According to Article 34 of the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses of the UAE (“the Law”), a transaction or arrangement between related parties must meet the “arm’s length” principle. In order to verify that an analyzed transaction is in line with this principle, a special study should be performed – a comparability analysis.
At the moment, the Law does not provide for the definition of the comparability analysis or the rules of how it should be performed. At the same time, the Law is broadly in line with the OECD transfer pricing (“TP”) guidelines, so the provisions of the latter can be used for interpretation.
According to the OECD TP guidelines, the comparability analysis involves assessing whether the conditions of transactions between related parties differ from those in comparable uncontrolled transactions. The parties involved in comparable uncontrolled transactions that share a functional and risk profile similar to that of the taxpayer are referred to as "comparables." The search for such comparables is a crucial step in the comparability analysis and can be categorized into two groups:
The process of identification of external comparables is termed the “benchmarking study” and is typically performed using databases that compile company accounts in an electronic format suitable for searches and statistical analysis.
There are two approaches to benchmarking study:
1. “Addictive” approach – this involves drawing up a list of third parties that are believed to carry out potentially comparable transactions (usually, a taxpayer’s competitors); further the information is collected on transactions concluded by these third parties to confirm whether they are in effect acceptable comparables, based on the pre-determined comparability criteria. The main challenge with this approach is the potential lack of available information on potential comparables, such as limited financial data.
2. “Deductive” approach – This approach is more commonly used than the "addictive" approach. It begins with a broad set of companies operating in the same sector, performing similar functions, and not displaying obvious economic differences. The list is then refined using selection criteria and publicly available information (e.g. from databases, Internet sites, etc.). In practice, the "deductive" approach often starts with a database search.
The “deductive” approach is believed to be more reproducible and transparent than the “addictive” approach. At the same time, the quality of the outcome of the “deductive” approach depends on the quality of the search tools on which it relies.
OECD TP Guidelines describe the typical search process under the “deductive” approach as follows (it is an accepted good practice but not a compulsory one, which is usually prescribed by local rules):
Step 1: Determination of years to be covered
Step 2: Broad-based analysis of the taxpayer’s circumstances
Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party, the most appropriate TP method, the financial indicator to be tested, and to identify the significant comparability factors that should be taken into account.
Step 4: Review of existing internal comparables, if any.
Step 5: Determination of available sources of information on external comparables where such external comparables are needed taking into account their relative reliability.
Step 6: Selection of the most appropriate TP method and, depending on the method, determination of the relevant financial indicator.
Step 7: Identification of potential comparables: determining the key characteristics to be met by aby uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors set out…
Step 8: Determination of and making comparability adjustments where appropriate.
Step 9: Interpretation and use of data collected, determination of the arm’s length remuneration.
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For over 10 years we have provided advice on transfer pricing to such clients as Volvo, Ritter Sport, Harmtann, Doppelmayr, Hansgrohe, Miele, Sierentz, Deke, Hoya Holding, Farmamondo, Biocodex and many others. For more details, please visit www.ade-solutions.ae.
