New UAE transfer pricing regulations to enhance UAE regional hub status

By Mourad Chatar and Sarah Bahous, Partners at Value Square, Dubai

On January 31, the United Arab Emirates Ministry of Finance announced the implementation of a federal corporate tax regime including transfer pricing regulations that are expected to be largely inspired by OECD transfer pricing guidelines.

Transfer pricing and its internally agreed arm’s length principle is becoming prevalent in the Middle East region with more countries either adopting regulations or focusing their scrutiny on transfer pricing-related issues. The list of countries adopting transfer pricing regulations is getting longer with Egypt, Saudi Arabia, Qatar,  Jordan and now the UAE.

A low corporate tax rate of 9%, coupled with the arm’s length principle, is the perfect balance the UAE has very carefully crafted to remain a location of choice for foreign direct investment in the Middle East.

Given its de facto regional leadership in attracting people and businesses, the UAE has the ability to transform any apparent challenge into an opportunity. It is a mindset and a skill set that is not given to any country and which sets the UAE apart from its neighbors.

The transfer pricing life cycle

It is of the utmost importance to remember that transfer pricing is not just about documenting its intragroup transactions.

In many forums organized by advisors with only Middle Eastern experience, one will notice that their key discussion topic is transfer pricing documentation. While important, transfer pricing documentation is only the last step of any transfer pricing strategy. This is mainly because tax, in general, and corporate tax, in particular, has been getting more important over the last three to five years in the Middle Eastern region.

Corporate tax and transfer pricing disciplines are intertwined with each other and, today, there is no serious international corporate tax strategy without an in-depth understanding and control of the transfer pricing life cycle within an MNE.   

It all starts with the design of the strategic corporate tax and transfer pricing strategy where an MNE would craft its plan to be compliant with rules and regulations while ensuring it has the most efficient structure limiting the tax frictions of all of its intragroup flows. It includes looking at the MNE’s legal and ownership structure, as well as the location of its economic substance, given an MNE’s ultimate goal is to maximize the value back to shareholders who have invested in it.

Once the blueprint plan is set, the implementation and operability phase is put in motion including three fundamental dimensions: people, processes, and systems of the MNE. To effectively implement any corporate tax and transfer pricing strategy (and walk the talk), one needs skilled people who will take ownership.  They will intuitively understand when to issue an intragroup invoice to one of their related subsidiaries, how to clear processes to avoid wrong implementation—or even to recognize the absence of effective implementation—and, finally, know the correct information systems to pull out the right data in the right quality and the right form.

Once implemented, the corporate tax and transfer pricing strategy needs to be documented. The documentation set is not limited to the transfer pricing documentation the OECD transfer pricing guidelines define. The documentation set is the entire corpus of written traces that will demonstrate to tax authorities that the MNE is putting its words into action. It includes the understanding that legal agreements provide a legal reality to the economic reality of the transactions, the corporate and transfer pricing policy statements, the manuals detailing the implementation processes, the working and computations sheets, and the transfer pricing documentation and related benchmarking studies.

Finally, the last phase of the MNE transfer pricing life cycle is the importance of being able to defend the transfer pricing strategy from any tax authority that would challenge the MNE’s positions. This plan includes designing a defense strategy depending on the approach the tax authority may take, having a thorough understanding of the MNE’s position, and remaining open to settling if the dispute gets too difficult.

Given the above, an MNE looking at transfer pricing in silo without looking at the corporate tax aspects—and also the indirect tax ones—would most probably fail in designing an efficient policy, implementing it consistently, and defending it successfully.

To this end, one needs to be surrounded by the right advisors who have extensive experience in international corporate tax and transfer pricing projects involving MNEs – not only currently in the Middle East but all around the world, especially in Western countries.

Transfer Pricing – a tool for enhancing regional hub status

For transfer pricing experts with solid international corporate tax experience, it is—and will continue to be—a pleasure to practice transfer pricing in the UAE.

Before these changes were made, the UAE was already attracting a lot of MNEs because of the regional transformation and business opportunities. Many were setting their regional hub in the UAE and, most often, in Dubai Emirates. Dubai became a brand known for its peaceful lifestyle, family-oriented infrastructure, and business-friendly governance. It counts more than a hundred free zones, multiplying and diversifying the offer to set up business activities.

This type of setting is key for any future corporate tax and transfer pricing planning that critically depends on where the economic substance is. With the upcoming transfer pricing regulations, if an MNE has put its economic substance in the form of people, capital, and assets in the UAE, it gains a competitive edge over its competitors who have not. More precisely, it will be able to structure its entire corporate tax and transfer pricing policy in a way to centralize most of its profits in the UAE and enjoy a low nominal corporate tax of 9% (carving out Pillar Two  MNEs that would be most likely subject to the 15% corporate income tax).

UAE transfer pricing rules and potential exemptions

Like its neighbors, the UAE decided to opt for a simple transfer pricing regime fully in line with the OECD transfer pricing guidelines.

The application of the arm’s length principle within the corporate tax regime allows MNEs and the UAE federal tax authority to adjust the declared taxable base to ensure it reflects arm’s length intragroup transactions, i.e. prices that would have been agreed between independent parties.

In addition to the above, the UAE transfer pricing regulations will include documentation obligations requiring MNEs to justify the rationale behind the pricing of the intragroup transactions involving the UAE entity. In line with the OECD transfer pricing guidelines, the documentation will be structured around the master file and the local file.

The thresholds for the documentation requirements—often based on a level of turnover and assets—will be released with the law. The UAE might decide to focus only on very large multinationals and set high thresholds, which would shield small businesses from a compliance burden.

That being said, the absence of documentation requirements for smaller businesses does not necessarily mean that they will not be subject to transfer pricing audits in the UAE and be in a position to justify their intragroup pricing. Therefore, one may not wait for a documentation obligation to look at their intragroup dealings.

On the contrary, the MNE should seize the documentation step as an opportunity to have fruitful insights and most probably come up with better plans to increase the tax efficiency of the framework of the MNE intragroup flows.   

So far, the Ministry of Finance only released guiding principles that include a reference to a potential exemption of qualifying intragroup transactions from corporate tax, provided the necessary conditions are met. Here more details would be welcome as it is not clear whether that means that a targeted type of intragroup transaction would be exempt from corporate tax and transfer pricing rules. The ministry’s intention is probably to rule out domestic intragroup transactions that would be in line with tax consolidation regimes allowing groups of entities located in the UAE to file one single corporate tax return on behalf of all of the entities it is scoping. In such a case, MNEs would have to focus only on the cross-border intragroup transactions. This topic brings up another question regarding free zones entities that still will be enjoying their tax incentives – except if they are involved with mainland entities.

Concluding remarks

With a transfer pricing regime in line with the OECD transfer pricing guidelines, the UAE will join the large club of countries that decided to apply the internationally-agreed principle governing intragroup transactions, i.e., the arm’s length principle.

Together with a corporate tax rate set at 9%, the implementation of the arm’s length principle is yet another opportunity for the UAE to further strengthen its leadership as the best regional hub for MNEs to organize their business in the Middle East region. With a complete tax system in line with international standards, the UAE is adding another advantage to a long list starting with the access to skilled resources, economic and political stability, state-of-the-art infrastructure, and strategic location between the West and the East. 

From an MNE perspective, it is recommended to take the time available before the implementation of the new regime to perform an initial high-level impact assessment of the transfer pricing arrangements, which are at the core of any MNE’s international tax policy. MNEs already operating in the UAE with the right level of economic substance will be able to leverage the arm’s length principle to increase the efficiency of their tax structure.

The corporate tax return, backed up with the right transfer pricing policy and the right documentation, will be critical when dealing with the federal tax authority. The UAE is ramping up its skill set to be able to assess the transfer pricing position of its taxpayers by 2023. Therefore, it’s now essential for an MNE to have the right resources and the right advisors by its side going forward.  

• Mourad Chatar and Sarah Bahous are regional tax partners at Value Square, Dubai