UAE and Transfer Pricing - The Path Ahead
21 December 2022
In this latest update, Aditi Mehra, Transfer Pricing Manager at AGA member firm in Delhi, Coinmen Consultants, and a member of AGA’s Transfer Pricing Global Practice Group updates us on the introduction of the new Corporate Tax law in UAE and the implications for MNC's.
To cement UAE’s position as an international hub for businesses and investments, on 9th December 2022, the UAE Ministry of Finance (‘MoF’) officially introduced a Corporate Tax (‘CT’) law under a Federal Decree -Law No. 47 (‘The Decree’) of 2022 on Taxation of Corporations and Businesses ('CT Regime’). The Decree is supplemented by Frequently Asked Questions (FAQs) to initially provide further details on specific matters pending publication of further guidance. Further guidance may be published in the form of Cabinet decisions and Executive Regulations. The new CT regime shall become applicable from 1 June 2023. With this introduction, UAE aims to reaffirm its commitment to meet international standards for tax transparency and to prevent harmful tax practices.
In April 2022, UAE MoF released a consultation paper to provide insight on the potential UAE CT regime, which resulted in a separate discussion on the Transfer Pricing (‘TP’) regime in UAE (‘UAE TP Regime’). The same was discussed in our earlier Article.
The purpose of this Article is to analyse and understand the published UAE TP Regime. Multinational Corporations (MNCs) across the world were eagerly waiting for the release of UAE CT Law, so that the impact on their businesses and business models may be assessed appropriately. Corporate tax and transfer pricing disciplines are intertwined with each other in such a manner that no effective international tax strategy is complete without an in-depth understanding of the transfer pricing life cycle within MNCs. Though a more detailed alert regarding features of UAE TP regime shall be issued, we are sharing an overview of the UAE TP regime and related considerations that may affect MNCs doing business in UAE.
A. A Brief Overview of UAE CT Regime
The CT shall be imposed on the Taxable income at the following rates:
- For individuals and juridical persons – 9% on Taxable Income that exceeds AED 375,000 (this limit shall be confirmed in the Cabinet's decision).
- A highly anticipated area of the CT regime was the treatment of Free Zone Persons. CT on Free Zone Persons shall be as follows: -
- 0% on Qualifying Income
- 9% on Taxable Income that does not meet the Qualifying Income definition
The conditions to be considered a Qualifying Free Zone Person include among others maintaining adequate substance, complying with transfer pricing provisions and not electing to be subject to CT. All Free Zone entities will be required to register and file a CT return.
Several questions remain unanswered such as what constitutes Qualifying Income (subject to Cabinet decision), the treatment of transactions between Free Zone entities and group entities located in mainland UAE, and whether the election of Free Zone Person to become subject to regular CT is irrevocable or not.
While MoF earlier in the consultation paper clarified that, a higher rate (minimum global rate of 15%) may apply to large MNCs subject to Pillar Two, the CT regime does not specify anything. Through FAQs, UAE MoF has reiterated its commitment to introduce these rules in due course.
B. Overview of UAE TP Regime
B.1 Introduction of Arm's Length Principle
Arm’s Length Principle (ALP) has found its place in the UAE CT Regime. As per the law, all transactions with related parties and connected persons shall be required to be at arm’s length. The language used in the regime is similar to OECD standards.
Articles in the CT regime also talk about the consideration of transactions with its Connected Persons needs to be determined by reference to their “Market Value”.
It is interesting to see the usage of the term ‘market value’ in addition to terms such as ‘arm’s length standard’ and ‘arm’s length range’. This feels similar to the concept of ‘fair market value’ provided in the Indian Tax provisions, where excessiveness and unreasonableness of expenditure is tested by the Indian revenue authorities. It will be interesting to see how interchangeably concept of arm’s length and concept of market value shall be used in practice.
As per the CT regime, TP Regulation shall apply to UAE businesses that have transactions with Related Parties and Connected Persons, irrespective of whether they are located in the UAE mainland, a Free Zone or in a foreign jurisdiction. It seems just like in India, we will be seeing domestic intra-group transactions covered under UAE TP regime, especially those that could potentially confer an overall tax advantage to the group. The same has been discussed in more detail below:
- Related Parties or Connected Parties:
The concept of Associated Enterprises as per OECD standards has been subsumed by “Related Parties” with the threshold of 50%. Further, related parties also include parties having the ability to determine or exercise significant influence over the conduct of their Business and affairs.
‘Connected Parties’ are different from related parties. The definition of a connected person aims to cover key management personnel.
The definition of related parties and connected parties is broad as compared to international standards. For example, under certain conditions kinship up to fourth degree may trigger transfer pricing provisions.
- Free zone regimes:
TP compliances has been specifically mandated as a condition for 0% taxation eligibility of Fee Zone Persons in addition to economic substance requirements. Accordingly, it would not be inappropriate to say that without appropriate TP policy and compliances, a Free Zone can lose benefits.
The Five TP methods mandated in the UAE TP regime for evaluating ALP are broadly in line with OECD TP Guidelines.
UAE has also introduced the 6th TP method (in line with the UN TP Manual), where none of the above methods could be used to derive arm's length results. The 6th method is somewhat like ‘Other Method’ under Indian Transfer Pricing regime
As per the UAE TP regime, the choice of the most appropriate method (not Most preferred Method) depends on Contractual terms, Characterisation, Economic Circumstances, FAR analysis, and Business Strategies. Again, this is in line with OECD TP Guidelines.
B.4 TP Documentation
The documentation requirements includes maintaining the following three-tiers:
- Tier 1 – Local File or TP Study Report, justifying the transactions entered by the enterprise.
- Tier 2 – Master File, highlighting the group level happenings, group financial details, intellectual properties, necessary financial arrangements etc.
- Tier 3 – Country by Country Reporting (CbCR) for large multinational groups effective 1 January 2019
The thresholds and other conditions such as contents, formats etc., of master file and local file are yet to be declared. TP Documentation provisions are brought in, with 30 days provided for submission to tax authorities when called for.
Similar to Indian TP Transaction Declaration Form 3CEB, the provision for the TP Disclosure form under UAE TP regime has been brought in. The said disclosure Form may have to be submitted along with the Tax Return.
B.5 Other Considerations:
a. Corresponding Adjustments
UAE CT regime provides for corresponding adjustments for transfer pricing adjustments made. This includes cases where a foreign tax administration adjusts the arms’ length price of the taxpayer.
b. Tax Grouping:
UAE Group companies shall be allowed to form a tax group i.e., fiscal unity and file a consolidated tax return provided the UAE parent company (directly or indirectly) holds at least 95% of the share capital and voting rights of each of the companies. To form a Tax Group, neither the parent company nor any of the subsidiaries can be an exempt person or a Free Zone entity benefitting from the 0% CT rate, and all companies must use the same financial year and prepare their financial statements using the same accounting standards.
Transactions between members of a Tax Group are eliminated in the consolidation of the Group’s financial results statements, and hence companies shall not be required to comply with the TP regime.
However, where a member of the Tax Group needs to compute its stand-alone Taxable Income for the purposes of utilising Tax Losses incurred before joining the Tax Group or when leaving a Tax Group, in that case they shall be required to comply with the TP regime.
c. Thin Capitalisation
UAE has shown its commitment to the OECD’s BEPS initiative to discourage excessive debt financing and introduced general and specific interest deduction limitation (thin capitalisation).
Under the CT regime, payment of interest by an entity to another shall be restricted to 30% of its earnings before interest, taxes, depreciation, and amortization (EBITDA). The amount of disallowed interest expenditure can be carried forward for a period of 10 years.
For specific interest deduction limitation, the FAQs also specify that additional restrictions such as justifying commercial substance shall apply to related party debt. The thresholds and other conditions, if any related to its applicability are yet to be declared.
d. General Anti-abuse Rules
UAE CT regime also introduced general anti-abuse rules which will apply to transactions giving rise to a tax advantage where no valid commercial reason exists, and where the tax advantage was the main or one of the main purposes of the transaction.
With a TP regime in line with the OECD TP guidelines, the UAE will be part of a long list of countries that will adopt the arm’s length principle. UAE has shown its commitment to introduce best practices of international taxation. UAE’s infrastructure, political and economic stability and strategic location has always made UAE an attractive destination for investments, and a strong candidate for international hubs of MNCs. The implementation of a TP regime in line with OECD TP Guidelines strengthens UAE’s position.
It is imperative to highlight that, UAE CT regime talks a lot about economic substance for availing benefits of various provisions. The regime also discusses specific and general anti abuse provisions. The same highlights UAE’s commitment to the OECD’s BEPS initiative. In our opinion, economic substance and transfer pricing is intertwined in the theme of UAE CT regime.
Accordingly, the implication of the new regime is far-reaching for MNCs doing business in UAE. MNCs are suggested to perform a high-level assessment of their Transfer Pricing Policies. MNCs will be required to gear up before the implementation of the new regime. However, considering the short time frame left for implementation of the new regime, it is imperative to act fast on any measures that may be required to be implemented for effective TP Policies.
For more information please contact Nitin Garg firstname.lastname@example.org in the first instance.
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About Coinmen Consultants
Founded in 2010, Coinmen is a financial and business consulting firm established by three visionary Partners Vikrant Suri, Mohit Aggarwal, and Nitin Garg, following their respected careers in the Big 4 accounting firms and successful individual paths. Eleven years later, they now have a team of 75 and 5 Partners. As the law firm representative of Alliott Global Alliance based in Delhi and Gurugram, the firm has a strong consulting practice and international orientation, with Japanese, Italian, Korean, and Spanish desks.