Managerial Remuneration Benchmarking in the UAE under Corporate Tax

A Comparative Discussion of Approaches that exist in the current situation

Executive Summary

Benchmarking managerial remuneration in the UAE presents a somewhat different challenge from benchmarking the remuneration of a conventional employee. In the case of a Key Management Personnel (“KMP”) who most likely be an owner, shareholder or founder, the individual may perform a combination of strategic, operational and management functions, while also having an economic interest in the business. The remuneration therefore needs to be considered in the context of the actual functions performed, the circumstances of the business and the distinction between compensation for services and returns attributable to ownership.

The UAE Corporate Tax framework requires transactions and arrangements involving Related Parties and Connected Persons to satisfy the arm's length principle. The FTA's Transfer Pricing Guide (CTGTP1) adopts the principle of selecting the most appropriate transfer pricing method for the particular transaction, having regard to the nature of the transaction, functional analysis, availability of reliable information and degree of comparability. It does not prescribe a specific remuneration database or a universal methodology for KMP remuneration.

Against this background, four practical approaches that may be considered for managerial remuneration:

1. an indirect TNMM analysis based on the overall profitability of the taxpayer;
2. a standard HR / salary survey report;
3. a bespoke HR / compensation consultant report; and
4. S&P / People Screening or similar commercial database information.

These approaches do not necessarily answer precisely the same question. Some seek to benchmark the individual's remuneration directly against market remuneration, while an indirect TNMM approach considers whether the taxpayer's overall profitability, after management remuneration, is consistent with comparable independent businesses.

Accordingly, the relevant question is not simply which source provides a remuneration number. The more fundamental question is whether the selected approach provides a sufficiently reliable basis, having regard to the nature of the remuneration, the KMP's functions, the taxpayer's circumstances and the quality and comparability of the available evidence.

2. Why Managerial Remuneration Is Different

The starting point should be to identify what is actually being remunerated.

A conventional salary survey generally compares employees performing broadly similar roles. A KMP in a privately held UAE SME may, however, perform a much broader range of functions. The individual may be responsible for strategic decision-making, business development, finance, operations, customer relationships, risk management and other functions that would be distributed among several senior employees in a larger organisation.

There may also be an ownership dimension. An owner-manager can receive both:

• remuneration for services actually performed for the business; and
• returns arising from ownership, such as dividends or appreciation in the value of the investment.

The two should not automatically be treated as economically equivalent. The benchmarking exercise should therefore identify the services and responsibilities for which remuneration is being paid before considering whether the amount is consistent with an arm's-length outcome.

The CTGTP1 taking sues from OECD Guidelines places considerable emphasis on accurately delineating the transaction through a functional analysis, including the functions performed, assets used and risks assumed, as well as the relevant economic circumstances. The Guide also recognises that actual conduct can be relevant where contractual documentation does not fully reflect the arrangements.

For managerial remuneration, relevant characteristics may therefore include:

• actual functions and decision-making authority;
• level of responsibility and seniority;
• qualifications and experience;
• time commitment;
• size and complexity of the business;
• industry and business model;
• geographic market;
• number of employees and scale of operations;
• financial performance;
• remuneration structure, including fixed and variable components; and
• whether the individual has an ownership interest.

This is particularly relevant when using employee-based compensation data to benchmark remuneration paid to an owner-manager.

3. The Four Practical Approaches

Approach 1 – Indirect TNMM

What the approach involves

The approach is not to establish a direct market salary for the KMP. Instead, it considers whether the taxpayer's profitability after taking KMP remuneration into account is consistent with the profitability earned by suitably comparable independent businesses.

The underlying logic is that independent businesses also incur management remuneration as part of their operating cost base (though the exact break-down may not be known given the limitation of the drilled down data that could be available from the best of the databases like TP Catalyst. Consequently, if the taxpayer's resulting operating margin is consistent with that of comparable independent companies, this may provide indirect support for the aggregate level of operating costs, including KMP remuneration.

This is conceptually different from saying that the comparable companies' management salaries constitute direct remuneration comparables.

The FTA Guide expressly recognises TNMM as one of the five prescribed transfer pricing methods. It also provides for the use of operating margin, net cost-plus/full-cost mark-up and return on assets or capital employed as possible profit-level indicators, with the appropriate indicator depending on the facts and functions of the tested party.

Potential advantages of this approach

• Does not require reliable employee-level salary data.
• Uses company-level financial information that may be more readily available.
• The management remuneration of the comparable companies is already reflected in their operating results.
• Can provide a useful corroborative analysis where direct remuneration data is weak.
• May be particularly relevant where the taxpayer's business model and functions can be reliably compared with independent companies.

Key limitations of this approach

The analysis does not directly determine whether the individual KMP would have commanded a particular salary in the external labour market.

More importantly, the FTA Guide states that TNMM should generally be applied at the transactional level and that a company-wide analysis becomes less reliable where the taxpayer performs different functions, undertakes different controlled transactions or operates different business segments that cannot appropriately be compared on an aggregate basis. A company-wide TNMM analysis may nevertheless be used as a corroborative analysis in appropriate circumstances.

Accordingly, an indirect TNMM approach should not be presented as an automatic or universally applicable method for managerial remuneration. Its reliability depends heavily on the quality of the underlying company comparables and the relationship between the remuneration being tested and the taxpayer's overall business profitability.

Classification

Where used as the principal transfer pricing analysis, it would need to be supported as an application of TNMM consistent with the UAE framework. Where used only as corroborative evidence alongside another analysis, its role should be clearly described as such.

Approach 2 – Standard HR / Salary Survey

A recognised HR published compensation report may provide salary ranges, median compensation and percentile data for specified industries, locations and designations.

Potential advantages

• Relatively easy to understand and communicate.
• Often provides standardised salary statistics.
• Industry and designation filters may allow a reasonably structured comparison.
• May provide useful evidence of prevailing compensation levels in the UAE employment market.

Key limitation

The principal question is who is represented in the underlying population.

A salary survey may predominantly capture employees occupying particular executive positions. That population may not closely resemble an owner-manager of a privately held SME who performs a broader entrepreneurial and strategic role.

The distinction does not make the data unusable. Rather, it affects the degree of comparability and the weight that can reasonably be placed on the resulting salary range.

A salary survey should therefore not automatically be treated as a transfer pricing comparable merely because it provides market salary information.

Classification

The report may provide evidence relevant to the arm's-length assessment, but its use does not automatically make the analysis a Comparable Uncontrolled Price (CUP). A CUP requires comparison of the price of a controlled transaction with the price in a comparable uncontrolled transaction in comparable circumstances.

Whether a salary survey constitutes a CUP or supports “Other method”, or is simply corroborative evidence would depend on the nature of the underlying data and methodology.

Approach 3 – Bespoke HR / Compensation Consultant Expert Report

Under this approach, an HR Firm or compensation specialist is engaged to identify remuneration for individuals having a comparable role, seniority and profile.

Potential advantages

A bespoke study may allow the analysis to be tailored more closely to the taxpayer, including consideration of:

• actual designation and responsibilities;
• industry;
• company size;
• geography;
• experience;
• qualifications; and
• compensation structure.

This flexibility can be valuable where standardised salary surveys do not adequately reflect the taxpayer's circumstances.

Key limitations

The underlying company or employee-level observations may not be available to the taxpayer because of confidentiality restrictions. The result may therefore be based on anonymised or aggregated information.

There is also a distinction between compensation expertise and transfer pricing analysis. An HR consultant may establish what comparable executives are paid, but additional analysis may be required to establish whether the resulting evidence appropriately addresses the UAE arm's-length requirement.

The same issue arises in describing the result as a CUP. A market comparison is not automatically a CUP. The classification depends on the actual nature of the uncontrolled observations and the comparability of the arrangements.

Classification

Depending on the methodology and underlying data, the report could potentially support a CUP analysis, another recognised method, or where the prescribed methods cannot reasonably or reliably be applied an Other Method analysis.

The UAE framework expressly permits an alternative method where none of the five recognised methods can reasonably or reliably be applied, provided the alternative method satisfies the arm's-length principle and is appropriately supported. The FTA Guide specifically requires economic and commercial rationale and supporting empirical analysis where such an approach is adopted.

Approach 4 - S&P / People Screening or Similar Commercial Database

Commercial people-screening or executive compensation databases may provide access to information that is broader than conventional HR surveys and may permit screening based on company and individual characteristics.

Potential advantages

• Potentially wider population.
• Ability to apply multiple screening criteria.
• Access to information that may not be available through conventional salary surveys.
• Possibility of identifying more closely comparable roles or businesses.

Key limitation – comparability

The database population must be examined rather than assumed to be representative.

If the population is concentrated among larger companies, multinational groups or global brands, differences may arise in:

• company size;
• revenues and assets;
• geographic footprint;
• organisational complexity;
• management structures;
• business risk;
• industry;
• role scope; and
• remuneration philosophy.

These differences do not automatically make the data unusable. They do, however, need to be considered when evaluating the reliability of the comparison.

The FTA Guide expressly recognises that commercial databases may be used and states that the FTA does not have a preference for a particular commercial database, provided the database provides reliable information for comparability analysis. It also indicates that domestic comparables should be considered as far as possible, with regional or global comparables considered where sufficient domestic data is unavailable.

The Guide further states that, where a private database is used, the FTA may request access to the database under Article 55(4) to review the results and understand the conclusions reached.

4. Comparative Assessment

The table is a ranking. It illustrates that the four approaches involve different types of evidence and different comparability questions.

5. Questions to Consider Before Selecting an Approach

A defensible selection could be guided by the following questions:

a. What exactly is being benchmarked?

Is the objective to establish a market salary for an individual, or to assess whether the remuneration borne by the taxpayer is consistent with an arm's-length business outcome?

b. Who is the individual?

Is the person a conventional executive employee, a director, an officer, an owner-manager or a founder? What services are actually being provided?

c. What functions are performed?

The designation alone may not adequately describe the role. The actual decision-making authority, responsibilities and time commitment should be considered.

d. What is the nature of the taxpayer's business?

The appropriate comparable population may differ significantly between, for example, a professional services firm, trading business, manufacturer and technology business.

e. What is the size and complexity of the taxpayer?

Revenue, assets, employees, geographic footprint, number of operating locations and organisational complexity can all affect the relevance of a comparable.

f. What reliable external evidence exists?

The availability and quality of direct remuneration data should be assessed before determining whether a direct salary comparison is sufficiently reliable.

g. How comparable is the underlying population?

The fact that data is available does not necessarily make it comparable. The relevant question is whether differences can reasonably be explained or adjusted.

h. What is the appropriate transfer pricing method?

The UAE framework requires consideration of the strengths and weaknesses of the recognised methods, the nature of the controlled transaction, functional analysis, reliable information and the degree of comparability.

i. Is an alternative or corroborative analysis useful?

Where one approach has limitations, a second analysis may provide useful corroboration. The FTA Guide expressly recognises circumstances in which a combination of methods may provide a more accurate result.

j. Can the selection be explained to the FTA?

The taxpayer should be able to explain not merely what method was selected, but why it was selected and why the available evidence provides a reasonable basis for the conclusion.

k. Documentation and Audit Readiness

Irrespective of the approach ultimately selected, the analysis should ideally be supported by contemporaneous documentation sufficient to demonstrate how the conclusion was reached.

Depending on the circumstances, this would include:

• job description and actual responsibilities;
• organisational structure;
• qualifications and professional experience;
• decision-making authority;
• time commitment;
• remuneration structure and components;
• ownership relationship, where relevant;
• taxpayer's revenue, assets, employees and other relevant size indicators;
• functional analysis;
• basis for identifying potential comparables;
• search strategy and screening criteria;
• reasons for inclusion and exclusion of comparables;
• source and nature of remuneration data;
• adjustments made and basis for those adjustments;
• benchmarking results;
• rationale for selecting the methodology; and
• copies or appropriate records of the underlying source material.

The FTA Guide specifically states that the comparable selection process should be transparent, systematic and verifiable, and that supporting information should be retained explaining the criteria used and reasons for excluding potential comparables.

It also expects contemporaneous transfer pricing documentation describing the controlled transactions, economic conditions, analysis and conclusions supporting the transfer pricing position.

7. Conclusion – An Informed Choice, Not a Prescribed Answer

There are multiple practical ways of approaching managerial remuneration benchmarking in the UAE, and the four approaches considered above rely on materially different forms of evidence.

An indirect TNMM analysis considers the remuneration within the broader profitability of the taxpayer. HR salary surveys provide standardised market compensation evidence. Bespoke HR studies can potentially provide a more tailored assessment of the individual's role. Commercial people and compensation databases may provide broader or more flexible datasets, but require careful consideration of the population from which the data is drawn.

The UAE transfer pricing framework does not establish a universal remuneration benchmarking technique. Rather, the FTA's guidance requires the selection of the most appropriate method having regard to the nature of the controlled transaction, functional analysis, reliable information and comparability. The FTA also expressly recognises the possibility of using company-wide analysis as corroborative evidence and alternative methods where the recognised methods cannot reasonably or reliably be applied.

Accordingly, the defensibility of managerial remuneration benchmarking should ultimately be assessed by reference to the facts, the nature of the KMP's role, the taxpayer's circumstances, the quality of the available data, the degree of comparability and the evidence supporting the selected approach.

The practical question is therefore not necessarily “Which database gives the answer?” but rather:

When benchmarking managerial remuneration of owner-managers / KMPs in UAE SMEs, which available approach produces the most defensible result given the actual facts and the quality of the comparable evidence?

That question may produce different answers for different taxpayers and that is precisely why the selection should remain fact-driven rather than being treated as a prescribed methodology.