Corporate Income Tax in the UAE-Related Parties Transactions
Risk of Double Taxation
In the realm of taxation, clarity and certainty are vital for taxpayers to navigate tax regulations and ensure compliance. UAE’s tax laws, notably Article 59 of the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“CT Law”), embody this by providing a pathway to tax clarifications and aligning transfer pricing with international standards like the arm’s length principle advocated by the Organisation for Economic Co-operation and Development (OECD). This article underscores the importance of clear tax obligations, allowing taxpayers to seek precise clarifications.
Article 59 paves the way for taxpayers to ensure that their transfer pricing in transactions with related parties and connected persons adheres to the arm’s length principle. It introduces the possibility of entering into Advanced Pricing Agreements (APAs) once the relevant program is activated. APAs serve as a mechanism to establish and confirm that the transfer pricing aligns with what unrelated parties would agree upon in comparable transactions, providing further certainty and compliance with the arm’s length standard.
In the complex landscape of international commerce, multinational enterprises engage in transactions with their affiliated entities, known as related parties. These transactions, often referred to as intercompany transactions, cover a range of activities. Ensuring these transactions are priced fairly and consistently with what unrelated parties would agree upon is crucial, especially in the GCC and ME region, due to several reasons and backgrounds, including the following:
- The new application of the Corporate Income Tax in the UAE with the adoption of the OECD’s principles of Arm’s Length;
- The majority of the companies and businesses in the UAE and the region are connected and doing business with each other, i.e., family businesses, government support, nationalizations, etc;
- The creation of a tax group between related parties is more strict than other conditions, i.e., VAT tax group requirements and
- The strategic role of government entities in establishing related entities and granting of business for various important reasons and considerations.
Thus, the concept of “Transfer Pricing” comes into an even more important play, and one significant tool in managing transfer pricing is the Advance Pricing Agreement (APA).
Any individual or entity can apply to the FTA to seek clarification on the application of the Corporate Tax Law or to enter into an advance pricing agreement related to a proposed or actual transaction(s). The applicant need not be a taxable person at the time of seeking the clarification, emphasizing the proactive nature of seeking tax certainty. Furthermore, this might involve related parties outside the UAE and, therefore, dealing with more than one Tax Authority.
So, What is advance pricing agreement (APA)?
An Advance Pricing Agreement (APA) is a formal arrangement between a taxpayer and tax authorities that determines important criteria in the transfer pricing methodology to be applied for a set of transactions over a fixed period of time, typically in the future. The aim of an APA is to prevent transfer pricing disputes by providing certainty to both the taxpayer and tax authorities regarding the appropriate pricing for transactions involving related or associated enterprises.
In the context of transfer pricing, related or associated enterprises are entities that are under common ownership or control, directly or indirectly. These entities could be a parent company and its subsidiary, sister companies under the same ownership, or any other relationships that might impact the pricing of transactions between them.
Types of APAs
There are three primary types of APAs:
- Unilateral APA: This involves an agreement between the taxpayer and the tax authorities in one jurisdiction where the taxpayer operates.
- Bilateral APA: This agreement involves the taxpayer, tax authorities from the home country, and those from the foreign country where the related party is located.
- Multilateral APA: This agreement involves the taxpayer and tax authorities from multiple jurisdictions where the related parties are situated.
Below are the key elements and benefits of an Advance Pricing Agreement:
- Methodology and Principles: APAs provide important criteria and clarity on the transfer pricing methodology and the principles that will govern how transactions between related parties will be priced. This is essential to ensure compliance with the arm’s length principle, aligning pricing with what would be agreed upon by unrelated parties in comparable transactions.
- Duration and Scope: APAs are usually agreed for a specific period of time, often 3 to 5 years. They cover a defined set of transactions and provide certainty for those transactions during the agreed period.
- Collaborative Process: The APA process involves negotiations and discussions between the taxpayer and the tax authorities. It’s a collaborative effort to agree on a reasonable and appropriate transfer pricing methodology.
- Documentation and Compliance: Taxpayers are typically required to maintain compliance with the agreed transfer pricing methodology and provide regular reports to tax authorities, demonstrating adherence to the terms of the APA.
APAs offer several benefits to taxpayers and tax authorities alike:
- Avoidance or reduction of Risk of Double Taxation: where there is a valid adjustment to transfer pricing by tax authorities on a taxpayer, it should be expected that a corresponding adjustment to the other party of the transaction that, in effect, prevents the same income from being taxed twice. The corresponding adjustments are not automatic, especially when dealing with two or more different tax authorities. The APAs might involve the ability to accept and perform the corresponding adjustment through the Mutual Agreement Procedures (referred to as MAP APAs).
- Certainty and Reduced Disputes: APAs offer certainty to taxpayers regarding the pricing of their transactions. This helps in reducing the risk of transfer pricing disputes and subsequent litigations.
- Time and Cost Savings: By proactively agreeing on transfer pricing methodologies and principles in advance, APAs save time and resources that would otherwise be spent on dispute resolution processes.
- Efficiency: APAs help in streamlining compliance by setting transfer prices in advance, saving time and resources during audits.
- Enhanced Relationships: Establishing clear and agreed-upon terms through APAs can enhance relationships between taxpayers and tax authorities, fostering a cooperative and transparent approach to transfer pricing compliance.
- Risk Mitigation: APAs help in mitigating the risks associated with potential adjustments to transfer prices, which could result in penalties, interest, and reputational damage.
Process of obtaining an APA
The process of obtaining an APA typically involves:
- Pre-filing Consultation: Taxpayers engage in discussions with tax authorities to assess the viability and form of the APA.
- Formal APA Application: The taxpayer submits a formal application with the required documentation and information.
- Negotiation and Agreement: Negotiations take place between the taxpayer and tax authorities to finalize the terms of the APA.
- Compliance and Reporting: Taxpayers adhere to the agreed terms and provide regular compliance reports to tax authorities.
The ultimate goal of preventing double taxation between related and connected parties could be significant. In the complex realm of transfer pricing, Advance Pricing Agreements are invaluable tools that offer stability, predictability, and compliance. They serve as a bridge of understanding between taxpayers and tax authorities, promoting fair tax distribution and fostering an environment of trust and cooperation. As companies prefer in many cases, to do business with related parties, as well as the aim to expand and operate in a globalized world and new markets, APAs play an increasingly vital role in ensuring a level playing field and a fair tax system for all.