Under the UAE Corporate Tax Law, transfer pricing (TP) rules require that transactions between related parties be conducted at arm’s length—i.e., consistent with prices charged between independent parties in comparable circumstances. This article talks about how trading/ reselling (“distribution”) are treated under the UAE’s transfer pricing laws. It explains how such transactions between related parties need to follow certain rules to make sure their prices are fair and in line with what independent companies would charge.
Types of Distributors
Depending on the quantum of risk undertaken and functions performed, the distributors are classified into the following types.
- Limited-Risk Distributors (LRDs): These distributors operate under a principal model where the parent or related party assumes most of the strategic risks. They focus primarily on local distribution and perform routine functions.
- Full-Fledged Distributors: These entities assume significant market, credit, and inventory risks. They engage in active marketing efforts and may also invest in intangible assets such as trademarks.
- Commission Agents: Commission agents act as intermediaries between buyers and sellers. They do not take title to the goods and do not assume any substantial risk.
- Buy-Sell Traders: These traders purchase goods from related or unrelated parties and resell them at their own risk. Depending on the level of risk and value addition involved, buy-sell traders may be classified as LRDs or full-fledged distributors.
For traders and resellers that purchase goods from related parties and resell them to unrelated customers without significant value addition, the Resale Price Method (RPM) is typically the most appropriate transfer pricing method for benchmarking.
Explore why evolving rules mean transfer pricing is only the beginning of modern tax compliance.
When Does RPM Apply in the UAE Context?
RPM is relevant when the following conditions are met:
- Involvement of Three Parties:
- A related-party supplier (e.g., a foreign parent or group entity),
- A UAE-based distributor (the tested party), and
- An unrelated customer in the open market.
- The method is most effective when:
- The UAE entity acts as a distributor and performs routine functions such as logistics and distribution, with minimal value addition to the goods.
- Limited value-added activities: The reseller does not engage in significant transformation of the goods but instead simply adds a margin to the purchase price. This includes any goods purchased from AE and sold in open market.
- Where the RPM is applied, the Controlled Transaction may be compared to an internal or an external Comparable Uncontrolled Transaction depending on the facts of the case and availability of data.:
- Internal Comparable: The arm’s length Resale Price Margin earned by the distributor or reseller in a controlled transaction is determined by comparing it to the margin the same reseller earns in a similar transaction involving both the purchase and resale with independent parties..
- External comparable: The arm’s length Resale Price Margin in a Controlled Transaction is determined based on the Resale Price Margin observed in a similar transaction between two unrelated parties.
- Low risk and minimal assets involved: The method is also appropriate when the distributor bears a relatively low level of risk and does not make significant investments in assets such as manufacturing facilities, intellectual property, or research and development.
Key Considerations When Applying the Resale Price Method (RPM):
- Operational Comparability: The reliability of RPM depends on the degree of similarity in business operations between related and independent parties. Differences in cost structures—such as those resulting from management efficiency or inventory handling—can affect profitability, even if resale prices remain similar. Such operational variances must be evaluated to ensure comparability.
- Functions, Assets, and Risks (FAR): The gross margin earned in a transaction is closely tied to the functions performed, assets employed, and risks assumed. A thorough FAR analysis should be conducted for the controlled transaction and functions performed and risks undertaken with respect to the distribution function should be evaluated..
- Accounting Practices: Differences in accounting practices between enterprises can affect how the Resale Price Margin is calculated. For instance, a cost may be treated as an operating expense in a controlled transaction but as cost of sales in an uncontrolled one. Without adjusting for such differences, profit margins may be inaccurately measured. Therefore, appropriate adjustments should be made to account for any significant variations in accounting treatment.
Transfer Pricing Methods and Profit Level Indicators (PLIs)
- Comparable Uncontrolled Price (CUP) Method
The CUP method compares the price charged in a controlled transaction to the price charged in a comparable uncontrolled transaction. It is the most direct and preferred method but requires high comparability in terms of products, contractual terms, and market conditions.
- Resale Price Method (RPM)
RPM starts with the price at which a product is resold to an independent party and subtracts an appropriate gross margin to determine the arm’s length purchase price. It is particularly suitable for distributors who do not significantly modify the goods or develop valuable intangibles.
However, depending on the circumstances and availability of data, TNMM can also be considered, and a suitable PLI should be chosen provided there are well enough reasons to substantiate the same.
Review key provisions of the UAE Corporate Tax Law that underpin every transfer-pricing decision.
Steps for Benchmarking distribution function in the UAE
- Functional Analysis: Identify functions, assets, and risks of the distributor to confirm suitability.
- Selection of Tested Party: The distributor is usually the tested party due to its limited-risk profile.
- Identify Comparables: Find independent distributors in the same or similar industry, using databases or public sources accepted by the UAE Federal Tax Authority (FTA). Understand the FTA’s Transfer Pricing Disclosure Form requirements before filing your return.
- PLI: Determine the most appropriate PLI to measure the profits earned.
- Determine Arm’s Length Range: Analyse the gross profit margins of selected comparables to establish a benchmark range.
- Compare Results: Evaluate if the UAE entity’s gross margin falls within the arm’s length range.
- Documentation: Maintain transfer pricing documentation (including a Local File and Master File, if applicable) to support the selection of the method and comparables as per Ministerial Decision No. 97 of 2023.
Conclusion
In conclusion, the application of transfer pricing principles to trading and distribution activities in the UAE requires a clear understanding of the functions performed, risks assumed, and assets used by the distributor. Given the commercial significance of distribution functions in controlled transactions, identifying appropriate comparables and ensuring consistency in accounting treatments is crucial. Variations in how costs are classified—such as between operating expenses and cost of sales—can significantly affect the accuracy of profit margin analysis. Therefore, making suitable adjustments for such differences is essential to arrive at reliable, arm’s length outcomes that align with UAE transfer pricing requirements.
How can BCL Globiz help?
At BCL Globiz, we support businesses in navigating the complexities of transfer pricing for trading and distribution functions in the UAE. Our team conducts detailed functional and risk analyses to understand the role of the distributor and ensure that intercompany transactions align with the arm’s length principle. We identify reliable comparables, adjust for accounting differences, and prepare comprehensive documentation that meets regulatory standards. With our tailored approach, we help clients achieve accurate pricing, reduce tax risks, and maintain strong compliance with UAE transfer pricing requirements.
For further assistance, reach out to our expert rakesh@bclglobiz.com and check out our website www.bcl.ae.
