came under the ambit of corporate taxation till date. However, according to the announcement of the Ministry of Finance, UAE, on January 31, 2022, a New Federal Corporate Income Tax System will be introduced in the emirates that will be effective from June 2023 onwards.
According to the announcement, the ministry proposes to levy a standard corporate income tax rate of nine percent upon the business profits earned by UAE businesses during a tax accounting period, following the global practice of taxation. Levying of Corporate Income Tax will imply levying of OECD Transfer Pricing Rules too! Various methods have been used to calculate the Transfer Pricing applicable to organisations and entities for years such as the:
- Traditional Transaction Methods including:
- Comparable Uncontrolled Price Method
- Resale Price Method
- Cost plus Method
- Transactional Profit Method including:
- Transactional Net Margin Method
- Transactional Profit Split Method
The implementation of Corporate Income Tax and OECD Transfer Pricing Rules in UAE implies that the transactions within and between the enterprises under common control and management will be conducted at Arm’s Length Pricing Terms
What is Arm’s Length Pricing Term?
The Arm’s Length Price Term practiced between two enterprises controlled by the same management implies that the transfer price paid for the transaction between the two related entities (under the same management) will be the same as the transfer price paid for the transaction between two unrelated and independent entities. Therefore, the transaction of flavouring agent between the UK Company and the Dubai Company would be dealt as if the Dubai and the UK Company were unrelated to each other. The Dubai Company would be treated as an independent supplier of the flavouring agent for the UK Company. This way the Dubai Company realises the appropriate cost and tax evasion between the companies would also not be possible.
Impact of Transfer Pricing
The impact of levying OECD Transfer Pricing Rules as part of the new Federal Corporate Income Tax System will definitely cause a ripple effect in the global market and therefore, it is the most trending topic currently. Some of the important impacts of transfer pricing includes:
- Corporate Taxpayers paying transfer prices at Arm’s Length Price between related entities. Thus the transactions between the related parties will also be treated at par with the transactions between independent parties.
- Payment of Transfer Price at Arm’s Length Price is the fair market price of the commodity, goods, or services in the open market.
- Transfer pricing will be calculated using various methods depending on the type of transaction and the entities involved
- The entities also need to undertake detailed transfer pricing documentation annually
- The Federal Tax authorities will be regularly assessing and scrutinising the policies related to transfer pricing, the documentation submitted by the organisations, and detailed scrutiny into the intercompany and inter group transactions conducted within the organisation within a tax assessment year.
- The entities will be subjected to harsh penalties in case of non-compliance with the Transfer Pricing rules and documentation procedures.
Though the entire process of transfer pricing and its documentation will increase the workload of the organisations operating out of the UAE, implementation of such transfer pricing rules is important in order to create parity between the UAE organisations and the global organisations.
Importance of Transfer Pricing
The transfer pricing rules, and documentation procedures might look cumbersome, but the introduction of the new Federal Corporate Income Tax System is beneficial for individual organisations as well as important for the UAE. Some reasons why the introduction of transfer pricing policy and documentation procedure is in the favor of the organisation include:
- Organisations that have a huge quantum of international operations can find ways to optimise their profits across the different jurisdictions of company operations. This is in accordance with the Base Erosion and Profit Shifting (Beps) Action Plan of OECD.
- The Transfer Pricing policy will lead to unprecedented disclosure from the organisational perspective. However, such disclosure will also lead to transparency in terms of corporate dealing, thus improving the corporate reputation and trust, in the long run, that too in the global domain.
- The global companies with headquarters in UAE and operations across the globe are expected to have streamlined supply chains.
- The global companies are also expected to mitigate their tax risks with the introduction of a Transfer Pricing policy.
- The global companies will also have a chance to fulfil the compliance requirements at multi-location operations with such a transfer pricing policy.
- The global companies with headquarters in UAE are expected to curtail their tax burdens with proper understanding and guidance on Transfer Pricing Policy and Beps regulation.
- With the curtailment of tax burdens, the returns of the shareholders of these global companies will also increase.
- Further, the prices fixed for the consumers, also, will be reduced with such savings on taxes by the global companies.
However, the introduction of the option of Beeps can lead to abuse and manipulation by the organizations in order to save taxes artificially. Therefore, the Federal Tax Authorities will have the added responsibility of scrutinizing the documentation submitted by the organisations thoroughly.