Ravishanker Vengathattil is a seasoned tax expert currently serving as a Senior Manager at Kreston Menon in Dubai since February 2023. With over a decade of experience, he held managerial positions at BSR & Co. LLP in Bengaluru and was previously a Partner at K B Nambiar and Associates for nearly six years. His journey in finance started as an Articled Assistant with K. B. Nambiar and Associates and Tata AIG.
Transfer pricing in the UAE: Adapting to the new regulations
October 20, 2023
Alongside the landmark introduction of corporate tax in the UAE comes the implementation of new transfer pricing rules. These aim to prevent taxpayers from distorting or reducing a business’s profits to avoid tax by placing certain requirements on the transactions made between related parties, or payments made to connected persons.
Arm’s length pricing
Broadly speaking, this includes payments to directors, shareholders, owners, key management, and other group companies with common shareholding or control. The UAE transfer pricing rules dictate that any such transaction or payment needs to be made at ‘arm’s length’ or ‘open market’ value. Companies that enter into these transactions must maintain adequate documentation and submit a transfer pricing disclosure form at year-end, alongside their corporate tax return.
We spoke to Ravishanker Vengathattil, Senior Manager of Audit and Taxation at Kreston Menon, to find
out more about the rules and how they are affecting businesses in the UAE.
“This is a major change in the economy,” says Ravishanker. “In an emerging tax environment, transfer pricing comes with its own challenges – especially in a place where there was previously no tax at all.”
The compliance requirements themselves are relatively straightforward, he adds, and may even feel fairly simplistic for multinational companies that already have a mechanism for handling transfer pricing in place. But for businesses based in the UAE, Ravishanker foresees some challenges as they move into a more formally structured business environment.
“We speak to a lot of businesses whose general practices have been quite informal. For instance, sharing
of resources is a common practice among group companies. This arrangement sometimes does not get as much attention or formal documentation as would be required going forward.”
Under the new rules, those businesses must treat each company and each owner as a separate entity – a shift from the current paradigm in the UAE, especially for businesses where audits were not mandated. For example, the VAT regime, which was introduced in 2018, allows for companies to be treated as a single group when filing VAT returns if they have a common shareholder, which is different from the tax grouping mechanism prescribed under corporate tax. Now, businesses must formally recognise the distinctions between different entities and keep proper records regarding any transactions between them.
In terms of corporate tax as a whole, Ravishanker suggests there are two main areas that UAE businesses should focus on: transfer pricing and documentation.
Compliance ahead of the new financial period
The corporate tax rules, including transfer pricing, apply to financial years starting on or after 1 June 2023. Companies that are not compliant with the rules risk incurring the following general penalties, amongst other specific penalties:
• AED 10,000 (AED 20,000 in each case of repeated violations within 24 months) for each record-keeping violation and other information specified in the law.
• Penalty of 14% per year, levied monthly in case of a tax pending settlement.
• Loss of 0% tax incentive for a free zone company
– this applies not only within the tax year that the company is non-compliant, but for five years altogether.
Over the past six months, Ravishanker has been working with UAE companies to understand the corporate tax rules and identify questions or challenges early on. Where problems arise that are not clearly communicated in the legislation, he encourages clients to use the process of private clarification to present their case to the Federal Tax Authority.
“There’s no need for us to make interpretations or take extreme tax positions when this option is available,” he explains. “It takes time, but when large amounts are at stake, I don’t think we should leave room for any sort of risk.”
The type of support that businesses need to comply with the new rules depends on their size and location. Larger multinationals, which often have in-house teams, need to adapt their existing transfer pricing mechanisms to comply with the UAE rules. UAE-based businesses, meanwhile, essentially need to start from scratch.
“Right now for the larger UAE businesses, what we are trying to do is get the structure in place so that they can hire the right people, establish the right policies, and get documentation, including transfer-pricing agreements, set out. Once the team is trained, the annual compliance will follow.
Most smaller and medium businesses are looking for a retainer, or maybe quarterly consultancy, to review their transactions regularly. They may not see merit in having an in-house team, and sometimes it’s not warranted.”
Businesses can also benefit from using the right accounting software to collect and process large amounts of data required for transfer pricing analysis. There is even potential for AI to play a role in analysing that data, with solutions in this area developing rapidly.
Corporate structure considerations
As we heard in our previous interview with Jadd Shalak at Averyx group, many companies are also reconsidering their structure to reduce their tax and administrative burden as a result of the changes.
“The talk about restructuring is very valid, especially from a transfer pricing perspective,” says Ravishanker. “As I mentioned, a lot of the businesses in UAE are structured very informally. They have one shareholder who holds multiple companies; it’s not a holding-and-subsidiary relationship. Under the corporate tax regime, businesses consisting of multiple companies are subject to separate transfer pricing evaluations for every transaction between those entities.
They also need to maintain separate records and filing. As a result, many businesses are considering establishing a holding company and subsidiary structure, consolidating the entities and effectively removing the need for transfer pricing analysis for transactions within the group.
Each business will need to consider this decision carefully. One major downside of forming a single tax group is that the corporate tax threshold (currently AED 375,000) would apply to the entire group’s profits, rather than to each company individually. On the other hand, it allows for much simpler management and fewer administrative requirements.
Challenges and evolving rules
As a new law, transfer pricing presents some specific practical challenges to UAE businesses and tax agents. One of those, Ravishanker notes, is the availability of comparable data:
“To compare with my previous experience in India, I always had a database available for comparability. If I was doing a transfer pricing study for, let’s say, an automobile manufacturer, I was able to get very relevant and comparable data from the largest automobile manufacturers in India, because there were service providers who had collated the database. In UAE, or GCC in general, we do not have that yet. Right now, we would have to leverage the data that is available for similar companies in the Asia Pacific, Europe and other parts of the world.”
The Law has not restricted the use of global databases, he explains, but neither has it prescribed it. The OECD also allows for this practice where region-specific comparable data is not available. So far, the UAE has also not prescribed the specific criteria to arrive at an acceptable arm’s length range, such as using the interquartile range or other percentiles.
Similarly, the question of whether companies can use multi-year data or single-year data in transfer pricing studies remains unanswered. In general, though, the UAE government has indicated that companies can follow OECD principles.
Apart from these questions about the specifics of the rules, there are a few areas that differ from the way transfer pricing rules apply in other countries. For instance, while many jurisdictions exclude tax-neutral companies (i.e. where the same tax applies to each) from transfer pricing, this is not the case in the UAE.
There is also no internal threshold on transaction amounts that transfer pricing rules apply to. The only exemption given to smaller businesses is a reduced requirement for documentation, as those with a turnover under AED 200 million and who are not part of a Multinational Enterprise group (a group whose consolidated turnover exceeds AED 3.15 billion) do not have to maintain a master file and local file.
Aside from this, transfer pricing rules and basic documentation requirements apply to small and large businesses alike – but it remains to be seen how this might change in the future.
“Over the past ten months, a lot of things have changed. It’s an evolving law, so there may be more changes going forward,” says Ravishanker. “As it stands now, the rules apply to all businesses. Accordingly, it is important that small businesses, who may not have adequate in-house resources, avail timely assistance to ensure compliance.”
Time is of the essence
The implications of new transfer pricing regulations are far-reaching and complex, adding layers of compliance and record-keeping to an economy previously unburdened by taxation. For UAE-based businesses, this is a significant departure from their existing working practices, and they’ll need to remain vigilant and adaptable as the law develops. Multinational corporations with experience in dealing with transfer pricing will also have to recalibrate their existing systems to align with the new norms.
With the financial year starting in January 2024 on the horizon, the clock is ticking. Companies must act now to mitigate risks and fully comply with the new transfer pricing regulations to avoid costly penalties and secure their position in the UAE’s rapidly evolving economic landscape.