UAE Transfer Pricing Guide. Financial Transactions
This alert reviews the published recommendations on intragroup financial transitions, which must be taken into consideration when making decisions on pricing and carrying out intragroup financial transactions with companies in the UAE.
Please note that our comments are based exclusively on our interpretation of the Guide, public sources and information that we had at our disposal on the date of this alert as well as our experience and knowledge of the principles of international transfer pricing (hereinafter, TP).
General provisions
The Guide’s recommendations on financial transactions are based, to a large degree, on the principles and provisions in Chapter 10 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter, the OECD Guidelines). The Guide also reflects the specifics of local TP law, which takes precedence. The UAE tax authorities note that the Guide serves as one of the main sources of information and explanations concerning TP-related issues in addition to the previously published laws.[1] If local legal acts do not address the certain aspects of TP rules application, taxpayers may rely on the OECD Guidelines.
The comments on financial transactions in the Guide cover a broad spectrum of issues: from comments on applying TP law to operations carried out within a treasury function to recommendations on analyzing whether prices in specific types of financial transactions are in line with the arm’s-length principle.
Treasury function
The Guide describes the key intragroup treasury functions. It notes that a treasury may carry out routine services in an MNE group without accepting or managing any material risks; in this case, the function should be remunerated similarly to a function providing centralized services. In some cases, the treasury function essentially performs the role of an intragroup bank, incurring and managing material risks and, consequently, should be remunerated appropriately.
Therefore, when analyzing TP issues related to the remuneration of treasury operations, one needs, first of all, to analyze the actual circumstances in detail as well as the nature of the treasury function.
Intragroup financing
The Guide gives special attention to intragroup financing in the form of loans. In particular, the Guide deals with the following issues:
- Determination of arm’s-length ranges of interest rates under the Comparable Uncontrolled Price (CUP) method, based on the availability of certain market data on loan transactions between unrelated parties
- Impact analysis of the borrower’s credit rating
- Influence of group membership on the borrower’s credit rating and its ability to raise financing
- Specifics involved in searching for comparable transactions between unrelated parties and comparability criteria
- Specifics of comparability adjustments
According to the Guide, the CUP method, as a rule, includes the following stages:
1. Analysis of material terms that affect a loan’s pricing
2. Analysis of the borrower’s credit rating in order to assess the creditor’s risk when it provides financing (taking into account the influence of group membership on the borrower’s credit rating)
3. Search for potentially comparable transactions concluded between unrelated parties with credit ratings comparable to the borrower’s and on similar terms
4. Comparability adjustments (if needed) and calculation of an arm’s-length interest rates range
The Guide’s approach to analyzing intragroup loans fully complies with the approach to analyzing intragroup financing transactions stipulated in the OECD Guidelines.
A borrower’s creditworthiness is one of the main factors that independent creditors take into account when they assess the terms of a financing transaction.
The Guide notes that a credit rating may be determined both for assessing the overall creditworthiness of an MNE group (or the group’s parent entity) as well as for a specific issue of debt. When both ratings are available, the credit rating of a financial instrument may be more appropriate to be used in a benchmarking study than the issuer’s (borrower’s) credit rating.
In addition, the Guide comments on the differences in the methodologies applied for assessing credit ratings determined with publicly available tools and by independent rating agencies. They note that public tools normally use limited quantitative data in assessing a credit rating, whereas independent rating agencies carry out a detailed quantitative analysis of historic and forecast data as well as a qualitative analysis.
The Guide also notes that group membership may influence the credit rating of a related borrower and its ability to raise financing.
The Guide pays special attention to the search for comparable transactions between unrelated parties. The following have been designated as comparability criteria impacting loan interest rates that must be taken into account:
- Issue date
- Currency
- Country of the borrower
- Tenor
- Type of interest rate
- Industry of the borrower
- Other factors capable of influencing the pricing of transactions for issuing financing, e.g., option of early repayment / demand for repayment of a loan
Unlike the recommendations published by the OECD, the Guide does not describe the principles to be followed for the correct determination of the terms of financial transactions. In particular, the Guide does not review the procedure for recognizing intragroup financing as a loan in substance[2] (to assess the probability that a loan will be reclassified as an equity contribution), nor does it comment on the identification of commercial and financial conditions[3] or the economically significant characteristics of financial transactions.[4]
In addition, the Guide, unlike the OECD Guidelines, includes a detailed example of a comparability adjustment of the tenors of potentially comparable transactions to make them consistent with the tenor of an analyzed transaction.
The Guide also explains the assessment of arm’s-length prices and remuneration for other types of intragroup financial transactions, such as:
- Cash pooling (including a description of cash pooling types, the circumstances of cash pooling use and the specifics of assessing arm’s-length remuneration for the cash pool leader and members)
- Hedging (including a description of hedging types and the assessment of arm’s-length prices)
- Financial guarantees (assessment of arm’s-length remuneration)
- Captive insurance (approaches to the assessment of arm’s-length remuneration)
Although the explanations published by the UAE tax authorities do not cover all aspects and types of financial transactions, the Guide is a significant step towards the development of TP practice in the UAE.
Companies carrying out intragroup financial transactions should assess whether their TP methodologies for financial transactions follow the principles stipulated in the Guide and, if need be, develop and make the appropriate changes in current policies and pricing procedures.
How can BaOne help?
The BaOne team stands ready to provide support with the following issues related to intragroup financial transactions and transactions of financial institutions in the UAE:
- Analysis of current financial structures and intragroup transactions involving companies in the UAE as well as diagnostics and assessment of TP risks
- Development of a methodology for determining arm’s-length interest rates and remuneration as well as a methodology for determining credit ratings
- Development of in-house regulations for the interaction of structural units in the process of implementing the methodology for determining the arm’s-length level of interest rates and remuneration
- Development of a TP operating model, involving companies from the UAE, and implementation procedures
- Preparation of TP documentation templates for financial transactions
- Performance of benchmarking studies of the arm’s-length level of interest rates and remuneration in controlled financial transactions
- Provision of TP consultations and recommendations when new transactions are concluded involving companies from the UAE
- Adaptation of TP methodologies and policies prepared under the laws of third countries in accordance with the TP legal requirements in the UAE
[1] Law “On Corporate Tax and Profits Tax” (2022) and Resolution No. 97 “Requirement to Compile TP Documentation” (2023).
[2] Clauses 10.4-10.13 of the OECD Guidelines.
[3] Clauses 10.14-10.20 of the OECD Guidelines.
[4] Clauses 10.21-10.38 of the OECD Guidelines.
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