TP – Arm’s Length Analysis Is Not Just Benchmarking Analysis
The UAE TP regulations state that arm’s length standard to be adhered for all transactions between related parties. In this connection there is a perception amongst many taxpayers that arm’s length analysis is only a benchmarking analysis.
This is a misnomer.
Arm’s length standard / analysis is a broader concept & one of the phases of this arm’s length analysis is undertaking a benchmarking study. Some of the key areas / aspects w.r.t. arm’s length principle is as follows:
- Understanding facts & circumstances: The economic circumstances surrounding the controlled transactions provides inputs for strategy / approach to be taken for comparability analysis. It also aids in understanding the economically significant risks & key value drivers w.r.t. the entire MNEGroup.
- Value chain analysis: The activities performed, assets deployed and risks assumed by each party is the basis for arriving at the characterization of the taxpayer. This includes understanding value contributed by the taxpayer to the Group from a TP perspective.
- Most appropriate method (MAM): Understanding the value creation by the taxpayer provides key inputs for determining the MAM for determining the arm’s length nature of the controlled transaction. For the MAM that is determined, the appropriate / relevant benchmarking analysis would then have to be undertaken.
For example, the taxpayer is a distributor, simply undertaking a benchmarking analysis by comparing net profitability of similar distributors would not be the appropriate approach.
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- If the taxpayer is the entrepreneur of the MNE Group and controlled transactions is sourcing from other less complex group entities, it would be appropriate to benchmark the results of the related parties rather than the taxpayer.
- Or where the taxpayer undertakes significant marketing activities (including having key IP)– which is one of the key value drivers for Group, depending on facts and satisfying other criteria, profit split method may be evaluated.
- Alternatively, where the taxpayer is a routine distributor and based on the extent of value adding activities, one may need to decide whether RPM or TNMM should apply.
Another example where there is a service provider, simply adopting a cost-plus billing model without understanding the role of the service provider whether it is an entrepreneur or limited risk entity will be faulty.
Further OECD Guidelines & UAE’s FTA TP Guidelines clearly provide for delineation of controlled transaction and undertaking of transactional analysis rather than entity level analysis.
Therefore, one may need to carefully evaluate the above-mentioned facts before jumping the gun on entity level benchmarking at net profit level. The above is more relevant for UAE taxpayers with CY as their accounting year, seeking to finalize the books of accounts.
