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What are the connected persons, and how can they affect taxable profits

Transfer price refers to the prices of goods and services charged on transactions between the related parties and with the connected persons. The key risk associated with the transactions between related parties and with the connected persons is that the owner or the person in control can influence the prices of goods and services for the transactions between them, which will affect the taxable profits and it will help them to avoid the tax.

In transfer pricing, the word “related parties” and “connected persons” are important, as arm’s length price can be compromised with these parties. In our previous articles, we have discussed the related parties as defined in the Public Consultation Document (the document), and in this article, we have covered the connected persons.

Since there is no personal income tax in the UAE, so there are chances that businesspersons can take extraordinary salaries and incentives from the business for themselves and/or connected persons, which will erode the tax base and it will reduce the tax liabilities. To control the situations like this, certain provisions have been added in the document which requires that the payments or benefits provided by a business to its connected persons will be deductible only if the business can demonstrate that the payment or benefit corresponds with the market value of the service provided; and is incurred wholly and exclusively for the purposes of the taxpayer’s business.

Considering the above requirements of the document, any payment made to a connected person above the market value will not be allowed as a tax expense. Moreover, any non-business expense will be considered an inadmissible expense.

Related parties also fall in the definition of connected persons. So, we can say that the following related parties, which we have already defined in our previous article, will be considered connected persons:

• Two or more individuals related to the fourth degree of kinship or affiliation, including by birth, marriage, adoption, or guardianship

• Individual and a legal entity will be assumed related parties where an individual alone or together with another related party directly or indirectly owns at least 50 per cent of shares of the company or controls the legal entity.

• Two or more legal entities where one legal entity alone, or together with a related party, directly or indirectly owns at least 50 per cent shares or controls the other legal entity

• Two or more legal entities where a taxpayer alone, or with a related party, directly or indirectly owns at least 50 per cent of shares or controls them

• Taxpayer and its branch or permanent establishment

• The partners in the same unincorporated partnership

• Exempt and non-exempt business activities of the same person

Other than the above, the following will also be considered connected persons, as mentioned in clause 7.7 of the document:

• An individual who directly or indirectly has an ownership interest in or controls the taxable person. This means any direct or indirect business owner will be assumed to be a connected person. Moreover, directly, or indirectly, the person who controls the business will also be considered a connected person.

• A director or officer of the taxable person. A director is a company leader selected by and accountable to shareholders, while officers like CFO, CIO, CTO etc. are executive leaders hired to oversee an organization’s daily operations.

• An individual related to the owner, director, or officer of the taxable person to the fourth degree of kinship or affiliation, including by birth, marriage, adoption, or guardianship. The words used, “fourth degree of kinship or affiliation”, are critical to understand this relationship. The first degree of kinship or affiliation is between husband and wife; and parents and child. Like spouses are related parties. Father/mother and daughter/son are related parties. The second degree of kinship or affiliation is between siblings. Like siblings are related parties. The third degree of kinship or affiliation is between the uncle/aunt with a niece/nephew, while the fourth degree is between first cousins. The above degree of relationship can be established based on birth, marriage, adoption, or guardianship. Like a father of a girl adopts a boy, then the children will be considered related parties based on the second degree of kinship. The kinship can be established based on guardianship as well. A guardianship order is a court appointment which authorizes someone to take actions or make decisions on behalf of an individual who lacks capacity, like a mother of a girl who has been nominated as a guardian by the court of any other girl. Both girls will be considered related parties under the second degree of kinship.

• Where the taxable person is a partner in an unincorporated partnership, any other partner in the same partnership. An unincorporated partnership has no legal personality, and it is simply an association/collection of two or more persons where members may change. The liability of such partnerships is not limited. The unincorporated partnership cannot enter contracts in its name. Instead, members enter the contract in their name, so all risks and liabilities are of the members.

After the announcement of the law, businesses will be required to identify and pay the connected persons at the market price to claim such payments and incentives as a tax-allowable expense.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official but a personal opinion of the writer based on the public consultation document on corporate tax. For any queries/clarifications, please write to him at compliance@kresscooper.com