UAE Corporate Tax Law – Alert on Transfer Pricing Regulations.

The United Arab Emirates (“UAE”) Ministry of Finance (MoF) issued the Federal Law on the Taxation of Corporations and Businesses by enacting the Federal Decree Law No.47 of 2022 on December 09, 2022 (herein after referred to as the “Decree Law”).

The Decree Law serves as the legislative basis for the introduction and implementation of Federal Corporate Tax (“CT”) in UAE and comes into force with effect from the Financial Year commencing on or after June 01, 2023.

We have presented a detailed alert focussing on the transfer pricing regulation embedded in the UAECTLaw. The alert covers:

1. Applicability – Applies irrespective of whether related parties, connected persons are in UAE mainland, a Free Zone or in a Foreign Jurisdiction. TP not applicable for transactions between entities forming part of the same Tax Group.
2. RelatedParty –  established through Ownership, control or kinship
3. Connected person – Ownership/controls, director or officer
4. 5 Methods of arriving at arms’ length price (ALP). Option of Sixth method also available
5. Option of correspondingadjustment , even for adjustment effected for foreign related parties by Foreign tax authorities
6. Introduction of disclosureform (to be filed), localfile and Masterfile (to be maintained)
7. Option of APA filing
8. Reference to ALP/market value in other CT sections- Freezone entities (TP provisions to be satisfied and maintaining Documentation as one of the conditions to claim 0% tax), transitional provisions, general anti abuse rules, investment manager exemption , Foreign PE, Interest.

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UnionBudget2024 – TransferPricing Takeaways

The full year Union Budget for 2024-25 was presented by the finance minister on 23 July 2024. VSTN alert summarizes the Transfer pricing updates viz.,

1. Power given to Transfer pricing Officer (TPO) to scrutinize Specified Domestic transactions not referred by the Assessing Officer (AO)
2. Announcement in the Budget speech on widening the scope of Safe Harbour and to update arm’s length conditions prescribed therein to make it more attractive for taxpayers. Safe Harbour rules are to be extended to foreign mining companies selling raw diamonds in India. These, however are not mentioned in the Finance (No.2) Bill 2024 or the memorandum to the said Bill.
3. Finance Companies in IFSC are exempt from the purview of Section 94B – Limitation on interest deduction.
4. Reduction of Corporate Tax rates to 35% for foreign companies.
5. Rationalization of time limits for filing appeal before Income Tax Appellate Tribunal (ITAT) to 2 months from the end of the month in which the order sought to be appealed is communicated.
6. Vivad Se Vishwas Scheme announced for 2024.
7. Streamlining of Transfer pricing assessment proceedings.
8. Withdrawal of Equalization levy, marking implementation of Pillar One and Pillar Two in India in the near term.

The finance minister in her Budget speech announced that the monetary limits for filing appeals by the revenue would be increased to INR 60 lakhs before Tax Tribunals, INR 2 crores before High Court and INR 5 crores before Supreme Court.

As a follow-up to the Budget, it is expected that draft regulations of Pillar One and Pillar Two and the revised rules for Safe Harbour Rules will be issued in the near term.

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FTA directive on APA- UAE (2)

FTA directive on Advance Pricing Agreements

Recently, the Federal Tax Authority (FTA) issued Decision No.4 of 2024, effective from July 01, 2024, which enunciates FTA’s policy on issuing clarifications & directives relating to federal taxes. While policy outlines the general framework for procedures of clarifications & directives, the processes & details shall be specified by FTA.

Article 59 of the Federal Decree law no 47 of 2022 provides that a person may make an application to FTA for entering into an APA with respect to an existing/proposed transaction with related parties. The FTA shall prescribe the form & manner in which application for APA should be made.

The said Decision now clarifies that start date for receiving APA applications, the procedures relating to submission & issuance of agreements will be announced by FTA during the fourth quarter of 2024.

As UAE TP Guidelines largely follows the OECD TP Guidelines, it is expected that UAE APA programme will also be in line with Chapter IV of the OECD TP Guidelines. A general overview of an APA program is as below:-

• ELIGIBILITY CRITERIA- Generally APA program provides an eligibility criteria for both the time limit within which such an application may be made for a financial year as well as defining a minimum threshold of the value of related party transactions undertaken / proposed to be undertaken
• TYPES OF APA- Can be Unilateral, Bilateral or Multilateral
• TIME PERIOD- Generally an APA would cover a specified period ranging from 3 to 5 years & would also provide for a rollback provision for prior years (3-5 years).
• APA PROCESS:- The APA process generally includes the following steps:-
  • Pre-filing consultation
  • APA Application
  • Preliminary processing of application
  • Procedure
  • Negotiation
  • Signing of Agreement
  • Post APA Compliances

Thus FTA’s directive, to be issued in last quarter of 2024, is expected to address not only the above aspects but also cover procedural aspects relating to format of application, filing fees etc.

The APA programme will no doubt serve as a powerful mechanism for dispute resolution fostering an environment of tax certainty & unanimity in the approach relating to related party transactions. However decision to opt for APA lies with the businesses which needs to evaluate considering the nature, criticality & value of the related party transactions vis-à-vis the time & cost that would be involved in that process. Once decision to enter into an APA is made, it is critical for businesses to:-

• Maintain robust TP Policy aligned with commercial substance
• Maintain intercompany agreements reflecting the TP policy
• Documentation to support that actual business conduct adheres to TP Policy
• Deciding on information, documents & agreements to be shared with APA authorities.

OECD Pillar 1 Supplementary Guidelines on Amount B

Further to the report published on Amount B- a simplified & streamlined approach for application of arm’s length principle to baseline marketing & distribution activities, OECD on Jun 17, 2024 issued supplementary Guidance on “Qualifying Jurisdiction“ & “Covered Jurisdictions”. Access VSTN alert published earlier on Amount B in comments.

1. QUALIFYING JURISDICTION –  SECTION 5.2 – OPERATING EXPENSES CROSSCHECK
   In Feb 2024 Report, a guardrail in the form of operating expenses cross-check mechanism, through a cap-and-collar, was included to determine whether the return on sales arrived using Amount B global pricing matrix is appropriate or requires adjustment. The mechanism provides for application of default cap rates & alternative cap rates (qualifying jurisdiction). Now Qualifying Jurisdiction are those classified by World Bank Group (WBG) as low income, lower-middle income, & upper-middle income based on the latest available ‘WBG country classifications by income level’. The current list of Qualifying Jurisdictions includes 132 countries, which also features India, China, Turkey, Malaysia & Mexico.
2. QUALIFYING JURISDICTION FOR SECTION 5.3 – DATA AVAILABILITY MECHANISM.
   The February 2024 report, included a data availability mechanism which provides for an upward country risk adjustment to the returns derived from the pricing matrix in respect of qualifying jurisdictions that do not have/insufficient data points in the global dataset. For this now qualifying jurisdiction for the purposes of Section 5.3 is a jurisdiction with sovereign credit rating of BBB+ or lower & has less than 5 comparables in the global dataset.
3. COVERED JURISDICTIONS
   The February 2024 report provided for an agreed political commitment under which the IF members commit to respect the Amount B outcome where the approach is adopted by a Low-capacity jurisdiction (LCJ) & relieve potential double taxation. Now LCJ is replaced with “Covered Jurisdiction” and includes :-
   • Low & middle-income IF jurisdictions, based on WBG classifications, excluding EU, OECD & G20 member jurisdictions; or
   • Low & middle-income OECD or G20 IF jurisdictions that expressed willingness to apply Amount B by Mar 2024; or
   • Any low- & middle-income jurisdiction, not in the inclusive framework, but otherwise meeting criterion & expresses willingness to apply Amount B.

Argentina, Brazil, Costa Rica, Mexico, & South Africa have expressed interest to IF. On a bilateral basis, Jurisdictions may extend their political commitment to other jurisdictions.

The list of qualifying jurisdictions & covered jurisdictions will be published & updated every 5 years on the OECD website.

With expected implementation of Amount B from Jan 1, 2025, all business should evaluate impact of Amount B as there are no thresholds for applicability.

APA Considerations with comments

Considerations before opting for Advance Pricing agreement ( APA)

Taxpayers, before deciding on APA, sometimes miss out on certain aspects which has to evaluated in advance through a feasibility study, on the pros & cons. Key areas warranting consideration:

1. Safe Harbour Rules: ~30% of UAPAs concluded in FY 22-23 was by IT sector, indicative of APA inventory. Taxpayer in IT sector, with international transactions < INR 200 crs should consider option of Safeharbour (17/18%), as arbitrage in outcomes under APA is almost Nil/reducing (>17%).
2. Free of Cost Assets (FoC): Different position / strategy can be adopted by business on FoC, but one has the opportunity to defend the position in normal litigation route. In APA, mark-up on FoC is required to be received by Indian business, i.e., suo-moto acceptance of FoC in its operations when signed off. Implications of such acceptance from GST perspective include 18% GST & interest (approx. 6-8%, if APA concludes in 3-4 years) to be paid – effectively ~28% on FoC per annum (without rollback). This is an immediate outflow post APA sign-off. If APA is concluded in 3rd year, availing input credit for GST on FoC for past years may be challenged hence can be a sunk cost. APA authorities generally attribute 2-5% of cost base as FoC.
3. Business Uncertainty: In case of commencement of new business line/ramping of operations, unless the business is able to estimate the changes with certainty, preferable to wait for it to stabilise & then opt for APA. This is because business environment is dynamic & business’s response to economic climate can impact transfer pricing aspects & can render APA outcome inoperable / futile.
4. Tenure: APA has a 5-year covered period, & if one decides for a shorter covered period say 3-years, there would be additional costs -filing, consultant fees, immediate renewal. Where APA is decided as the best dispute resolution route, there should be a very valid reason & detailed analysis documented for a shorter term. For a 10-year period, there would be 2 APA filings if full 5-year period opted, but 3 APA filings if 3-year is chosen as the covered period. This would result in artificial increase in the inventory of cases in APA and unnecessary burden on the government’ s APA resources.
5. Post APA compliances: When a cost benefit analysis is undertaken, one needs to factor the post APA compliances for every covered year as it involves additional effort & resources including filing ACR & compliance audit.

Therefore, businesses should diligently test the waters before taking the plunge for APA. The credibility and efficiency of the Indian APA programme would improve if businesses saved only non-routine or complex transfer pricing issues for APA authorities.

OECD ‘s updated Guidance on Country-by-Country reporting

Recently, the OECD had issued its updated guidance on Country-by-Country reporting. The May 2024 update is on treatment of dividend in Table 1 of the Country-by-Country (CbC) report.

The BEPS Action 13 report prescribes the format for CbC report as well as the definitions for each of the line item such as Revenue, profit (loss) before Income tax (PBT), Income Tax Paid (on Cash Basis), etc. For ‘Revenue’, the definition specifically excludes dividend income from constituent entities. However, there was no parallel exclusion in the definition of Profit (Loss) before Income Tax, resulting various approaches being adopted.

The updated guidance now clarifies that payments received from other Constituent Entities that are treated as dividends in the payer’s tax jurisdiction will have to be excluded from PBT as well.

The guidance also clarifies on the expression “payments received from other Constituent Entities that are treated as dividends in the payer’s tax jurisdiction”. In this regard the guidance clarifies that there should be consistency in the treatment of payments between the payer and the recipient viz.,

• Where the payer treats the payment as the dividend, the recipient to treat it as dividend and exclude from the revenue and PBT.
• Whereas, when the payer treats the payment other than dividend – such as interest, the recipient to retain the receipts in the revenue and PBT

The guidance also clarifies that where applicable accounting standards requires an entity to include an amount from the profit of another constituent entity in its PBT, then such amount will be treated as dividend and should be excluded from revenue and PBT for the recipient. This guidance shall not apply where the entity from whom such amounts are received is a transparent entity for tax purposes.

This guidance applies to reporting fiscal years commencing on or after 01 January 2025.

This update to guidance aligns the definition of ‘revenue’ and ‘profit (loss) before income tax’.

ICAP

Recent updates – OECD International Compliance Assurance Programme (ICAP)

OECD has recently published an updated document (FAQ) in respect of International Compliance Assurance Programme (ICAP/Programme), which commenced on September 2021.

What is ICAP?

ICAP is a voluntary risk assessment & assurance process designed to be an efficient and effective tool to facilitate MNE Groups achieve increased tax certainty with respect to their activities/transactions concerning transfer pricing and other international tax matters(hybrid mis match arrangements, withholding taxes, treaty benefits).

At present only 23 tax administrations have participated in ICAP. To benefit MNCs Headquartered in jurisdictions which are currently not a participant of the ICAP process, the FAQ addresses this critical issue and provides an alternative in terms of another tax administration to act as a Surrogate Lead Tax Administration.

For e.g Take a case of a MNC headquartered in India having subsidiaries across the world. As India is not a participating jurisdiction, those MNCs were not able to opt for the ICAP process. Given this clarification in FAQ for a Surrogate Lead Tax Administration, these MNCs are now eligible to approach alternative tax administration where it has significance presence to be a surrogate Lead tax administration. Considering that there is no filing fees, shorter timeline (24-28 weeks) for an outcome letter, submission of documentation already maintained by the Group (CbC, masterfile, local file etc), it can be as an effective tool for increasing tax certainty.

In the attached newsletter we have captured the background of ICAP , process, the recent clarifications in the FAQ, difference between APA and ICAP and the way forward.

OECD has also released a document of information on the participating tax administrations and their contact details so that MNC desirous of entering into this process can reach out before the application deadline of 30 September 2024. Generally applications are accepted at one of the two annual application deadlines –31 March and 30 September

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KSA APA

KSA – APA Program

The introduction of the APA program comes as a silver lining to the KSA Transfer Pricing tax regime. This welcome move demonstrates the proactiveness of the KSA Government in fostering a non- adversarial transfer pricing environment and providing tax certainty to MNEs in relation to their related party transactions.  On May 19, 2024, ZATCA commenced receiving applications for Unilateral Advance Pricing Agreements from taxpayers and Zakat payers. While the comprehensive guidelines in this regard is yet to be rolled out by ZATCA, some of the key aspects of the KSA APA program as laid down in the amended TP Bylaws and the recent notification inviting applications for Unilateral APAs are brought here below-

A. Applicability

• Applicable to Taxpayers and Zakat Payers
• Applicable from Financial year beginning on or after January 01, 2024

B. Eligibility

• Transaction Threshold
  • In order to apply for APA, the value of transactions with related parties shall not be less than SAR 100 million.(~26.66 million USD).
• Timing of Application
  • The taxpayer/ zakat payer would be required to submit the completed application at least 12 months before the start of the first financial year covered by the agreement.

C. Type of APA

• As of now only applications for Unilateral APA are received by ZATCA. Further guidelines from ZATCA on the APA program is expected to provide more clarity on Bilateral and Multilateral APAs.

This alert summarises the critical aspects of the KSA APA program and also provides an overview of the general APA process with an intent to familiarize businesses and keep them abreast of the upcoming changes.

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Management charges

Decoding Intra-group services

MNEs around the world endeavour to achieve economies of scale by centralising certain activities among the Group (i.e., IT, legal, payroll, back office, marketing, R&D, etc.,). Considering the very terminology of intra-group services (IGS), it becomes an easy target for tax authorities to impose transferpricing adjustments. As benefit received from IGS are often auxiliary, taxpayers are encountered with satisfying ‘Need-benefit test’.

More often than not, focus is more on mark-up charged on IGS, leaving behind big picture i.e., cost base/cost pool. Determining accurate cost base is essential to arrive at an arm’s length cross-charge, and accordingly, directly identifiable costs, pass through costs, etc., ought to be identified for cost pool. Selection of reasonable allocation keys for indirect costs allocation is another key point. IGS cross charge is arrived at by adding an arm’s length mark-up to such costs. For defending such mark-up, countries who have adopted OECD TPG such as EU, UAE may resort to mark-up of 5% on LVS (Low Value adding services) while others may undertake independent benchmarking using Global databases from a service provider perspective.

Having said that, not all IGS warrant a compensation i.e., shareholder activities, duplicative services, incidental benefits, etc., One may need to evaluate nature of services before categorizing them as chargeable IGS.
In spite of offering varied services to the benefit of affiliates, taxpayers customarily term them as “ Managementcharges ”, without emphasising the technicality of services, which might mislead tax authorities to categorise them as LVS. Instead, one may look at adopting apt nomenclature, e.g production support, technical support, marketing support etc., thereby demarcating from LVS.

Since IGS attracts tax authority’s attention, one may make note of the following:

• Clear identification of category of services (Technical or LVS) to be done.
• Data justifying ‘Rendition test, ‘Need-benefit’ test to be sourced on a contemporaneous basis to handle litigation seamlessly.
• Consistency in Group policy to be evaluated– eg., Regulatory requirements in few countries like China may restrict IGS charge resulting in disparity.
• IGS < INR 10 cr. – Indian taxpayers may resort to Safe harbour rules to ring-fence it from tax litigation where certificate of cost pool workings is required.
• IGS > INR 10 cr.- May opt normal litigation / APA – Critical to note, there is a dual requirement in APA– a) cost plus which is agreed and b) cap on overall quantum i.e., as a % on sales.
• Can opt for MAP, in case of TP adjustment. Relief may be provided based on factual pattern.

Depending on the factual circumstances, one may take a calculated call in determining the approach to be adopted.

Aggregation of Transactions

Aggregation of Transactions – “When to” & “When not to”

Aggregation of transactions during benchmarking analysis has seen wide adoption without appreciating the nuances of transactional analysis. Though various country regulations and OECD guidelines lay down various criteria to determine if the transactions are so closely linked to warrant aggregation, one should not consider commencing TP pricing/benchmarking with this as a default approach.

In this post, we highlight certain instances wherein a Transactional Analysis approach should be adopted as against the aggregation approach.

• Setting up of Pricing PolicyIn case when a TP policy is to be established for various new transactions, the FAR analysis should be carried out for every distinctive activity/service/ transaction that it proposes to undertake with related parties (RPs). Every transaction needs to be clearly delineated since the FAR qua the transaction vary, and the return which an entity is expected to earn is correlated to its key value adding activities / risks. Thus, determining the arm’s length margin to be earned by an entity at net level by aggregating all transactions may not be appropriate. This is more relevant for jurisdictions which have recently commenced TP regime in their tax law (e.g UAE). Transaction level analysis is critical for price setting for the first year, for such cases.
• Payment of royaltiesPayment for intangibles has always been a litigated area and hence the arm’s length price for such IP transactions (right to use/ transfer of IP) is to be built on a robust DEMPE analysis considering the IP arrangement between the RPs & their relative contributions to the Intangibles. Aggregation of these transactions under TNMM are finding less favour with the Tax authorities and adoption of standalone testing using CUP method is required, though taxpayers contest that these are inextricably linked to the major activity.
• Payments to Key Managerial Personnel (KMP)Countries such as UAE, Qatar cover payment to KMP as a related party transaction. Generally, taxpayers aggregate KMP payments with other transactions to substantiate arm’s length pricing. This however is not a fool proof approach. For Ex., where an entity incurs losses, question arises if there will be no payment allowed to KMP. This transaction should be evaluated on a standalone basis, & the price should be arrived at having regard to roles & responsibilities of KMP, proof that services were rendered, need benefit test analysis etc.
• Financial TransactionsFinancial transactions cannot be clubbed with other transactions & will have to be tested on a standalone basis by evaluating various terms & conditions of underlying loan, credit rating of borrower, currency of loan and other factors.

Hence, one should consider evaluating the facts / specificity and all the parameters before deciding aggregation approach.