TP Risk Management: What Issues Could be Preliminarily Planned/Set Up?

In accordance with OECD TP (transfer pricing) rules almost all countries (including the UAE starting from the 2023 reporting year) are subject to international transfer pricing regulation, which mandates following the "arm's-length" principle in all business transactions with related companies.

This means that multinational businesses with operations in the UAE must adhere to these rules to minimize negative consequences and tax risk exposure. In practice, the "arm's-length" principle encompasses the following economic aspects: inter-group pricing, allocation of the total margin among different business segments, and the form and conditions of inter-group contracts.

Most material transactions between related parties or within a single group, in accordance with TP legislation, are categorized as "controlled transactions" and are subject to review by tax authorities in different jurisdictions. Furthermore, such transactions must be disclosed, including providing proof of compliance with the arm's-length principle.

The optimal approach to mitigating TP risks for a multinational group is to establish robust and comprehensive TP planning from the outset. This means when the group is preparing its business and financial model, it should incorporate specific benchmarks for gross/operating margin, sales prices, and the required documentation (or audit trail) that should later be disclosed in a timely and proper manner.

Additionally, international TP legislation establishes minimum and maximum benchmarks for margins to be used, depending on the level of value-added activity. That means that multi-national businesses should prepare good quality functional analysis and classify all of their activities in each jurisdiction.

Example: The Group opens a large warehouse facility in the UAE. In accordance with its business strategy the Group produces clothes in China using the IP rights (technology) registered in the USA, and then the clothes are delivered to a warehouse hub in Dubai from where they are distributed to retail stores worldwide. The main areas and questions to be covered in order to minimize tax risks are:

Revenue flow, cost/profit centers identification and split;

Functional analysis in TP methodology and classification;

Methodology of indirect costs and allocation of overheads (which affect the segment results);

Benchmark study in terms of each material function (including operations in the UAE) – identification of safe harbour margins for each function in terms of the TP legislation;

Preparation/formalization of the group pricing and the accounting policies;

Preparation of the financial business model covering all the above issues;

Preparation of the reporting documents for the TP filing and disclosure.

Why it is important to prepare the appropriate financial business model at the very beginning? Many business owners and managers mistakenly believe that preparing the right financial business model is not an immediate concern and can be addressed later. Unfortunately, this approach often leads to more effort and investment down the road in order to rectify mistakes and potential tax risks.

Issues that can be avoided include:

Actual transactions with incorrectly defined and applied margin policies that result in disproportions in profit margins by function or profit centre.
Possible external parties, such as local UAE banks, already have received a business plan, making it more challenging to make substantial changes.
Lack of audit trail (primary documents, accounting and pricing policies), which makes it more difficult to prepare correct tax documentation/reporting for filing purposes later on.
Unnecessary overspending when it is economically beneficial for the owner to utilize external professional sources to obtain reliable benchmark information.
The need to prepare transfer pricing documentation based on actual results with embedded margin disproportions, requiring additional effort in terms of calculation and potentially consuming more time and resources.
The ability to formalize the financial business model and TP (transfer pricing) mechanism/rules as part of the business process and internal group procedures. These procedures can include the minimum required internal controls within this process, enhancing the business's credibility and long-term strategy, such as preparing for an IPO or securing bank financing.

ADE Professional Solutions can provide the following support on various transfer pricing issues, including:

Carrying out diagnostics of controlled transactions while considering the TP methods’ peculiarities;
Providing methodological support and professional advice on the application of TP legislation;
Preparing a TP documentation package on the transaction, including justification of the methodology and appropriate compliance of the applied prices with the market level;
Offering other professional tax consultations.

For over 10 years we have been 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.