With the UAE’s adoption of corporate tax, Transfer Pricing (TP) regulations have become central to ensuring tax transparency and compliance. A key area under scrutiny is the treatment of Key Management Personnel (KMP) remuneration, especially when such individuals qualify as Connected Persons.
Since there is no individual income tax in the UAE, payments made to connected persons are closely monitored and scrutinized, as companies may potentially overcompensate key managerial personnel (KMP) to inflate expenses and reduce their corporate tax liabilities. Therefore, benchmarking such payments is crucial to ensure compliance and transparency.
Determining whether KMP fall within the Connected Person definition, applying the arm’s length principle to their compensation, and benchmarking such payments in a nascent data environment present unique challenges for businesses.
This article outlines the TP considerations around KMP remuneration in the UAE, common benchmarking difficulties, and practical steps companies can take to align with regulatory expectations.
Who are Connected Persons?
- Ownership or Control [36(2)(a)]: An individual who directly or indirectly has an ownership interest in, or controls the taxable person.
- Director/ Officer [36(2)(b)]: A director or Officer of the taxable person
- Kinship with Owner/ Director/ Officer [36(2)(c)]: Any related Party of the owner, director or officer of the taxable person.
- Partnership [36(4)]: Where the Taxable Person is a partner in an Unincorporated Partnership, a Connected Person is any other partner in that same Unincorporated Partnership, and any Person that is a Related Party of that partner.
Any payment or benefit made by a Taxable Person to a Connected Person shall be deductible only if it is incurred wholly and exclusively for the purposes of the Taxable Person’s business and corresponds to the Market Value of the service, benefit, or consideration provided in return. In determining whether such payment or benefit reflects Market Value, the relevant provisions of Article (34) on Arm’s Length Principle of this Decree-Law shall apply, as appropriate.
Understanding the Applicability Framework
- Arm’s Length Principle: Remuneration paid to Key Management Personnel (KMP) must reflect fair market value and be commensurate with the nature and extent of services rendered.
- Substantiation and Record-Keeping: Companies should maintain comprehensive documentation to support that KMP compensation aligns with market comparables and is commercially justified.
- Reporting Requirements: Taxable persons must disclose transactions with Connected Persons in the annual Transfer Pricing Disclosure Form, provided materiality thresholds are met. Where transactions exceed prescribed limits, additional compliance through Local and Master File documentation may be required.
- Regulatory Oversight: The Federal Tax Authority (FTA) is expected to closely examine payments to Connected Persons—particularly those that appear excessive—as potential indicators of profit shifting or non-arm’s length arrangements.
Challenges in Benchmarking KMP Remuneration
- Limited Guidance: Benchmarking KMP remuneration in the UAE is challenging due to the lack of specific regulatory guidance. Unlike standard intercompany transactions, KMP roles are unique and often not directly comparable.
- Comparability Issues:
- Complex Role Structures: KMP often balance strategic and operational responsibilities, making external benchmarking difficult.
- Owner-Managed Businesses: In family-owned or closely-held firms, directors may perform multiple functions, blurring the lines between different types of compensation.
- Data Constraints: Reliable, UAE-specific market data for executive roles is scarce, particularly in niche industries or non-traditional business models.
- Audit and Compliance Risk: Significant deviations from market-aligned remuneration may trigger scrutiny by the FTA, increasing the risk of disputes, adjustments, or penalties.
- Profit Shifting Concerns: Compensation that appears excessive or understated could be flagged by the FTA as an attempt to shift profits or erode the tax base.
Avoid corporate tax penalties in the UAE by proper documentation and benchmarking.
Practical Solutions for Benchmarking KMP Remuneration
- Functional Analysis: Assess the KMP’s roles, responsibilities, and risk profile to justify remuneration.
- External Benchmarks: Use salary surveys, industry reports, and public data from comparable companies.
- Internal Comparables: Compare with similar roles within the company, adjusting for scope and impact.
- Role-Based Allocation: For owner-directors, split pay based on strategic vs. operational involvement.
- Robust Documentation: Maintain clear records—contracts, board resolutions, and performance reviews—to support pay decisions.
- Independent Review: Use third-party experts for added credibility in complex cases.
- FTA Preparedness: Keep TP policies and documentation audit-ready and regularly updated.
Benchmarking: Key to KMP Compliance
- Reduce Audit Exposure: Addressing potential FTA concerns upfront lowers the risk of disputes and tax adjustments.
- Strengthen Corporate Governance: Clear and transparent pay practices build confidence among investors, regulators, and other stakeholders.
- Align Strategy and Compensation: Ensuring fair KMP remuneration supports better alignment between pay policies and the company’s strategic objectives.
Conclusion
With the UAE’s introduction of corporate tax, Transfer Pricing compliance for Connected Persons—especially KMP remuneration—has become crucial. Despite challenges like limited local data, businesses can manage risks by applying functional analysis, benchmarking compensation to arm’s length standards, and maintaining thorough documentation. These steps not only ensure compliance but also enhance governance and strategic alignment in the evolving UAE tax environment.
How BCL Globiz helps?
Benchmarking remuneration for Connected Persons, especially Key Management Personnel, is essential for Transfer Pricing compliance and minimizing tax risks. Accurate valuation, functional analysis, and thorough documentation ensure payments reflect economic reality and meet regulatory standards. At BCL Globiz, we assist businesses by identifying appropriate comparables, conducting detailed analyses, and preparing robust documentation to support KMP remuneration. Our tailored approach aligns compensation with the arm’s length principle and UAE regulations, helping clients manage risks and maintain defensible Transfer Pricing positions.
For further assistance, reach out to our expert rakesh@bclglobiz.com and check out our website www.bcl.ae.
