Navigating global business: The art of transfer pricing and the arm’s length principle

In today’s intricate global business landscape, multinational corporations frequently engage in a variety of transactions and arrangements with related parties or connected persons. These dealings span a wide spectrum, encompassing the exchange of goods and services, financial transactions, and interactions involving permanent establishments. This practice, known as transfer pricing, carries significant implications for taxation, accounting, and risk management.

The crucial role of transfer pricing

At its core, transfer pricing revolves around the pricing of transactions that are influenced by the relationships between the parties involved. Unlike independent parties, who typically establish their terms based on market dynamics and negotiations, related parties and connected persons may not face the same competitive pressures. Consequently, they may resort to non-arm’s length pricing in their controlled transactions to manipulate profits reported in specific jurisdictions and optimise tax liabilities.

The arm’s length principle

To counter such practices, the international standard for pricing these transactions is the arm’s length principle, now integrated into the UAE Corporate Tax law under Article 34. This principle dictates that transactions between related parties or connected persons should be priced as if they had occurred between independent parties in similar circumstances. The key is to determine the price that two independent parties would agree upon, supported by direct or indirect evidence of their behaviour whenever possible.

No formal agreement, no excuse

It’s important to note that the absence of a formal pricing arrangement or legal agreement between related parties does not negate the application of the arm’s length principle. In cases where property transfers or services are exchanged without a formal agreement or at remuneration below market value, the principle should be applied to assess whether such transactions would occur between independent parties under comparable circumstances and at what value.

Treating related parties as separate entities

The arm’s length principle treats related parties as separate entities, even within the same corporate group. It underscores the importance of a comparability analysis to align profits with functions, assets, risks, and contributions. This principle extends to domestic transactions, ensuring related parties and connected persons receive their equitable share of profits as if they were independent entities.

The writer is partner at MI Capital Services (MICS).