UAE Transfer Pricing Approach to Reimbursements and Pass-through Costs

What are pass through costs/reimbursement of expenses?

The term “pass through costs or reimbursement” has not been defined in the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“UAE Corporate Tax Law”). However, the Transfer Pricing (“TP”) Guide issued by the Federal Tax Authority describes a pass-through cost or reimbursement arrangement as an arrangement wherein a Group company arranges and pays on behalf of its “Related Parties or Connected Persons” for goods or services acquired from various vendors.

Treatment of pass-through costs as per the UAE TP Guide

A primary step in relation to pass-through costs is to determine whether the cost to be reimbursed should be charged at a mark-up/profit element or at the actual cost incurred by the provider.

As per section 7.2.2.3 of the UAE TP Guide and in accordance with the Organisation for Economic Co-operation and Development (“OECD”) TP Guidelines, the group service provider may pass on the costs of the acquired services to its related parties or connected persons without a mark-up, provided that:

• The acquired goods or services are requested by and for the benefit of the related parties or connected persons;
• The Group service provider is merely the paying agent and does not enhance the value of the acquired goods or services in the process whatsoever; and
• The costs of the acquired goods or services is the legal or contractual liability of the related parties or connected persons. This condition can be met even if the Group service provider is legally or contractually liable to pay for the acquired goods or services through an inter-company agreement.

The Group service provider should nonetheless charge an appropriate arm’s length mark-up for its function in arranging and paying for the acquired goods or services on behalf of its related parties or connected persons especially when the group service provider adds significant functions or provides value-added services. The mark-up should be based on the aggregate costs of performing the function and should reflect the nature of its own services as well as the extent of the value-addition generated for the related parties or connected persons.

Insights into practical implications

• Reimbursements paid

In the case of reimbursements paid by a UAE entity to its foreign related party, if it can demonstrate the existence of a back-to-back arrangement with sample copies of invoices, the transaction of reimbursement may generally not be subject to intense scrutiny by the FTA. However, it important to note that where payments are, in effect, for services rendered by related parties or as global cost allocations, taxpayers must demonstrate actual receipts of services and the benefits derived.

• Reimbursements received

Reimbursements received by an UAE entity from its related parties could be subject to a detailed scrutiny as compared to the reimbursement paid. Further, if such recoveries are for some services provided by the UAE taxpayers to their foreign related parties, the UAE entity is expected to charge a mark-up on the value of such recoveries.

• Arms’ length value for reimbursements

Pure reimbursements of third-party costs, where the UAE entity or the foreign entity (as the case maybe) does not add any value can be cross charged without any mark-up and the same shall be accepted to be at arm’s length.

While there exist contradictory views with regards to benchmarking of reimbursement transactions to demonstrate their arms’ length nature, where the expenses are reimbursed on a cost-to-cost basis, no independent benchmarking is required. Instead, demonstrating the reasonableness of the allocation keys applied could be accepted by the tax authorities as adequate.

Furthermore, in addition to demonstrating that a transaction of reimbursement is at cost, it is also equally important to demonstrate that the reimbursement has arisen out of a business need and is “wholly and exclusively” connected with the taxpayer’s business.

Key takeaways

While the TP guidelines suggests that reimbursements or pass-through costs can be cross charged on a cost-to-cost basis without an added markup, such a cost-to-cost approach heavily reliant on the unique facts and circumstances of each case. Hence, cross-recharge arrangements require a detailed analysis, and the taxpayers must maintain sufficient TP documentation and other supporting evidence to demonstrate that indeed the arrangements represents recovery of cost without any value addition.