Transfer Pricing Audits in the UAE: A Closer Look at FTA’s Focus Areas
Transfer Pricing (“TP”) audits are no longer a distant possibility; they are becoming a reality in the UAE. With the Corporate Tax Law now in full effect, the FTA is prioritizing TP reviews to ensure that related-party transactions reflect arm’s length pricing and genuine economic substance.
Why TP Audits Are Gaining Momentum
The UAE’s TP framework is built on OECD principles, but its enforcement reflects local realities. Following the initial compliance cycle, the FTA is likely to examine gaps in documentation quality, appropriateness of method selection, and alignment with economic substance. These areas are now subject to heightened scrutiny because:
- Weaknesses in initial filings: Many taxpayers relied on generic benchmarking without incorporating UAE-specific adjustments, leading to significant comparability risks.
- Substance under scrutiny: The FTA is expected to verify that profits reported in the UAE reflect actual decision-making and value creation, rather than being driven solely by contractual arrangements.
- Risk-based audit focus: Industries engaged in high value cross border transactions; such as trading, distribution, and IP intensive businesses are likely to be prioritized for TP audits.
- Global alignment and BEPS pressure: In line with international tax transparency commitments, the UAE is expected to demonstrate strong enforcement of TP rules.
FTA’s Potential Key Focus Areas:
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Benchmarking analysis |
Regional comparables: Global datasets without regional adjustments can distort results. FTA expects UAE-specific analysis attempted or regionally adjusted benchmarks. Adjustment accuracy: Working capital or capacity adjustments must be well-reasoned and documented as unsupported changes increase audit risk. Method justification: While TNMM is common, methods like CUP may suit financing or IP transactions. Taxpayers must justify the chosen method. |
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Intercompany Service
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Evidence of benefit: The FTA expects clear proof that services deliver measurable value such as emails, reports, Key Performance Indicators (“KPIs”), and meeting notes. Documentation should demonstrate that the services are not duplicative and provide genuine operational support. Allocation and mark-up: Cost allocation keys must be logical and based on actual usage or benefit Avoiding shareholder activity misclassification: Services benefiting only the parent entity such as investor relations or group strategy should not be charged to subsidiaries. Misclassification can lead to disallowance of deductions and audit challenges. |
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IP Licensing and Intangibles
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DEMPE analysis: Identification of Development, Enhancement, Maintenance, Protection, and Exploitation functions determines where value lies. FTA will expect clear documentation of who performs these functions and where they are located. Royalty benchmarking: Determining appropriate royalty rates requires support from external data and alignment with industry norms. The FTA will expect evidence that rates are not arbitrary and are based on reliable benchmarks. Substance of IP ownership: Entities holding IP without performing real functions face significant audit risk. The FTA will expect clear evidence of actual control and decision making over the IP. |
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Intra-Group Financing
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Arm’s length interest rates: Determining appropriate interest rates requires a creditworthiness assessment and reference to market data. The FTA will expect clear evidence that rates are based on borrower specific credit rating and not based on generic assumptions. Interest limitation compliance: UAE tax rules cap net interest deductions at 30% of EBITDA. The FTA will expect alignment between TP and tax regulations to avoid disallowances. Guarantees and implicit support: These factors are often overlooked but are critical for pricing justification. The FTA will expect clear evidence of whether guarantees or group support were considered in determining the price. |
Typical Situations Likely to Attract Audit Scrutiny
- Large related-party transactions disclosed in TP forms: Significant cross-border dealings, particularly those involving high-value goods, services, or financing, often attract heightened scrutiny.
- Persistent low margins or losses in UAE entities: Continuous reporting of low profitability or recurring losses may signal potential profit shifting or misalignment with economic substance requirements.
- Free zone structures interacting with mainland operations: Complex arrangements, especially where tax incentives apply, are subject to review to ensure compliance with TP and substance regulations.
- Inconsistent data between TP documentation and audited financial statements: Discrepancies in revenue, cost allocations, or intercompany charges can indicate inaccuracies or incomplete disclosures, increasing audit risk.
Best Practices for Pre-Audit Readiness
- Conduct a comprehensive TP health check: Before submission, review the appropriateness of the selected TP method, the robustness of benchmarking, and the overall quality and completeness of documentation. This proactive step helps identify gaps early and mitigate audit risk.
- Maintain contemporaneous data: Ensure that records of services provided, key decision-making processes, and tangible deliverables (such as reports, meeting notes, and KPIs) are readily available. These documents serve as critical proof of economic substance and benefit.
- Validate benchmarking through sensitivity analyses: Demonstrate how profit margins or pricing outcomes vary under different assumptions or scenarios. This adds credibility to the benchmarking process and shows resilience of the chosen method.
- Align TP documentation with actual business substance: Confirm that the Functional, Asset, and Risk (“FAR”) analysis accurately reflects operational activities rather than relying solely on contractual terms. This alignment is essential to withstand regulatory scrutiny.
Conclusion: Proactive Compliance Is Key
FTA audits go beyond checking numbers; they assess the substance of transactions. Viewing TP as mere compliance can lead to financial and reputational risks. A proactive approach through robust documentation, defensible benchmarking, and alignment with economic substance ensures audit readiness and builds credibility with regulators.
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