Transfer Pricing: Arm’s Length Standard & Comparability Analysis

Businesses conducting intra-group cross-border transactions need to consider the arm’s length principle while determining the transfer prices. The arm’s length principle requires MNEs to treat their members as separate entities rather than as inseparable parts of a single unified business during cross-border transactions. The focus falls on the nature of the transactions between those members and on whether the conditions differ from the conditions that would be obtained in comparable (similar) uncontrolled transactions.

As per OECD Guidelines, such an analysis of uncontrolled transactions is called comparability analysis, which forms the crux of the application of the arm’s length principle. The application of the arm’s length principle is based on a comparison of the conditions in a controlled transaction with the conditions that would have been made had the parties been independent and undertaking a comparable(similar) transaction under comparable (similar) circumstances. Transfer pricing advisors in Dubai can help you with the comparability analysis.

This blog introduces you to the concept of comparability analysis and how it works. Read ahead for further insights:

Identify the commercial or financial relations

The first aspect of the comparable analysis involves identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations in order that the controlled transaction is accurately delineated.

The typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attached to those relations requires a broad-based understanding of the industry sector in which the MNE group operates (e.g. mining, pharmaceutical, luxury goods) and of the factors affecting the performance of any business operating in that sector.

The understanding is derived from an overview of the particular MNE group which outlines how the MNE group responds to the factors affecting performance in the sector, including its business strategies, markets, products, its supply chain, and the key functions performed, material assets used, and important risks assumed. This information is likely to be included as part of the master file

Compare the conditions and economically relevant circumstances

The second aspect is to compare the conditions and the economically relevant circumstances of the controlled transaction as accurately delineated (outlined) with the conditions and the economically relevant circumstances of comparable (similar) transactions between independent enterprises.

The accurate delineation (outlining) of the actual transaction or transactions between the associated enterprises requires analysis of the economically relevant characteristics of the transaction. These economically relevant characteristics consist of the conditions of the transaction and the economically relevant circumstances in which the transaction takes place.

Applying the Arm’s Length Principle: Comparability Factors

The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate (outline/define) the actual transaction can be broadly five categorised as follows:

  1. The contractual terms of the transaction
  2. The functions performed (Functional Analysis) by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the MNE group to which the parties belong, the circumstances surrounding the transaction, and industry practices
  3. The characteristics of property transferred, or services provided
  4. The economic circumstances of the parties and of the market in which the parties operate
  5. The business strategies pursued by the parties

Consult with Tax Gian’s Transfer Pricing Advisers in Dubai, UAE

Arm’s Length Principle is a well-established framework for determining transfer pricing. However, it is a complex area that businesses may find complex to navigate as the UAE corporate tax regime came into effect only recently (June 1st 2023). Tax Gian, a division of Jitendra Tax Consultants (JTC), 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.

Tax Gian has a dedicated team of transfer pricing and valuation professionals with vast experience from many years in the field. 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.