Why It Matters: Compliance in a No-Income-Tax Environment
With the UAE’s recent adoption of corporate tax, Transfer Pricing (TP) regulations have taken centre stage in ensuring transparency and compliance. In a jurisdiction that historically has had no individual income tax, one critical area attracting tax authority scrutiny is the compensation of Key Management Personnel (KMP)—especially when these individuals qualify as Connected Persons.
The absence of personal income tax creates an opportunity for businesses to overstate such remuneration, thereby reducing taxable profits. This puts KMP compensation directly under the spotlight, making it imperative to ensure payments are made at arm’s length and solely for business purposes. Companies that fail to address this risk proactively may find themselves facing penalties, disallowed deductions, and reputational harm.
Setting the Context: Who Are Connected Persons?
Under Article 36 of the UAE Corporate Tax Law, the following categories are considered Connected Persons:
- Ownership or Control [36(2)(a)]: Individuals with direct or indirect ownership interest in, or control over, the taxable person.
- Director/ Officer [36(2)(b)]: Any director or officer of the taxable person.
- Kinship with Owner/ Director/ Officer [36(2)(c)]: Any related party to the owner, director, or officer.
- Partnership [36(4)]: In the case of an Unincorporated Partnership, this includes other partners and their related parties.
Two key tests determine the deductibility of payments to such Connected Persons:
- Arm’s Length Test: Payments must be consistent with what would be paid between independent entities.
- Wholly and Exclusively Test: Payments must be incurred wholly and exclusively for business purposes.
What’s Under the Microscope? A Closer Look at KMP Compensation
Transfer Pricing rules don’t just apply to intercompany goods or services—they also apply to managerial pay. Here’s what may be evaluated:
- Salaries – Base pay, monthly or annual.
- Bonuses – Incentives tied to performance.
- Stock Options – Equity grants, if applicable.
- Perquisites – Housing, cars, insurance, etc.
- Retirement Benefits – Pension contributions or gratuity.
- Sitting Fees – For non-executive board members.
Every component must align with the person’s actual responsibilities and market norms—or it may not pass the Arms’ Length test.
The Real Risk: Overcompensation that’s Not Arm’s Length
In a country with zero individual income tax, inflating KMP pay might seem harmless. But for the company, it lowers the profit base—and that’s where the tax authority steps in. The Federal Tax Authority (FTA) is alert to signs of disguised profit distributions via excessive KMP compensation. If you can’t justify the number, they might simply disallow it!
Learn more about how related parties and transfer pricing regulations in the UAE impact compliance.
The FTA’s View: Economic Substance and Fair Play
Authorities are increasingly focusing on whether KMP remuneration reflects genuine commercial substance. Payments must correlate with actual responsibilities, performance, and value addition. Inflated pay packages without adequate justification could be treated as disguised profit distribution, especially in closely held or family-run businesses. In such cases, the FTA may challenge not just the quantum of payment but its business necessity altogether.
Compliance Burden: Documentation and Audit Readiness
Under Article 55 of the UAE Corporate Tax Law, the burden of proof lies with the Taxable Person. It is their responsibility to:
- Maintain comprehensive documentation to support their Transfer Pricing position.
- Justify the commercial rationale behind compensation levels.
- Respond promptly to information requests from the FTA.
Without clear benchmarking and functional analysis, companies may struggle to defend their position during tax audits, leading to adjustments and possible penalties.
Challenges in a Nascent Data Environment
Benchmarking compensation in the UAE presents a unique challenge due to the limited availability of public salary data. However, companies can take the following steps to mitigate risk:
- Conduct functional analysis to evaluate roles, responsibilities, and value creation.
- Use regional or global benchmarking databases where local comparables are scarce.
- Rely on job grading and evaluation systems to document and rationalize compensation levels.
- Document all related-party transactions thoroughly, including board resolutions and performance review metrics.
Our detailed guide on transfer pricing documentation for KMP in the UAE explains what records you need to keep to avoid compliance issues.
Practical Steps for Businesses
To align with Article 36 and protect themselves during audits, companies should:
- Identify all individuals who may qualify as Connected Persons.
- Review and document the rationale behind each component of their pay structure.
- Benchmark total compensation—not just base salary—against comparable roles in the region or industry.
- Establish internal policies on KMP remuneration to demonstrate governance.
Conclusion: It’s Not Just HR Anymore—it’s a Tax Risk
Managerial pay in the UAE is no longer just about attracting talent—it’s now a tax compliance issue. Ignoring this risk can result in denied deductions, added taxes, and possible penalties.
In a low-tax environment, compliance with Transfer Pricing norms for Connected Person has become not just advisable, but essential. The message is clear: either get your compensation structures aligned, or risk finding them under fire.
You can also explore our insights on salary benchmarking practices in the UAE for accurate and compliant pay structures.
Don’t wait for an audit. Start benchmarking now.
Paying at arm’s length is no longer optional—it’s your obligation.
You can reach out to us at rakesh@bclglobiz.com for any query or clarification.
