UAE Corporate Tax: Business groups have to carefully navigate transfer pricing

The introduction of UAE Corporate Tax has resulted in the emergence of practical issues businesses were not focusing on. One such area is management ‘cross-charges’.

In businesses with a global presence, centralizing management services is standard practice. Common group services - accounting, human resources, information technology, legal services, marketing, and other back-office functions - are consolidated at the headquarters level. By centralising these, companies streamline their operations, achieve greater efficiency, and maintain a cohesive approach to business practices.

These intra-group services are then cross-charged to the benefiting group entities based on cost centres, group policy of cross-charge, and requirement of laws. As shared, costs can affect the tax liabilities at the group level, and tax authorities are paying close attention to cross-charging practices.

Let us walk you through the significant tax implications of allocated management charges under Transfer Pricing (TP) regulations, Corporate Tax law, and VAT.

Transfer pricing implications

With the introduction of TP and anti-abuse regulations in the UAE, the intra-group services must be analyzed to demonstrate substance and fair value. The expenses could be disallowed if the transaction is not found at fair value and with substance.

The OECD’s TP guidelines provide guidance in connection with the intra-group services so that these are appropriately identified and associated costs are allocated within the group following the arm’s length principle. Certain categories of charges do not warrant a cross-charge and should be left out. The following best practices can be adopted during a TP analysis:

Identification of chargeable and non-chargeable activities

Shareholder’s activities

The head office of the company performs these activities due to ownership. Such activity is not a service and does not justify a cross-charge to the group members.

Duplication

Where certain activities are performed by the group entity or via a third-party, the cross-charge for similar activity from headquarters raises questions.

Incidental benefits

Some of the activities or decisions of the group may be in connection with a specific entity or division, which could also generate some incidental economic benefit to entities. Ordinarily, the incidental benefits arising should not constitute service provisions to the other entities.

Ensure benefit test

The key element to justify management charges is to ensure the benefit test is met. This would entail checking whether the service recipient would have been willing to pay for the services to a third-party or would have performed the activities by itself and whether the economic and commercial benefit derived from the service can be demonstrated.

Verify charging mechanism

Authorities also tend to verify the charging mechanism and whether the allocation of costs is done on a reasonable and arm’s length basis.

Maintain documentation

Since management charges are a recurring cost, it is crucial to have robust documentation to identify chargeable activities, benefits derived, and, more importantly, appropriate cross-charge. For example: Maintaining master service agreements, regular invoicing, justification of cost drivers of allocation, and proof the services are performed.

Corporate tax implications

For a business to claim cross-charged management costs as a deductible business expense for tax purposes, it must meet the arm’s length pricing test and demonstrate that the services provide benefit to the company. With the introduction of anti-abuse rules, the activities that merely impact a reduction in group-level tax cost without actually demonstrating the economic substance would have high tax and penalty risks.

Documentation is critical to reducing this risk.

VAT implications

Some of the key issues which would need to be considered for cross-charges between entities that are not in the same VAT group are:

Applicable tax rates and obligation to account for tax

Where a UAE entity charges fees for services to entities outside the UAE, the supply may, potentially, be subject to VAT at 0 per cent. This ability to zero-rate services is, however, subject to certain conditions.

Further, where a non-resident entity recharges costs to a UAE VAT-registered entity, the UAE entity would need to consider if it must self-account for VAT to the FTA under the reverse charge mechanism.

Value of supply

Where related parties agree on a value below the market value and the recipient would not be able to recover the incurred VAT in full, the supply’s value will be deemed the market value for VAT purposes.

Further, where a service is provided without any consideration at all, it would be necessary to consider if the arrangement may constitute a deemed supply and, therefore, still give rise to VAT obligations.

Input tax recovery

In instances where these recharges are subject to VAT at 5 per cent, it is important to assess if the recipient entity would be able to recover the VAT incurred. Any VAT that cannot be recovered would end up being a cost to the group.

Management fees should be considered in the context of direct and indirect taxes and must accurately reflect the economic reality of the services provided. A comprehensive analysis of all activities, personnel, and cost drivers is required to determine the actual cost of delivering such services.

Maintaining adequate backup documentation is key to determining the cost-benefit analysis. Following these guidelines, companies can ensure their management fees are fair and reflect the appropriate cost of providing these services.