Companies transfer goods, services, and intangibles to their subsidiaries / related parties in different countries. The Transfer Pricing (TP) regulations require that the price at which related parties transact must be a fair market value or at “arm’s length”.
One of the ways to arrive at the arm’s length price (ALP), is through the safe harbour rules (SHR) where arm’s length price is pre-determined if certain criteria are met.
In this write-up, we analyse the concept of SHR in TP and the rules applicable in the UAE.
What are Safe Harbour Rules (SHR)?
SHR simplify TP compliance. They offer clear guidelines on acceptable pricing methods and margins for certain types of transactions. When companies follow these guidelines, tax authorities generally accept their TP study report without detailed scrutiny. This reduces the administrative burden and risk of audits for businesses.
How do SHR Work?
SHR vary by country. Generally, a company must meet certain conditions to apply these rules, viz.
- Turnover threshold up to a certain limit;
- Belonging to a specific industry; or
- Rendering specified services which are clearly identifiable based on segmental results etc.
If a company meets these conditions, it benefits from the "safe harbour." This means the tax authority will not challenge its TP arrangements.
What are SHR in the UAE?
The TP Guide in the UAE incorporates the SHR in a limited manner, i.e., it provides that companies may choose to use a safe harbour margin of cost plus 5% mark-up to arrive at arm's length compensation on intragroup services that are routine or low value-added support services (non-core services). Such services include centralised services such as administrative, information technology support, payroll management etc.
Suppose a multinational company provides IT support services to its subsidiaries. Under SHR, the company might use a cost-plus method with a fixed mark-up (e.g., cost plus 5%). If the cost of providing IT support is AED 100,000, the company would charge its subsidiaries AED 105,000. By adhering to this rule, the company ensures compliance and reduces the risk of audits.
What are the Benefits, Challenges and Limitations?
Application of SHR is simple and brings certainty for companies and their CFOs. It also reduces the risk of litigation and the litigation costs.
Despite their benefits, application of SHR is not without challenges. They may not cover all types of transactions, as in the case of the UAE which applies these rules only in case of intra-group services with a low value addition. However, one may say that the UAE TP Law is at its nascent stage and may mature with the passage of time.
Further, companies that don’t fit into the specified categories (eg. turnover threshold, nature of services etc.) cannot benefit from SHR.
Also, the fixed profit margins may not always reflect the true economic conditions, leading to potential mismatches. Conversely, if the tax authorities do not accept ALP as per SHR, which may happen in rare circumstances, the chances of litigation may arise.
Conclusion
SHR in TP are a valuable tool for businesses. They simplify the complex process of TP and provide certainty and cost savings. Such rules may be particularly relevant for companies having global capacity centers (GCCs) in developing countries.
However, they are not a one-size-fits-all solution. Companies must carefully consider whether they qualify for these rules and whether the prescribed conditions align with their business activities.
Disclaimer: Content posted is for informational and knowledge sharing purposes only, and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/interpretation of the publisher is based on the available Law, guidelines and information. Each reader should take due professional care before you act after reading the contents of that article/post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide, and should not be relied on for tax or accounting advice.
