How do transfer prices change fundamentals? – New
CA Manu Palerichal, FCA, CMA | Partner and CEO, Emirates Chartered Accountant Group
With the announcement of corporate tax in the UAE, the most debated topic within the business community is transfer pricing (“TP”). In the public consultation document published in April 2022, it is stated that all transactions between related parties / related parties (whether domestic or international) must be carried out under arm’s length conditions, i.e. as if they were between independent parties. It is recommended that the OECD Transfer Pricing Guidelines be followed to determine what the Arm’s Length (“ALP”) price is.
It is observed that every industry has a unique way of doing business. This gives rise to one-time related party transactions that are difficult to value. In the prevailing business climate in the UAE, it has long been common to have an office that houses the workforce of many group companies, all of which have implicit support from the parent company in terms of technology, solvency and centralized services.
Applying TP guidelines to such unique transactions and arriving at ALP is a real challenge for companies, mainly because there are no exact comparables available for most of these transactions. Additionally, no formal arrangement of roles and responsibilities or use of assets is maintained by the companies.
Intra-group services may take the form of services provided by one group entity to another entity within the same group, including centralized services and shareholder services. Some services are duplicated by the parent company even though the group entity has undertaken the same thing in its capacity, some may only be ancillary benefits due to group synergies. Are all intra-group services the responsibility of TP? Should each of them be valued? Can there be exceptions? It is very important to check which services should be evaluated on the basis of the “benefit test”.
Once it is determined that the benefits test is passed, the ALP of the transaction will need to be determined. When applying the arm’s length principle to intra-group services, it is necessary to consider both the perspective of the provider and the recipient of the service. The service must be of value to the recipient and the price must be what an independent party would be willing to pay. Another aspect to consider is the concept of “low value added intra-group services”, where one would have the possibility of applying a simplified approach to value the services.
Another very complicated area for the assessment of related party transactions is when financing activities are undertaken by the parent company or a group entity on behalf of one or all of the group entities. For example, centrally managed treasury functions, intra-group credits/loans, financial guarantees given by one entity for the facility used by another, where there is cash pooling, hedging, captive insurance, etc.
The first challenge is to determine whether the transaction can be considered an equity or debt transaction. It will be necessary to delimit the transactions according to the characteristics of the financial instruments, the contractual conditions, the economic circumstances, etc. Once the transaction is identified as a debt transaction, another challenge is to arrive at its ALP. What would be the comparable interest rate? The opinions of banks, rating agencies and other qualitative and quantitative factors should all be taken into account.
The transfer price of intangible assets (patents, trademarks, goodwill, government licenses, designs, customer data production model, etc.) is an important issue in international tax law.
It helps to determine how the superprofits generated by multinationals through the exploitation of valuable intangible assets are distributed among the jurisdictions in which they operate.
It is general practice for the intangible to be developed by one entity, recorded by another, and used by the third. It is difficult to find appropriate fees or royalties for intangibles because there is often no comparable transaction for intangibles.
The OECD guidelines suggest an alignment between functional and legal ownership taking into account the costs incurred and the risks incurred by the different entities of the group. It insists on the analysis of DEMPE functions (development, improvement, maintenance, protection, operation). The OECD guidelines also provide valuation advice on intangibles that are partially developed at the time of transfer or those that would not be used for several years after transfer, as well as those that have not been tested. or whose outcome is not known.
From a transfer pricing perspective, corporate restructuring refers to a change in organizational structure or business model. Alternatively, it may involve ending current agreements or fundamentally renegotiating them. The production model, the sales model or the IP model can all be modified models.
It will be necessary to analyze which functions, which assets and which risks are transferred to arrive at the ALP of such a transaction. Again, the availability of realistic data on the potential benefits/losses of restructuring would be the biggest challenge. Further, the arm’s length principle and transfer pricing guidelines should not and should not apply any differently to post-restructuring transactions than to transactions that were structured as such from the outset. Entrepreneurs in the UAE must identify their related parties and related party transactions now, and they must conduct their transactions in accordance with OECD guidelines once the law comes into force.
Given the challenges, UAE companies need to identify transactions that would fall under the transfer pricing regime and ensure their ability to document them (agreement, arrival base at ALP, master file and local file). At Emirates Chartered Accountants Group, we have specialist professionals experienced in advising large multinationals in different jurisdictions, now also available in the UAE.
CA Manu Palerichal, FCA, CMA is Partner and CEO of Emirates Chartered Accountant Group.