Businesses must Understand Arm’s Length Standard for Transfer Pricing compliance

Abiding by transfer pricing rules in the UAE is critical for businesses after the introduction of corporate tax. Transfer pricing refers to the prices charged for goods, services, or intellectual property (IP) between associated entities within an enterprise, such as between a parent company and its subsidiaries. This might appear simple but it can become complex when it comes to cross-border transactions involving multiple tax jurisdictions.

This is where the arm’s length principle comes into play. As per transfer pricing regulations, each entity that carries out intercompany sales or purchases of goods or services need to establish that it has priced those items at arm’s length. Availing transfer pricing advisory services in Dubai can come to help resolve the arm’s length complexities. The following blog will help you understand the arm’s length principle:

Demystifying the Arm’s Length Principle

The arm’s length principle was established by the Organisation for Economic Co-operation and Development (OECD). It is an international transfer pricing standard that OECD member countries have agreed should be used for tax purposes by MNE groups and tax administrations. The arm’s length principle mandates that the members of an MNE group must be treated as separate entities rather than as inseparable parts of a single unified business during an intra-group cross-border transaction. In line with the arm’s length principle, businesses need to ensure the transfer price matches the market price under similar conditions, with both parties remaining independent of each other.

The Importance of the Arm’s Length Principle

From the perspective of global tax authorities, the arm’s length principle is critical for preventing profit shifting and tax evasion. Sometimes the cross-border transaction may take place between a high-tax jurisdiction and low-tax jurisdiction. In such a situation Multi-National Enterprises (MNEs) may be tempted to manipulate transfer prices to transfer profits from high-tax jurisdictions to low-tax jurisdictions so that they can reduce their overall tax burden. However, the arm’s length principle makes it tough for the MNEs to manipulate prices for tax advantage as they are required to price their transactions as if they were between unrelated parties. Transfer pricing advisers in Dubai can help companies adhere to arm’s length standards.

An Example of the Arm’s Length Principle

Consider this example for Arm’s Length Principle: John, an international contractor based in the UAE, owns a design firm in the US called John’s Design Co. John’s Design Co plans to buy a new design software manufactured by John’s UAE office. Following the arm’s length principle, John should sell the software to John’s Design Co at the same price he would sell to any unrelated design firm in the US under similar conditions.

If John sells the software at a discounted price, the tax authorities would consider it an attempt to shift profits from the US (potentially a higher-tax jurisdiction) to the UAE (a lower-tax jurisdiction. It will raise the suspicion of the tax authorities. In this situation, John can navigate the arm’s length complexities by seeking advice from the best transfer pricing consultants in Dubai.

Transfer Pricing Methods for the Arm’s Length Principle

Businesses need to use the most appropriate method to ensure their transfer prices are in line with the arm’s length principle. The transfer pricing methods include “traditional transaction methods” (Comparable uncontrolled price (CUP) method, Resale price method & Cost-plus method) and “transactional profit methods” (Transactional net margin method (TNMM) & Transactional profit split method). The most appropriate method depends upon the specific circumstances of the transaction. Providers of transfer pricing services in Dubai can advise you on the transfer pricing methods.

Tax Gian can Help You Navigate Transfer Pricing in the UAE

If you’re struggling to determine transfer pricing in the UAE as per the arm’s length standard, Tax Gian, a leading tax expert can help you. We are one of the top transfer pricing advisers in Dubai, operating as a division of Jitendra Tax Consultants (JTC).  We offer bespoke transfer pricing consulting services in Dubai in line with regulatory expectations and aligned with our client’s global business goals.

Tax Gian can deliver transfer pricing models that are consistent with our client’s value chain. Our highly qualified transfer pricing advisors in Dubai can help companies ensure that all related party transactions are documented to position their Transfer Pricing model in compliance with regulatory provisions. Tax Gian’s team of corporate tax professionals can guide you through complex areas of international tax to mitigate the risk of non-compliance.