The documentation is mandatory to provide tax administrations with useful information to use in performing a sufficiently thorough audit of the transfer pricing practices of taxable entities in their jurisdictions.
Transfer pricing refers to the prices of goods and services charged on transactions between related parties and with related persons. Organization for Economic Co-operation and Development (OECD) BEPS Action 13 requires companies to maintain appropriate documentation under a three-tier structure when the arm’s length value of their related party transactions exceeds a certain threshold during the relevant tax period and that the same was almost reproduced in paragraph 7.12 of the UAE Corporate Tax Public Consultation Paper.
The OECD Guidelines (the Guidelines) require transfer pricing documentation to be critical to achieving three basic objectives. One of these is to ensure that enterprises give due consideration to transfer pricing requirements when setting the prices and other terms of transactions between associated enterprises and when reporting income derived of these transactions in their tax returns. Secondly, documentation is required to provide tax administrations with the information needed to make an informed transfer pricing risk assessment, and thirdly, documentation is required to provide tax administrations with useful information to use in performing an audit sufficiently review of entities’ transfer pricing practices. subject to tax in their jurisdiction.
To achieve the above objectives, the guidelines require countries to adopt a standardized three-tiered approach to transfer pricing documentation and maintaining a local file is one of them.
As discussed in our previous article, the master file is the MNE “model” while the local file provides information about the local entity and controlled transactions between related parties. The local file provides assurance that the taxpayer has taken appropriate steps to ensure that an arm’s length price has been charged for all material transactions between related/associated parties.
Annex II of Chapter V of the Guidelines requires that the local file contain information on (I) the local entity, (ii) the controlled transaction and (iii) the financial information.
Local entity information includes information about the local entity’s management structure and organizational chart, which helps tax authorities understand who does what in the organization. To whom local management is accountable, and the country or countries in which these people maintain their main offices. In addition, the local file contains information about the competitors of the local business. It includes details of the business and business strategy adopted by the local entity, including an indication of whether the local entity has been involved in or affected by corporate restructurings or transfers of intangible assets during the current year or the previous year and an explanation of these aspects. such operations affecting the local entity.
This section of the file contains information about specific controlled transactions between related parties. For each category of controlled transaction, the guidelines require companies to keep the description of the controlled transaction which can be the sale of goods, management services, sale of intangible assets, etc. to related parties, and the context in which these transactions took place. square. The guidelines require documenting the amount by jurisdiction of intra-group receipts and payments of the foreign recipient or payer as well as associated companies involved in the controlled transaction and the relationship between the entities. Copies of all material intercompany agreements entered into by the local entity and the detailed comparability/functional analysis of the taxpayer and relevant associates, including any changes from previous years, should be included in the local file. The assumptions made, the summary of the financial information used in the application of the transfer pricing methodology and the copy of the existing unilateral and bilateral/multilateral advance pricing agreements must be included in the local file. What is the most appropriate transfer pricing method, and the reasons for its selection as well as the details of the tested party and the reasons for its selection to be documented. The reasons for performing the multi-year analysis, the list and description of the selected uncontrolled comparable transactions (internal or external) and the description of any comparability adjustments, if any, should be included in the local file. A description of the reasons why it was concluded that the relevant transactions were priced on an arm’s length basis based on the application of the selected transfer pricing method should be included.
With respect to local file financial information, the guidelines require companies to retain financial statements. Businesses would not need to keep audited financial statements; even those that have not been verified would be acceptable. Companies would have a combined cost/revenue, which requires an allocation of costs and revenues. Disclosure and allocation schedules should be prepared and documented showing how financial data has been used in applying the transfer pricing method. Relevant financial data should be retained for the comparables used in the analysis in a summary format and the sources from which this data was obtained.
After the publication of the UAE Corporate Tax Act, companies that would be part of the multinational group and meet the revenue threshold criteria under BEPS Action 13 would be required to have a appropriate local file in light of the guidelines.
Mahar Afzal is Managing Partner at Kress Cooper Management Consultants. The above is not an official opinion but a personal opinion of the author based on the public consultation document on corporation tax and the OECD guidelines. For any questions/clarifications, please write to him at [email protected]