Key Managerial Personnel (‘KMP’)
Compensation to Key Managerial Personnel (‘KMP’)
One of the unique aspects of UAE’s Transfer pricing regulations is determination of the arm’s length nature of payments to connected persons, viz., compensation to Key Management Personnel (KMP).
To be aligned with the UAE TP Guidance issued by the Federal Tax Authority (FTA), which clearly states transfer pricing method should be applied at a transactional level rather than aggregate basis, it is important that the approach for benchmarking the compensation to KMP ought to be based on economic principles and stand the test of transfer pricing.
Some of the key aspects with regard to compensation to KMP are as follows:
1. Remuneration to KMPs in Loss-Making Companies: We often notice that the most common approach for benchmarking KMP compensation which has been adopted in the region is aggregating and testing the profitability of the entity, at the net-level. However, this approach suffers a fundamental flaw viz., if one were to adopt this approach, would one conclude that no compensation is to be paid to KMP if the company incurs losses. And no independent third party will agree on to this proposition.
The transfer pricing approach to benchmark KMP compensation should be ‘all-weather’ approach – irrespective of profitability of the company, and hence adopting profitability-based approach for benchmarking KMP compensation is not appropriate from a transfer pricing perspective.
Similarly, another approach generally adopted is to understand the salary packages available in public domain for the said position for example CEO / MD. However, the salary paid would also depend on the business that is being managed – for example, the compensation to the CEO managing USD 1 million Company will differ from the compensation paid to CEO heading USD 100 million Company. Hence, use of data from generic salary database may not be used as a comparable information on an as- is basis.
Hence, taxpayers ought to undertake an arm’s length analysis at a transactional level and also ensure being correct from a transfer pricing / economic perspective.
2. Compensation to KMP being the only related party transaction: In many instances, taxpayers might only have compensation to KMP as their related party transaction. In such cases, testing the profitability of the company at the entity level would result in subjecting the entire company to transfer pricing – which is not the correct approach. This is in addition to the above-mentioned underlying shortcoming of using profitability-based approach for benchmarking compensation to KMP.
3. KMPs as both related party and connected persons: In many UAE entities especially closely held or family-owned businesses, KMPs may qualify as Related Parties and Connected Persons under transfer pricing regulations. This overlap will require justification of compensation w.r.t. being “wholly and exclusively for business purposes”. The FTA might view some of the activities undertaken as shareholder activities, for which no compensation is required and accordingly a portion of the compensation paid to KMP will be disallowed.
Further there might arise uncertainty in connection with disclosure of such payments in the Disclosure Form (DF) – whether under section for Related Party or Connected Person, especially since there is a difference in the threshold limits for disclosure of such payments for each of the said categories.
