The UAE Ministry of Finance (MOF) announced on January 31, 2022, that a federal corporate tax (CT) would be implemented for financial years beginning on or after June 1, 2023. Family businesses may need to reconsider their conventional methods of operation as enterprises modify their legal and accounting structures in advance of the UAE’s new corporation tax regime, which takes effect in June of next year.
The Organization for Economic Co-Operation and Development (OECD) model would be used, the Ministry of Finance (MOF) said when it would adopt corporate tax. This would also introduce a well-known corporate taxation idea, namely the principle of transfer pricing. Even if linked businesses are located in free zones, financial support and transactions between them will be subject to more scrutiny under transfer pricing.
WHAT DOES TRANSFER PRICING MEAN AND HOW DOES IT AFFECT CORPORATE TAX IN UAE?
Transfer pricing is a concept that focuses on business transactions between related organizations, which are frequent in the region. This includes international corporations and, in certain circumstances, large family-owned corporations in the UAE that have market power.
By using a tax loophole to charge a linked business a significantly lower or larger fee for a transaction, the concept ultimately prohibits a business from paying less tax by inflating taxable income and claiming income to be much lower than it really is in practice.
Based on the FAQs, the planned UAE Corporate Tax regime will encompass the adoption of formal transfer pricing laws and Transfer Pricing documentation requirements in compliance with the Transfer Pricing Guidelines established by the Organization for Economic Cooperation and Development (OECD TP Guidelines) (OECD TP Guidelines). Additionally, other corporate tax considerations (such as tax grouping, the free zone regime, etc.) may affect whether the businesses must comply with the transfer pricing regulations.
Let us try to explain this by taking an example of two businesses – calling them ABC Business and XYZ Business
Suppose the ABC Business and XYZ Business is owned by the same person or entity. It is said that ABC Business operates within UAE while the XYZ Business operates outside UAE but it still render management services to the ABC Business. Let us assume that ABC Business makes AED 12,000,000 in taxable income. In order to offset this, XYZ Business charges ABC Business a management fee of AED 10,000,000 (even though the real price would be considerably lower), which lowers the taxable income from what should have been a much greater taxable income to only AED 2,000,000.
In addition to services, it also applies to the transfer of commodities between companies that are related.
WHAT ARE THE OECD GUIDELINES RELATED TO CORPORATE TAX IN UAE?
The MOF declared it would align itself with OECD principles, but we’ll have to wait to see exactly what the corporate tax legislation requires once it’s made official.
When evaluating transfer pricing, the OECD applies the “arm’s length concept.” Simply put, this means that any transactions between related businesses are subject to the same rules that apply to transactions between unrelated businesses. Consequently, neither business treats the other differently.
The OECD offers comprehensive instructions on how a valuation should be determined, but basically, five approaches are applied, notably the:
1) Comparable uncontrolled price method
2) Resale price method
3) Cost plus method
4) Profit split method
5) Transactional Net Margin Method
The most important documents that must be kept up to date by businesses, according to the OECD, are a Master File and a Local File. The local file is focused primarily on the company inside the local jurisdiction, in this case the UAE, whereas the master file includes the entire group of connected companies.
HOW CAN BUSINESSES PREPARE FOR THE CORPORATE TAX REGIME AND IMPLICATIONS OF TRANSFER PRICING IN UAE?
It is not advisable for multinational corporations to make significant, broad adjustments until the real legislation is approved because they won’t know exactly what needs to change. To ensure they are ready for when the legislation is released and to properly comply with it, businesses can take into account the OECD concepts and principles and then self-evaluate their existing position and how they operate, particularly with regard to their transfer pricing strategy. Failing to prepare your property can result in breaking the law and putting yourself at danger of the penalties that will definitely be imposed in such circumstances.
The UAE government, however, hasn’t hesitated to emphasize that regional companies with minimal expertise in corporate tax systems should continue to use regular accounting procedures to stay in compliance. The levy on corporations will change how businesses operate from a legal and accounting perspective, but it is anticipated that its implementation will help the business climate. This includes allowing tax groups to be formed and maintaining the tax holidays provided to free zone businesses.