Why Functional Analysis is a Key Test in Transfer Pricing Analysis?

As the UAE corporate tax has become a reality, companies engaging in intra-group cross-border transactions need to consider transfer-pricing regulations. They need to ensure that the prices are at arm’s length range, for which a comparability analysis must be performed on the basis of five comparability factors such as characteristics of property or services; functional analysis; contractual terms; economic circumstances; and business strategies.

Transfer pricing advisors in Dubai can help you navigate the challenges of comparability analysis. In this blog, you can learn about ‘Functional Analysis’, one of the five comparability factors under transfer pricing. Read ahead for more insights:

Functional Analysis: The Core of Transfer Pricing

An MNE’s operations are likely to be highly integrated across jurisdictional borders. Its functions, assets, and risks might be shared by multiple entities. While outlining a transaction, you may come to know that one entity performs a particular function, but that the risk in the transaction is borne by another entity. Moreover, one entity may bear the legal risk and another may carry the financial risk. The functional analysis will highlight these transfer pricing issues and help you identify who is benefiting from what, and determine the appropriate compensation. Transfer pricing consultants in Dubai can help you with functional analysis.

Key Focus of Functional Analysis

Functional Analysis pursues to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to the transactions. The analysis focuses on what the parties actually do and the capabilities they provide. Such activities and capabilities will include decision-making, including decisions about business strategy and risks.

The process of identifying the economically relevant characteristics (Comparability factors) of the commercial or financial relations should include consideration of the capabilities of the parties, how such capabilities affect options realistically available, and whether similar capabilities are reflected in potentially comparable arm’s length arrangements. The functional analysis should consider the type of assets used, such as plant and equipment, the use of valuable intangibles, financial assets, etc., and the nature of the assets used, such as the age, market value, location, property rights protections available, etc.

Analysis of risks in commercial or financial relations

A functional analysis should also identify and consider the material risks assumed by each party. The actual assumption of risks would influence the prices and other conditions of transactions between the associated enterprises. The level and assumption of risk, therefore, are economically relevant characteristics (Comparability factors)  that can be significant in determining the outcome of a transfer pricing analysis. The steps to identify risks are given below:

  1. Identify economically significant risks with specificity
  2. Determine how specific economically significant risks are contractually assumed by the associated enterprises under the terms of the transaction
  3. Determine through a functional analysis how the associated enterprises that are parties to the transaction operate in relation to the assumption and management of the specific, economically significant risks, and in particular which enterprise or enterprises perform control functions and risk mitigation functions, which enterprise or enterprises encounter upside or downside consequences of risk outcomes, and which enterprise or enterprises have the financial capacity to assume the risk
  4. Determine whether the contractual assumption of risk is consistent with the conduct of the associated enterprises and other facts of the case by analysing (i) whether the associated enterprises follow the contractual terms and (ii) whether the party assuming risk, as analysed under (i), exercises control over the risk and has the financial capacity to assume the risk.
  5. If the party assuming risk does not control the risk or does not have the financial capacity to assume the risk, apply the guidance on allocating risk
  6. The actual transaction as accurately delineated (outlined) by considering the evidence of all the economically relevant characteristics (comparability factors) of the transaction should then be priced taking into account the financial and other consequences of risk assumption, as appropriately allocated, and appropriately compensating risk management functions

Hire the Best Transfer Pricing Advisors in Dubai, 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.