Transfer pricing, the practice of determining the price of transactions between related parties or connected persons, plays a crucial role in today’s complex global business landscape. Multinational corporations engage in various transactions and arrangements with related parties, including the exchange of goods and services, financial transactions, and interactions involving permanent establishments. However, these dealings can carry significant implications for taxation, accounting, and risk management.

Unlike independent parties, related parties and connected persons may not face the same competitive pressures and may resort to non-arm’s length pricing in their controlled transactions to manipulate profits and optimize tax liabilities. To counter such practices, the international standard for pricing these transactions is the arm’s length principle, now integrated into the UAE Corporate Tax law.

The arm’s length principle dictates that transactions between related parties should be priced as if they had occurred between independent parties in similar circumstances. The key is to determine the price that two independent parties would agree upon, supported by evidence of their behavior whenever possible. It’s important to note that the absence of a formal pricing arrangement or legal agreement between related parties does not negate the application of the arm’s length principle.

Treating related parties as separate entities, the arm’s length principle also emphasizes the importance of a comparability analysis to align profits with functions, assets, risks, and contributions. This principle extends to domestic transactions, ensuring that related parties and connected persons receive their fair share of profits as if they were independent entities.

Related parties are defined under the UAE Corporate Tax law and include associated persons, regardless of their UAE residency. Connected persons, on the other hand, are persons associated with taxable persons. Payments or benefits provided by a taxable person to a connected person are deductible for corporate tax purposes if they correspond to the arm’s length price and are incurred exclusively for the taxable person’s business purposes.

Exemptions from the restriction on deducting payments or benefits provided to connected persons based on the arm’s length price are specified under the UAE Corporate Tax Law. These exemptions apply to taxable persons whose shares are traded on recognized stock exchanges, those subject to regulatory oversight in the UAE, and others determined by a decision issued by the Cabinet.

Understanding transfer pricing and the arm’s length principle is vital for businesses engaged in related party transactions. These principles ensure fairness, transparency, and accountability in financial dealings, guarding against profit manipulation and tax avoidance strategies. The incorporation of these principles into the UAE’s corporate tax law demonstrates a commitment to aligning the country’s tax regulations with international standards, ultimately promoting a fair and competitive business environment.

Prateek Tosniwal is a partner at MI Capital Services (MICS), a company that specializes in providing transfer pricing and other financial services.