The introduction of UAE Corporate Tax requires businesses to follow specific rules for transactions between related entities. The arm’s length principle is a mandatory requirement. It ensures these transactions are priced fairly, as if they were conducted between independent companies. This guide discusses the principle, its application, and the necessary steps for compliance.
The arm’s length principle states that the price and conditions for a transaction between related parties must be the same as they would be for a transaction between unconnected parties in an open market. This rule is cemented in Articles 34–36 of the Corporate Tax Law and further clarified in the Federal Tax Authority (FTA) Transfer Pricing Guide. This principle applies to:
The objective is to ensure accurate profit allocation and prevent income from being artificially moved to lower-tax jurisdictions.
Adhering to this principle is not optional. Failure to comply leads to significant business risks and financial penalties.
Example: A Dubai-based manufacturer sells equipment to its subsidiary in Abu Dhabi for AED 90,000. The established market price for identical equipment is AED 130,000. The FTA has the authority to increase the manufacturer's taxable income by the AED 40,000 difference and impose related penalties.
The FTA accepts five internationally recognized methods to determine the arm's length price. These methods should be applied in a specific hierarchy, starting with the most direct.
If none of these methods are suitable for a specific transaction, a business may use an alternative method, but it must provide a detailed justification for its choice.
Businesses meeting certain revenue thresholds and transaction volumes must prepare and maintain specific transfer pricing documentation.
A Functional Analysis is also an important part of the documentation. It details the functions performed, assets used, and risks assumed by each party in a transaction. The FTA can request these records at any time, and penalties apply for failure to provide them or for late submission.
A Qualifying Free Zone company provides IT support to its mainland affiliate. It charges a rate of AED 250 per hour. The market rate for equivalent third-party IT support is 450 AED per hour. The FTA can identify the AED 200 per hour shortfall as a non-arm's length transaction. Thus, this difference, multiplied by the total hours billed annually, added to the mainland affiliate's taxable income. This could also jeopardize the Free Zone entity's tax-exempt status.
A related party generally includes individuals or companies linked by ownership (typically 50% or more voting rights), control, or kinship (up to the fourth degree). So, this also includes branches and permanent establishments of the same entity.
No. The arm's length principle applies equally to domestic transactions between two UAE-based entities and cross-border transactions between a UAE entity and a foreign related party.
Penalties can be severe. The primary consequence is an adjustment to taxable income, leading to a higher tax liability. Additionally, administrative penalties apply for failing to submit the Disclosure Form or maintain the required Master and Local files.
Mostafa is a seasoned Tax Consultant with over 5 years years of experience gained in diverse taxations matters. He has vast expertise in settling tax disputes with the Federal Tax Authority and handling of tax procedures in compliance with tax laws. He is adept in investigating underlying tax intricacies and offering expert tax advisory. He is also well-versed in conducting tax analysis’s and negotiations with the Tax Regulators, upon tax preparation and filing. Mostafa specializes in the areas of Tax law, Auditing, Accounting and Banking law.