What is transfer pricing benchmarking?
Transfer pricing benchmarking is the process of testing whether the price, margin, interest rate, royalty, service fee, or other financial result of a transaction between related parties is consistent with the arm’s length principle. In practical terms, it asks a simple question: what would independent parties have agreed to under comparable circumstances?
The benchmarking exercise uses comparable transactions or comparable independent companies to establish a defensible arm’s length result. Depending on the transaction, the analysis may compare a controlled price directly with an uncontrolled price, or it may compare profitability indicators such as gross margins, operating margins, or returns on assets.
For UAE businesses, this is especially important because the Corporate Tax regime incorporates transfer pricing rules for transactions and arrangements between Related Parties and Connected Persons. The Federal Tax Authority (FTA) states that transfer pricing rules apply to both domestic and cross-border transactions. The rules are intended to ensure that related-party transactions are carried out on arm’s length terms.
Why is transfer pricing benchmarking important in the UAE?
The UAE introduced Federal Corporate Tax for financial years starting on or after 1 June 2023. Alongside the Corporate Tax Law, the UAE introduced a transfer pricing framework aligned with the OECD Transfer Pricing Guidelines. The framework requires taxpayers to apply the arm’s length principle to relevant related-party and connected-person transactions.
Benchmarking gives a taxpayer evidence for the pricing position it has adopted. It can help explain why an intercompany management fee, distribution margin, loan interest rate, royalty rate, or other controlled transaction is commercially supportable. It also provides an analytical foundation for transfer pricing documentation where documentation requirements apply.
Importantly, UAE rules should not be reduced to the statement that every business must automatically prepare a formal benchmarking report for every related-party transaction. The arm’s length principle applies broadly, while specific transfer pricing documentation requirements, including the Local File and Master File, are subject to the conditions and thresholds set by UAE legislation and Ministerial Decision No. 97 of 2023. Businesses should therefore distinguish between the obligation to apply the arm’s length principle and the obligation to maintain particular documentation.
How does transfer pricing benchmarking work?
A robust benchmarking study normally follows a structured process. The exact steps vary according to the transaction and the transfer pricing method selected, but the analysis generally covers the following:
1. Identify and understand the controlled transaction: The first step is to define what is actually being tested. This may be a sale of goods, provision of services, royalty, intra-group loan, guarantee, cost contribution, distribution arrangement, or another transaction between related parties.
2. Perform a functional analysis: The parties are assessed based on the functions they perform, assets they use, and risks they assume. This is commonly called a FAR analysis. It helps determine the economic character of each party and what level of return would be appropriate.
3. Select the most appropriate transfer pricing method: UAE Corporate Tax rules recognize the OECD-aligned transfer pricing methods. The method should be selected based on the facts and circumstances of the transaction, including the nature of the transaction and the availability and reliability of comparable information.
4. Search for comparable transactions or companies: The analysis identifies independent transactions or businesses that are sufficiently comparable. Internal comparables, where reliable, can be particularly useful because they involve the taxpayer or its related party dealing with an independent party. External comparables may be obtained from commercial financial databases when internal comparables are unavailable or insufficient.
5. Apply comparability criteria: Potential comparables are screened for differences in products, functions, markets, geography, assets, risks, business size, accounting treatment, and other economically relevant factors. Companies that are not sufficiently comparable may be rejected.
6. Make appropriate comparability adjustments: Where reliable adjustments can improve comparability, the analysis may adjust for factors such as working capital or other material differences. Adjustments should be supported and explained rather than used simply to obtain a preferred result.
7. Determine the arm’s length result or range: The selected comparable set is used to determine an arm’s length result. Depending on the method, this may produce a price, margin, mark-up, interest rate, royalty rate, or statistical range. The interquartile range is commonly used in profitability benchmarking when appropriate.
8. Compare the tested transaction with the benchmark: The taxpayer’s actual pricing or financial result is compared with the benchmark. If the result is outside the appropriate arm’s length range, the taxpayer should assess whether an adjustment is necessary and whether the underlying facts, accounting data, or comparability analysis need further review.
What are comparables in transfer pricing?
Comparables are independent transactions or businesses used to test whether a controlled transaction is consistent with market conditions. A comparable is not simply a company operating in the same broad industry. It should be sufficiently similar in economically relevant characteristics.
For example, if a UAE company provides routine administrative support to a related company, a benchmarking study may search for independent companies performing similar routine support activities. The analysis may then compare operating margins or mark-ups after considering differences in functions, risks, geography, business scale, and other relevant factors.
The quality of a benchmarking study therefore depends heavily on the quality of its comparables. A large database search does not automatically create a reliable result. A smaller set of genuinely comparable companies can be more defensible than a large set containing businesses with materially different functions or risk profiles.
Internal comparables vs external comparables
An internal comparable exists when the taxpayer or its related party has a comparable transaction with an independent third party. For example, if a UAE distributor buys the same product from its related overseas manufacturer and also buys the same product from an unrelated supplier under comparable circumstances, the independent purchase may provide useful evidence.
An external comparable comes from independent companies or transactions outside the taxpayer’s own dealings. External comparable searches are commonly performed using specialist commercial databases containing financial and company information.
The FTA Transfer Pricing Guide specifically contemplates the use of internal or external comparable uncontrolled transactions and expects taxpayers to document the comparable search methodology, the selected comparables, relevant financial indicators, and any comparability adjustments.
Which transfer pricing methods are used in benchmarking?
Comparable Uncontrolled Price (CUP) Method: Compares the price charged in a controlled transaction with the price charged in a comparable uncontrolled transaction. It can be highly reliable where the transactions are genuinely comparable.
Resale Price Method: Starts with the price at which a product acquired from a related party is resold to an independent party and works back to an appropriate gross margin for the reseller.
Cost Plus Method: Applies an appropriate mark-up to the relevant cost base incurred by the supplier. It is often relevant to routine manufacturing, services, and similar arrangements.
Transactional Net Margin Method (TNMM): Tests a net profit indicator, such as an operating margin relative to sales or costs, against results earned by comparable independent businesses. It is widely used where reliable price or gross-margin comparables are not available.
Transactional Profit Split Method: Allocates the relevant combined profit between related parties based on the relative contributions of the parties. It can be relevant where transactions are highly integrated or where both parties contribute unique and valuable functions or intangibles.
What does the UAE FTA expect from a benchmarking analysis?
The FTA Transfer Pricing Guide provides practical guidance on applying the UAE transfer pricing regime. For a transfer pricing analysis, the documentation should be capable of explaining the transaction, the parties involved, the functional analysis, the selected transfer pricing method, the comparable search, the financial indicators used, any comparability adjustments, and the conclusion that the transaction is arm’s length.
The FTA also expects financial information used in the transfer pricing method to be supported and reconciled to the taxpayer’s financial accounts. This means a benchmarking study should not sit separately from the company’s accounting records. The tested financial results should be traceable to the underlying financial information.
UAE transfer pricing documentation thresholds
Ministerial Decision No. 97 of 2023 sets the conditions for maintaining a Master File and Local File. A Taxable Person is generally required to maintain both when, during the relevant tax period, either the Taxable Person’s revenue is at least AED 200 million, or the Taxable Person is a Constituent Company of an MNE Group with consolidated group revenue of at least AED 3.15 billion.
These thresholds relate specifically to the Master File and Local File requirements. They should not be confused with the broader arm’s length principle. A business can have transfer pricing obligations even when it is not required to maintain a Local File and Master File under these thresholds.
The FTA also states that businesses claiming Small Business Relief do not have to comply with transfer pricing documentation rules, while they must still comply with the arm’s length principle. Eligibility for Small Business Relief is subject to the conditions in the applicable rules.
Does transfer pricing benchmarking apply to UAE Free Zone companies?
Transfer pricing rules are not limited to mainland companies. The FTA confirms that transfer pricing rules apply to UAE businesses with transactions involving Related Parties and Connected Persons, whether those parties are in the UAE mainland, a Free Zone, or outside the UAE.
A Qualifying Free Zone Person must comply with transfer pricing rules and maintain relevant transfer pricing documentation as part of the conditions for its tax treatment. Therefore, Free Zone businesses should not assume that their preferential Corporate Tax treatment removes the need for arm’s length analysis.
Example: benchmarking an intercompany management fee
Consider a UAE subsidiary that pays AED 1 million a year to its overseas parent for finance, human resources, strategy, and administrative support. The existence of an invoice does not by itself prove that AED 1 million is arm’s length.
A transfer pricing study would first identify the actual services received and the functions, assets, and risks of each party. It would then determine an appropriate method. If a cost-based approach is appropriate, the study may examine independent service providers performing comparable activities and determine an arm’s length mark-up. The resulting analysis would be compared with the UAE company’s actual charge and the supporting cost base.
The objective is not to find a number that makes the transaction look acceptable. The objective is to demonstrate, using reliable evidence and a consistent methodology, what independent parties would reasonably have agreed to under comparable circumstances.
Common mistakes in transfer pricing benchmarking
- Choosing comparables based only on industry classification without reviewing actual functions and risks.
- Using companies with materially different business models or valuable intangibles without adequate analysis.
- Ignoring internal comparables that may provide stronger evidence.
- Failing to document why certain potential comparables were rejected.
- Using financial data that cannot be reconciled to the tested party’s accounts.
- Making unsupported comparability adjustments.
- Treating the benchmarking range as a target to manipulate pricing rather than as evidence for an arm’s length conclusion.
- Assuming that a company below the Local File and Master File thresholds has no transfer pricing responsibilities.
- Using an old benchmark without considering whether the transaction, business model, market conditions, or relevant comparables have materially changed.
How often should a transfer pricing benchmark be updated?
The appropriate update cycle depends on the facts, the transaction, and the applicable documentation requirements. A benchmarking analysis should be reviewed when there are material changes to the business, transaction terms, functions, assets, risks, market conditions, or other factors that could affect comparability. For recurring transactions, taxpayers should also consider whether the comparable data and financial results remain current enough to support the transfer pricing position for the relevant tax period.
How BCL Globiz can help with UAE transfer pricing benchmarking
BCL Globiz provides transfer pricing and benchmarking support for UAE businesses, including transaction review, functional analysis, comparable company selection, database searches, comparability adjustments, arm’s length range analysis, and transfer pricing documentation support.
Relevant service: BCL Globiz Transfer Pricing Services in the UAE
BCL Globiz states that its benchmarking approach includes industry and economic analysis, transaction review, FAR analysis, systematic comparable selection, comparability adjustments, and statistical analysis to establish an arm’s length range. Its UAE transfer pricing offering is positioned around FTA requirements and OECD-aligned methodologies.
Frequently Asked Questions
What is transfer pricing benchmarking?
It is the process of comparing a controlled related-party transaction with comparable independent transactions or companies to determine whether the pricing or profitability is consistent with the arm’s length principle.
Is transfer pricing benchmarking mandatory in the UAE?
The arm’s length principle applies to relevant Related Party and Connected Person transactions. A formal benchmarking report is not a blanket documentation requirement for every UAE business and every transaction. Specific documentation requirements depend on the UAE Corporate Tax Law and applicable decisions, including Ministerial Decision No. 97 of 2023.
What is the purpose of a benchmarking study?
Its purpose is to provide objective evidence supporting an arm’s length price, margin, mark-up, interest rate, royalty, or other transfer pricing result.
What databases are used for benchmarking?
Depending on the transaction, practitioners may use commercial financial and transaction databases containing company accounts, market data, royalty information, or other relevant information. The database should be appropriate to the transaction and geography being tested.
Does benchmarking apply to domestic UAE transactions?
Yes. The FTA states that UAE transfer pricing rules apply to both domestic and cross-border transactions involving Related Parties and Connected Persons.
Do Free Zone companies need transfer pricing compliance?
Yes, where the UAE transfer pricing rules apply. A Qualifying Free Zone Person must comply with transfer pricing rules and maintain relevant documentation as part of the conditions applicable to its status.
What is the difference between benchmarking and a Local File?
Benchmarking is an analytical process used to establish or test an arm’s length result. A Local File is a broader transfer pricing documentation file that contains information about the taxpayer, the controlled transactions, the functional analysis, the selected method, and supporting financial and comparable information, where the Local File requirement applies.
Can BCL Globiz prepare a transfer pricing benchmarking report in the UAE?
BCL Globiz offers transfer pricing benchmarking and documentation support for UAE businesses, including comparable searches, FAR analysis, arm’s length range analysis, and FTA-focused compliance support.
Conclusion
Transfer pricing benchmarking is fundamentally an evidence-based exercise. It connects the commercial facts of a related-party transaction with independent market evidence to determine whether the resulting price or profitability is consistent with the arm’s length principle.
In the UAE, benchmarking has become an important part of transfer pricing risk management under the Corporate Tax regime. Businesses should understand the distinction between the broad requirement to apply the arm’s length principle and the specific documentation thresholds that trigger Local File and Master File requirements. A well-designed benchmarking study should be based on a clear functional analysis, an appropriate transfer pricing method, reliable comparables, defensible adjustments, and financial information that can be reconciled to the taxpayer’s accounts.
For UAE businesses dealing with related parties or connected persons, early transfer pricing analysis can make tax positions easier to support, explain, and defend if the FTA reviews the transaction.
