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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.

Undertaking benchmarking study for arriving at the arm’s length prices for KMP payments, that involves:

• Understanding the roles and responsibilities of the KMP to the Company and determine the search strategy and search process
• Arriving at the broad comparables from database based on the nature of roles
• Detailed review of comparables and identify final comparables based on detailed review of the facts
• Arriving at an appropriate arm’s length compensation based on final comparables selected.

► TP comfort letters / Memo for auditors

• • • Identifying the related parties and related party transactions
    • Determining whether the RPT are at arm’s length
    • Issuance of Comfort letters/ Memo for auditors that the RPT are at arm’s length.

► FIN 48 assistance – quantification of TP exposure on uncertain tax positions

• • • Identify related party transactions
    • Understand the TP Policy
    • Determine and quantify Fin48 Transfer Pricing Exposure

► Cost benefit analysis documentation for intra group payments – Royalty and Management charges

► Proactive way to eliminate future litigation for covered transactions once the agreement is signed between the cbdt and the tax payer, for 5 forward looking and 4 rollback years.

► We offer:-

• • End to end support including :-
    • Indepth analysis of business and alligning the transfer pricing policy with the business model
    • Providing strategic guidance in preparation and submission of APA application
    • Negotiation with APA authorities
    • Post conclusion support,
    • Filing of annual compliance report and
    • Audit

• Formulate audit defense strategy before all forums (TPO, DRP, Commissioner of Income Tax ( Appeals) and Income Tax Appellate Tribunal
• Providing assistance in terms of preparation of written submissions / appeal documents
• Representation before authorities
• Briefing of senior counsel, in case of High Court & Supreme Court

► Preparation of detailed transfer pricing documentation (local file) for all countries (Global Documentation) encopassing:-

• • Understand the related party transactions entered into by the Company with its related parties;
  • Analyse the industry in which the company operates;
  • Identify the functions performed, assets utilized, and risks assumed by the Parties to the transaction.
  • Evaluate the most appropriate transfer pricing method as prescribed under the applicable Transfer Pricing Regulations for those related party transactions
  • Undertake a detailed benchmarking analysis using public databases
  • Determine the appropriate arm’s length price for the transaction as per the applicable Transfer Pricing Regulations

► Issuance of Accountant’s report in Form 3CEB by a Chartered Accountant irrespective of any threshold

Per Section 92E of the Indian Income Tax Act, every enterprise having international transactions with its Associated Enterprise(s) (‘AEs’) is required to obtain an Accountant’s Report in the prescribed format within the due date prescribed. Our support in this regard would entail:-

• • Examining the international transactions and related accounts and records of the Company in respect of AEs, and report whether in our opinion, proper information and documents as prescribed by Rule 10D of the Income-tax Rules, 1962 (‘Rules’) have been maintained by the Company;
  • Examine and report whether in our opinion the particulars required to be furnished under Section 92E read with the annexure to Form No. 3CEB of the Rules are true and correct.

• Evaluating the applicability of safe harbour provisions to the related party transactions
• Preparation and filing of safe harbour application (form 3cefa in india)
• Subsequent representation before the tax authorities

► PREPARATION OF MASTERFILE IN ACCORDANCE WITH THE COUNTRY REGULATIONS :-

• Preparation of master file document for MNE group as per the format prescribed by the OECD, Indian Regulations or any other jurisdiction.
• • Customization of existing MNE group ‘s master file for the purpose of the local group transfer pricing compliance.
  • Preparation of the relevant Formsfor the MNE which entails:-

Group Structure

• • Understanding group structure
  • Understanding the business operations of operating entities
  • Understanding the key drivers and policies in place

FAR Analysis

• • Understanding the business strategy of the group
  • Understanding the functions performed, assets employed and risks borne by each entity

Master File Contents

• • Develop a detailed understanding on the following:

• • • Group overview
    • Business of the Group
    • Intra Group policies
    • Intangibles
    • Financing arrangements
  • Prepare master file based on the above understanding and analysis
• Review of the group master file in light of the respective coutry requirements and providing inputs w.r.t. alignment of the local file and master file.

► Support for country by country reporting where the consolidated Turnover of the Multinational Group exceeds EUR 750 million

• Preparation of Country-by-Country report (CbCR) for the MNE Group as per the format prescribed by the OECD, and agreed by Inclusive framework countries.
• Preparation of the relavt form as per the parent entity jurisdiction  and assistance in filing with the Tax authorities.
• Review of the three tier documentation – CbCR, Master File and Local file, undertaking gap analysis to identify any inconsistencies and providing inputs on alignment the three-tier documentation with the facts of the MNE Group.

► Risk assessment of the Group’s transactions based on the key parameters

► IP Structuring/ DEMPE Analysis

• • Identify the intangibles used and the economically significant risks associated with DEMPE;
  • Identify the full contractual arrangements, with an emphasis on legal ownership, rights and obligations, including assumption of risks;
  • Identify the parties performing functions, using assets and managing risks related to DEMPE;
  • Confirm consistency between the contractual terms and the parties’ conduct and determine whether the party assuming economically significant risks controls and has the financial capacity to assume those risks, applying the risk guidance;
  • Delineate the actual controlled transactions related to the DEMPE of ip; and
  • Price the delineated transactions.

► Designing Global Transfer pricing Policy

• • Evaluate the business and identify the value drivers in the supply chain
  • Identify the characterization of entities (in accordance with the functions performed, risks assumed and assets utilized) and selection of tested party for the analysis.
  • Evaluate the most appropriate transfer pricing method as prescribed for the international transaction as per the applicable Transfer Pricing Regulations.
  • Price setting through benchmarking
  • Evaluate the cost covered for invoicing with respect to all transacting entities in the proposed structure
  • Provide guidance as to the internal documentation that may need to be maintained by the company from transfer pricing regulations perspective
  • Support to draft the global TP policy

► Drafting Intercompany agreements

• • Drafting intercompany agreements from a transfer pricing perspective on various clauses and aspects, based on understanding of the business activities undertaken by the Company and its Group entities.

► Transaction Structuring

• • Evaluate the supply chain to identify the value contributions of various entities and the transaction flows across jurisdictions
  • Support to ensure compliance with the OECD BEPS action plans in conenction with various inter group transctions (tangible, intangible, financing, services)
  • Support to evaluate any implications on account of business model conversions including exit charge implications in various jurisdictions