If you are a business operating in the UAE, transfer pricing rules and practices play a crucial role in your success.

What is Transfer Pricing?

Transfer pricing refers to the pricing of goods, assets, or services transferred between the business/individual entities in different tax jurisdictions. The ultimate goal of transactions is to ensure the prices are fair, aligned with the market conditions, and comply with the tax regulations to prevent base erosion and profit shifting (BEPS). Employing the transfer pricing rules, businesses can lock the high profit margins

Various transfer pricing methods are used to identify the arm’s length price, which means that the price of goods, services, or assets will be agreed upon between the unrelated parties under fair conditions. The transfer pricing services help you understand and adopt the right transfer pricing methods favorable for your business. According to the OECD and UAE Transfer Pricing Guidelines, below are the two broad categories for transfer pricing.

Traditional Transaction Methods

This method directly identifies the prices charged in transactions between related parties and compares them to similar transactions between independent entities.

Controllable Uncontrolled Price (CUP) Method

This is one of the most reliable methods to determine the transfer pricing. It compares the price charges for a controlled transaction (i.e., between related parties) with the price charged for a similar uncontrolled transaction (i.e., between unrelated parties). The method is particularly useful when the market has data to compare the price of goods, services, or assets.

Example Transactions:

• Interest rates: Comparing interest charged between related and unrelated parties.
• Royalty/license fees: When a company licenses intellectual property to a related entity, the royalty rate can be compared with the rate charged to unrelated entities.
• Purchase/Sale of goods: If similar goods are traded between unrelated parties, the prices can be compared to those charged in related-party transactions.
• Provision of services: Services provided by a parent company to a subsidiary can be compared to similar services provided between unrelated entities.

Resale Price Method (RPM)

The RPM method is used when transactions involve reselling of goods, services, or assets without VAT. Its focus is on the resale price of the product and deducts a reasonable gross margin to arrive at the transfer price. This method is useful in trading operations when a company buys a product without VAT.

Example Transactions:

• A second party buys a product from the parent company and resells it to a third party. The profit and resale price earned are compared to those in similar independent transactions.
• The reseller does not add significant value, such as manufacturing or processing costs to the product being resold.

Cost Plus Method (CPM)

The third method is CPM, which involves determining the cost of providing services or manufacturing goods and adding a suitable markup to arrive at the transfer price. The markup depends on the profit margin typically earned in similar uncontrolled transactions. This method is often used for semi-finished goods, services, or transactions where detailed cost data is available and the company adds value through production or service provision.

Example Transactions:

• A parent company sells semi-finished goods to its subsidiary. The cost of production is used as a base, and a markup is added based on industry standards.
• If a company provides services to a related party, such as administrative or research services, the cost of service provision is used as a basis for pricing.

Transactional Profit Methods

TPM focuses on the profitability of transactions instead of the specific price charged. These methods are used when comparable prices in the market are hard to obtain or there is unreliable transaction data available.

Profit Split Method (PSM)

The PSM allocates the combined profits of the related entities based on the economic contributions of each party. This method is most useful when both parties contribute significantly to the creation of value (e.g., intangibles, highly integrated operations). This method is applicable for the transfer of intangible assets which do not have any reliable comparable data available, patents, trademarks, etc.

Example Transactions:

• When a parent firm distributes a patented technology to a subsidiary, the income from the technology’s use might be divided according to how much each entity contributed to its development and marketing.
• in intricate joint ventures or supply chains where every stakeholder is essential to the creation, marketing, or manufacturing of a product.

Transactional Net Margin Method (TNMM)

In the TNMM, the net profit margin earned by a related party in a controlled transaction is compared to the net profit margin earned by comparable independent entities in similar transactions. This method is used when the Resale Price Method (RPM) is unreliable, particularly in manufacturing operations or trading activities where there are some functional differences or contributions that are complicated as compared to the traditional methods.

Example Transactions:

• A business produces goods and sells them to a connected party. The related-party transaction’s net profit margin, also known as return on sales, is contrasted with that of independent manufacturers involved in comparable operations.
• The TNMM is used to examine the net profit margins of connected and unrelated parties when the RPM is insufficient because of the value that a reseller adds.
• By contrasting the net profit margins of independent service providers providing comparable services with those of a service provider involved in a related-party transaction, the TNMM can be used in service sectors.

Conclusion

To conclude, transfer pricing methods are crucial for businesses to ensure a fair price between related entities and to comply seamlessly with tax regulations. Traditional transaction methods (CUP, RPM, CPM) are best when reliable comparables exist, focusing on specific transaction prices. Transactional Profit Methods (PSM, TNMM) are used when comparables are scarce, analyzing profitability instead. However, the method choice depends on the transaction complexity and available data. At Accountax, we offer you these services for your company assets, goods, or services to ensure compliance with regulatory goods and work. Our transfer pricing advisory services in the UAE help businesses lock high profit margins by adopting the right methods.