Arm’s Length Rule and Benchmarking in Corporate Tax

The Arm’s Length Rule and Benchmarking play a crucial role in corporate tax compliance, particularly in transactions between related entities. These principles ensure that transactions between associated enterprises are conducted as if they were between independent entities in an open market, thereby preventing tax avoidance and ensuring fair taxation.

What is the Arm’s Length Rule?

The Arm’s Length Rule is a transfer pricing principle that mandates that transactions between related parties (such as subsidiaries, parent companies, or affiliated businesses) must be priced as if they were conducted between unrelated parties. This ensures that profits are appropriately distributed and taxed in the jurisdictions where economic activities take place.

Legal Basis

In the UAE, the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses mandates the application of the Arm’s Length Principle (ALP) to related-party transactions. This aligns with OECD Transfer Pricing Guidelines and global best practices.

Importance of Benchmarking in Transfer Pricing

Benchmarking is the process of comparing related-party transactions against similar transactions conducted between independent entities in an open market. It helps determine an appropriate price or profit margin to ensure compliance with the Arm’s Length Principle.

Steps in Benchmarking Analysis

1. Identifying Comparable Transactions:
   • Finding similar transactions in the same industry.
   • Ensuring comparability based on functions, risks, and assets involved.
2. Selecting the Most Appropriate Transfer Pricing Method:
   • Comparable Uncontrolled Price (CUP) Method
   • Resale Price Method (RPM)
   • Cost Plus Method (CPM)
   • Transactional Net Margin Method (TNMM)
   • Profit Split Method (PSM)
3. Performing Economic Analysis:
   • Reviewing financial data of comparable companies.
   • Adjusting for material differences to enhance comparability.
4. Documenting the Benchmarking Study:
   • Maintaining proper documentation for compliance and audit purposes.
   • Justifying transfer pricing policies to tax authorities.

Compliance and Documentation Requirements

Businesses engaged in related-party transactions must maintain:

• Transfer Pricing Documentation – A detailed report justifying pricing methodologies.
• Benchmarking Analysis Reports – Justification of applied pricing.
• Intercompany Agreements – Contracts supporting transaction terms.
• Local and Master Files – As per OECD’s BEPS Action 13 guidelines.

Conclusion

The Arm’s Length Rule and Benchmarking are essential for corporate tax compliance in the UAE. Businesses must ensure proper documentation, conduct benchmarking studies, and align their transfer pricing policies with international standards. Failure to comply may result in penalties, tax adjustments, and increased scrutiny from tax authorities.

For expert assistance in Transfer Pricing Documentation and Compliance, contact Capital Zone Accounting & Bookkeeping today!