Arm’s Length Comparability Analysis: Contractual Terms of the Transaction

A comparability analysis is a crucial step in transfer pricing, a practice used to determine the pricing of transactions between related entities, such as subsidiaries of the same multinational enterprise (MNE). The objective of a comparability analysis, according to paragraph 1 of article 9 of the OECD Model Tax Convention, a prime base of bilateral tax treaties among the OECD member countries, is to assess whether the terms and conditions of a comparable (similar) controlled transaction are consistent with those that would have been agreed upon between unrelated parties (i.e., independent enterprises) under comparable (similar) circumstances.

The process of comparability analysis starts with understanding and defining the controlled transaction to be tested. Apart from the contextual information on the industry and the overall business of the taxable person, the comparability analysis is structured around the five comparability factors: the characteristics of the property or service; contractual terms; functional analysis; economic circumstances and business strategies.

In this blog, you will learn more about the Contractual terms of Transactions. Transfer pricing advisers in Dubai can help you further with comparability analysis as per the Arm’s Length Standard. Read ahead for more insights:

What are the contractual terms of the transaction?

Business transactions occur as the result of or as an expression of the commercial or financial relations between two parties. Crafting a written contractual agreement helps the associated persons to formalise these transactions.

Written agreements turn out to be the starting point for delineating the transaction between them and how the responsibilities, risks, and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract. The terms of a transaction may also be found in communications between the parties other than a written contract.

What happens when written contracts are not sufficient?

Written contracts alone will not provide businesses with all the necessary information to conduct a transfer pricing analysis. Businesses will be required to obtain further information on the evidence of the commercial or financial relations provided by the economically relevant characteristics (comparability factors) in the other four categories.

Transactions are inconsistent with the written contract

Sometimes the characteristics of the transaction that are economically relevant (comparability factors) can be inconsistent with the written contract between the associated enterprises. In such a case, the actual transaction should generally be delineated (outlined) for purposes of the transfer pricing analysis in accordance with the characteristics of the transaction reflected in the conduct of the parties.

Businesses need to consider the commercial or financial relations between associated enterprises to examine whether the arrangements reflected in the actual conduct of the parties substantially conform to the terms of any written contract, or whether the associated enterprises’ actual conduct indicates that the contractual terms have not been followed, do not reflect a complete picture of the transactions, have been incorrectly characterised or labelled by the enterprises, or are a sham. If conduct is not fully consistent with economically significant contractual terms, further analysis is required to identify the actual transaction.

Comparability Analysis when there are material differences

If there are material differences between contractual terms and the conduct of the associated enterprises in their relations with one another, the following aspects should be considered in the context of the contractual terms to determine the factual substance and accurately delineate (outline) the actual transaction:

  • The functions they actually perform
  • The assets they actually use,
  • The risks they actually assume

Comparability Analysis when there is a change in terms

If there is a change in the terms of a transaction, you need to examine the circumstances surrounding the change to determine whether the change indicates that the original transaction has been replaced through a new transaction with effect from the date of the change, or whether the change reflects the intentions of the parties in the original transaction.

You should be careful in case any change may have been triggered by knowledge of emerging outcomes from the transaction. Changes made in the purported assumption of a risk when risk outcomes are known do not involve an assumption of risk since there is no longer any risk. Transfer pricing advisors in Dubai can help you further.

Tax Gian Can Help you Simplify Transfer Pricing in the UAE

Transfer pricing in the UAE can be complex for businesses, especially the factors of comparability analysis. In order to ensure the prices are at arm’s length range as per the OECD Guidelines, transfer pricing experts in Dubai can help you. Corporate tax experts at Tax Gian are your best option to simplify the regulations of transfer pricing.

Tax Gian is a brand of Jitendra Tax Consultants (JTC), which is one of the leading providers of transfer pricing services in Dubai, UAE. We have over 21 years of experience and our expertise can help you simplify the complex provisions of the UAE corporate tax law. Through a diverse range of services, we can help companies set up transfer pricing structures, show them how to shift from one transfer pricing structure to another, and how to transfer intangibles between countries. You can learn more about how we can help your company with transfer pricing by scheduling meetings with our highly qualified transfer pricing consultants in Dubai, UAE.