The United Arab Emirates (UAE) is commonly used as a trading hub for the MENA region. While the Covid-19 pandemic has made it necessary for many investors to cut costs in the UAE, profitability can be increased by using the UAE’s favourable tax environment. This legal briefing takes a closer look at increasing profitability through transfer pricing adjustments.
The United Arab Emirates (UAE), particularly the emirates of Dubai and Abu Dhabi, have traditionally served as trading hubs for European and North American companies. This is due to the country’s strategic location, excellent infrastructure, and favourable tax environment.
Unlike other countries in the Middle East, the UAE currently does not levy any corporate income tax (CIT). While there are certain exceptions to this concerning oil & gas activities, and it has been repeatably discussed to introduce a CIT, there are no concrete plans regarding the general roll-out of a CIT.
Foreign investors that use the UAE as a trading hub will typically need to adhere to transfer pricing regulations that their affiliated companies are subject to (e.g., those companies from which they buy goods to resell or provide services to the foreign group entity). Transfer price describes the price at which related parties transact with each other.
While the Covid-19 pandemic has made it necessary for many investors to cut costs, it is an interesting option to increase group profitability by using the UAE’s favourable tax environment.
2. Transfer Pricing Adjustments
Since the UAE does not levy any CIT, there are no federal or emirate level legal regulations on transfer pricing and respective adjustments. Therefore, foreign investors will need to understand the transfer pricing rules in the relevant jurisdiction from which they buy goods from affiliated entities, including the OECD Guidelines
Assuming that transfer pricing adjustments lead to an increase in revenue and profit in the UAE trading entity, the UAE entity would pay out higher dividends to the headquarters typically located in high tax jurisdictions (e.g., European countries). The dividend income of the parent entity is typically wholly or partially exempt from CIT, ultimately leading to higher profitability of the entire group’s performance.
3. Transfer Pricing Benchmarking
One of the significant aspects that determine transfer pricing is the arm’s length principle (ALP). According to the ALP, the price charged in a controlled transaction between two related parties should be the same as that in a transaction between two unrelated parties on the open market.
Benchmark studies are typically used to define the open market price for a transaction. The following aspects are to be considered for the pre-research and setting of the criteria:
- The companies must perform similar activities;
- Functions and risk allocation should be on the same or at least the highest comparable level; and
- Further financial benchmarks, such as revenue or profit ranges or might be helpful to identify comparable companies.
A profile is to be created which covers the general criteria of the functions of the company and its allocated risks. Once the criteria have been set, data of the companies which fulfill the criteria can be collected. The most common way is to purchase financial reports from data platforms. The reports are then to be analysed based on the appropriate method for transfer pricing.
According to the OECD transfer pricing guidelines, five main methods are recognized: Cost Plus, CUP (comparable uncontrolled price), Resale Price, Profit Split Method, and TNMM (transactional net margin method). However, the determination of the suitable method depends on various aspects and the applicable tax laws and administrative practices in the relevant countries.
4. Controlled Foreign Cooperation & Economic Substance Rules
In order to make use of the UAE’s beneficiary tax system, it is essential that adjacent tax regulations are complied with.
From the perspective of the UAE’s parent entity, it is essential to keep in mind controlled foreign corporation (CFC) rules, which were recently updated through the Anti-Tax Avoidance Directive (ATAD) in most of the European countries. CFC rules are designed to limit artificial profit shifting through affiliated entities by making muse low or no CIT jurisdictions. CFC rules can generally be avoided if the parent entity can demonstrate that the foreign subsidiary carries on effective trading activity conducted from its country of establishment or registered office.
From a UAE perspective, investors would also need to consider the newly introduced Economic Substance Regulations (ESR). ESR also aim at preventing artificial profit shifting and can be considered the UAE counterpart of the CFC rules. ESR require economic substance and reporting for geographical mobile business activities. With regard to UAE trading hub companies, this means that such companies are typically carrying on geographical mobile business in the form of “Distribution Business” with the consequence that they need to file an Economic Substance Notification and Report. The Economic Substance Report needs to reflect that the entity is carrying out the so-called “Core Income Generating Activity” in the UAE, directs and manages the activity in the UAE, and made adequate investments in the UAE (e.g., adequate number of qualified staff, adequate operating expenditure and physical assets – all in the UAE).
Transfer pricing adjustments are an attractive way to increase the profitability of UAE trading companies and, thereby, take advantage of the UAE’s favorable tax advantage to increase the overall financial performance of the group. This having been said, it should be noted that careful planning in terms of complying with the relevant transfer pricing regulations, controlled foreign corporation & economic substance rules is essential. Transfer pricing benchmarking is an essential tool for the documentation of an adequate definition of a transfer price.
Dr. Constantin Frank-Fahle, LL.M.
T: +971 (0) 2 694 8585
T: +971 (0) 2 694 8585
This publication does not necessarily deal with every important topic or cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice.
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