Part 2- A conceptual framework of Transfer Pricing for your business

In continuation to our first part of the blog on Transfer Pricing overview, MBG is pleased to share the second part of the blog series focusing on TP documentations, exceptions on maintenance of master file and local file, and specific cases for special considerations as stated below.

7. TP DOCUMENTATION

1. Transfer Pricing Documentation – TP documentation needs to be maintained by taxable persons on Contemporaneous basis. Below are the five documentation required to be prepared:

8. EXCEPTIONS ON MAINTENANCE OF MASTER FILE & LOCAL FILE

1. As an exception, any Taxable Person that is part of a UAE headquartered group that is not an MNE Group (i.e. a group that does not have business establishments outside the UAE) is not required to maintain a Master File. However, they should maintain a Local File as per the above thresholds;
2. A Taxable Person not meeting either of the conditions is not required to maintain either a Master File or a Local File. In such cases, the Taxable Person is still required to maintain reasonable records to support the arm’s length nature of the Taxable Person’s transactions or arrangements with its Related Parties and Connected Persons. The FTA can request such information to be produced within (30) thirty days following a request by the FTA, or by any such other later date as the FTA directs.

9. SPECIAL CONSIDERATIONS FOR SPECIFIC CASES

1. Recognizing the UAE’s position as a financial and investment hub, the Guide offers useful guidance for specific TP areas commonly encountered by businesses operating in the UAE. Broadly, the guidance is consistent with the OECD TP Guidelines:
2. Financial Transactions - Taxpayers are expected to conduct all financial Controlled Transactions in line with the arm’s length principle. The main areas addressed in the Guide are determining the arm’s length remuneration for the following:

1. Settlement for the Controlled Transactions - Any outstanding amount arising out of a controlled transaction should be settled within a reasonable period. If the actual settlement period exceeds what was agreed upon on a regular basis, the extended credit period could be regarded as an advancement of loan and accordingly compensation in the form of a fee or interest would be required to be charged.
2. Intra-Group services – The analysis of TP considerations for intra-group services mainly involves analysis of the following aspects:
   1. Determining whether an intra-group service has been rendered
      1. Benefits Test – Whether a group entity is in receipt of economic or commercial value to enhance or maintain its business position.
      2. Shareholder activities – Any activity undertaken by a Group member as a parent entity or a regional holding company because of its ownership interest in one or more other Group members (i.e. in its capacity as shareholder). It may also be required to perform such activities for regulatory compliance reasons, which would also indicate these activities are performed in the service provider’s capacity as a shareholder. These types of activities would not be considered to be intra-group services, and thus would not justify a charge to other Group members.
      3. Duplication - Duplication of services occurs when a service is provided to a Related Party that has already incurred costs for the same activity performed either by itself or on its behalf by an independent provider. There is no commercial or practical necessity for such duplicative service and thus, applying the benefit test, no service is considered provided.
      4. Incidental Benefits - an intra-group service relates only to some Group members but incidentally provides benefits to other Group members. Because the activities producing the benefits were never intended for them, and would not be ones for which an independent party ordinarily would be willing to pay.
3. Treatment of pass through costs - Sometimes, a Group company may arrange and pay for, on behalf of its Related Parties or Connected Persons, goods or services acquired from various vendors. These are generally called pass-through costs and are subject to reimbursement.
   1. A question may arise as to whether the Group company arranging and paying for such goods or services should add a profit element to the amount paid to the vendors when recharging such costs to Related Parties or Connected Persons.
   2. The Group service provider may pass on the costs from the vendors without a profit element or mark-up provided that:
      1. the acquired goods or services are requested by and for the benefit of the Related Parties or Connected Persons;
      2. the Group service provider is merely the paying agent and does not enhance the value of the acquired goods or services in the process whatsoever; and
      3. the cost of the acquired goods or services is the legal or contractual liability of the Related Parties or Connected Persons. This condition can be met even if the Group service provider is legally or contractually liable to pay for the acquired goods or services through an inter-company agreement;
      4. The Group service provider should nonetheless consider charging an appropriate arm’s length standard margin (profit mark-up) for its function in arranging and paying for the acquired goods or services on behalf of its Related Parties or Connected Persons. This should be based on (but not limited to) the aggregate costs of performing the function, and reflect the nature of its own services and extent of value-add generated for the Related Parties or Connected Person

1. Profit mark-up – In determining the arm’s length charge, the service provider should apply a mark-up to all costs that are not pass-through in nature. In general, the low value adding services (“LVAS”) should meet the following criteria:
   1. The services are supportive in nature;
   2. they are not part of the core business of the MNE Group (i.e. not creating the profit-earning activities or contributing to economically significant activities of the MNE Group);
   3. they do not require the use of unique intangibles;
   4. the performance of such services does not involve significant risk
   5. The final step is to apply a profit mark-up, in the case of the low value adding services safe harbor the mark up shall be 5%.

1. Intangibles - The Guide provides detailed guidelines regarding intangibles, which involves their identification and determination of the arm’s length price. The legal owner of the intangible would be only entitled to the arm’s length compensation, if any, for holding the title. Group members which contribute to Development, Enhancement, Maintenance, Protection and Exploitation (‘DEMPE’) functions are entitled to receive proportionate remuneration from intangibles. This is aligned with action plan 8-10 of BEPS.
2. Cost contribution arrangements (‘CCAs’) - In order to benchmark CCAs, the TP Guide highlights that the most crucial step is to calculate the value of each participant’s contribution to the joint activity and finally to determine whether the allocation of CCA contributions align with the expected benefits.
3. Permanent Establishment – For Transfer Pricing purposes, a PE is treated as a separate and independent entity (from its parent entity) and thus, transactions between Related Parties or Connected persons with a PE need to comply with ALP. Benchmarking a PE transaction involves undertaking a thorough FAR analysis to identify the activities performed by the PE vs. the parent, in order to determine the compensation/ profits attributable to the PE.
   1. The FTA expects Taxable Persons to attribute the appropriate amount of profits and associated costs to PEs in accordance with the Arm’s Length Principle. The Arm’s Length Principle requires treating a PE as if it is a separate entity that operates independently from other parts of the Group and the parent to whom the PE belongs (i.e. a head office).
   2. The FTA expects Taxable Persons will follow the above approach when attributing profits to PEs and that contemporaneous documentation supporting the application of the approach will be maintained and provided to the FTA upon request. This is expected to form part of the Transfer Pricing documentation prepared for each period.
4. Reliance on arm’s length standard carried out by members of the MNE group- The MNE Group may have a Group-wide Transfer Pricing policy for common transactions and arrangements based on the arm’s length standard for such transactions and arrangements. Such a Transfer Pricing policy should be evaluated from the UAE context based on two parameters:
   1. whether the Taxable Person is carrying out similar transactions and arrangements with Related Parties and Connected Persons; and
   2. whether the arm’s length result of the Group-wide Transfer Pricing policy takes into account local and/or regional comparables in order to meet the arm’s length standard.
5. Cash/bank settlement between Related Parties and Connected Persons- The Arm’s Length Principle requires that there should be a reasonable mechanism settlement period exceeds what the Related Parties or Connected Persons agree upon on a regular basis, the extended credit period could be regarded as an advancement of loan. As a result, a compensation in the form of a fee or interest could be charged
6. Transfer Pricing Adjustments - Transfer Pricing adjustments are designed to ensure that the taxable outcome of the Controlled Transaction is aligned with the Arm’s Length Principle. Transfer Pricing adjustments can be initiated by both Taxable Persons and the FTA in cases where it is believed that a transaction has not been conducted in an arm's length manner.