Transfer Pricing: Methods, IFRS & UAE CT | Humayun Atif CMA,CPA

What is Transfer Pricing?

Transfer Pricing is an accounting and taxation practice that refers to the prices of goods and services that are exchanged between companies under common control. For example, if a subsidiary company sells goods or renders services to its holding company, the price charged is referred to as the transfer price.

Businesses rely on transfer pricing to ensure that transaction pricing between related parties is comparable to fair market value and there is a guideline issued by the Organization for Economic Cooperation and Development (OECD) and many countries have adopted these as a reference to ensure that transfer pricing practices align with international standards and are consistent with IFRS principles. There are five OECD-approved methods, and each may yield a different result.

Article 9 of the OECD Model describes the rules for the Arm’s Length Principle. It states that transfer prices between two commonly controlled entities must be treated as if they are two independent entities, and therefore negotiate at arm’s length.

Transfer Pricing brings many benefits to business as it optimizes pricing decisions and reducing the risk of over or under-pricing on intercompany transactions. It also reduces disputes with tax authorities as it brings transparency and consistency. In Short, Transfer pricing allows for better pricing and simplicity of the accounting process.

One should Consider all of the following factors when Choosing a Transfer Pricing Method:

• Nature of Transactions
• Degree of comparability
• Business Strategies
• Legal, and Economic Conditions
• Tax Efficiency
• Avoidance of Double Taxation

The 5 Transfer Pricing Methods

Transfer Pricing methods are used to establish whether Controlled Transactions are conducted at arm’s length and there are five internationally accepted Transfer Pricing methods, and these methods are aligned with guideline issued by the Organization for Economic Cooperation and Development (OECD) and also with UAE Corporate tax parameters.

Broadly there are following approaches for Transfer Pricing:

1. Traditional Transaction Methods: Compare prices of similar transactions.

• CUP method
• Resale price method
• Cost plus method

2. Transactional Profit Methods: Evaluate profits for transfer pricing analysis.

• Transactional Net Margin Method (TNMM)
• Transactional profit split method.

Traditional Transaction Methods

Traditional Transaction Methods focus on direct comparisons of prices or costs in controlled and uncontrolled transactions.

1. Comparable Uncontrolled Price Method (CUP)

The comparable uncontrolled price (CUP) method establishes a price based on the pricing of similar transactions that have taken place between third parties.

This is most reliable transfer pricing method as no one can challenge it but works well if comparable uncontrolled prices exist.

CUP method considered as most direct and preferred Transfer Pricing method for determining the arm’s length result and also the most widely used Transfer Pricing method.

2. The Resale Price Method (RPM)

This method is used when a product is purchased from a related party and then resold to an independent party. It starts with the resale price and then we subtracts an appropriate gross margin to determine an arm’s length price for the original transaction. It is typically used when the buyer does not add substantial value to the goods.

Please note that material differences in accounting practices can affect the gross margins of independent comparable companies so this method is not widely used.

3. Cost Plus Method (CPM)

This is our third and last transactional method. This approach calculates a fair transfer price by adding a standard profit margin to the standard cost of delivering goods or services.

The cost-plus method is applied in related-party transactions that involve manufacturing and assembling goods, where costs are easily determined.

Transactional Profit Methods

4. Transactional Net Margin Method (TNMM)

This method is useful when there are no comparable uncontrolled prices and evaluates the net profit margin earned by a related party in a controlled transaction and compares it to the net profit margin earned in comparable uncontrolled transactions.

5. Profit Split Method (PSM)

This method is used when transactions are highly unified, and it is difficult to find comparable uncontrolled transactions. The method divides the combined profits from controlled transactions between the related parties based on their relative contributions. It allocates the total profit based on each party’s contribution to the combined profits.

Transfer Pricing & IFRS

IFRS does not provide detailed transfer pricing rules, but TP is addressed through a combination of accounting standards and guidelines, and it aligns with the arm’s length principle, which is central to transfer pricing. Further, IFRS standards require that transactions between related parties be disclosed, and the financial statements should reflect these transactions at amounts that are consistent with those that would be agreed upon by unrelated parties.

We have seen that many standards relate to Transfer pricing methodology like IFRS 12, IAS 24, IFRS 10 and IFRS 15.

• IFRS 12 – Disclosure of Interests in Other Entities require entities to disclose related party transactions and balances, including the nature of the relationships.
• IAS 24 – Related Party Disclosures requires that Entities must disclose the nature of the related party relationships, the transactions conducted, and any outstanding balances.
• IFRS 10 – Consolidated Financial Statements states that Transfer pricing practices should align with the consolidation requirements to ensure that intra-group transactions are properly reflected and eliminated in consolidated financial statements.
• IFRS 15 – Revenue from Contracts with Customers also emphasize that Transfer prices used in intercompany transactions must be consistent with the revenue recognition principles outlined in IFRS 15 to ensure that revenue is recognized appropriately. https://accountingblogger.com/ifrs-15-revenue-from-contracts-with-customers/

IFRS 15 – Revenue from Contracts with Customers | Humayun Atif

Compliance with UAE Corporate Tax Laws

Under UAE Corporate Tax law, Transfer Pricing methods are a significant area that deals with the cost of different transactions between related parties. The domestic legislative basis for Transfer Pricing in the UAE can be found under Articles 34 to 36 of the Corporate Tax Law and Federal Tax Authority (FTA) has also issued a comprehensive guideline on Transfer Pricing in October 2023 which described all the details about Transfer pricing methods, Related Parties and Connected Persons details and documentation which are required to maintain to support their transfer pricing policies.Please also review :https://accountingblogger.com/uae-corporate-tax-of-natural-persons/

UAE Corporate Tax of Natural Persons | Humayun Atif (CMA,CPA)

Final Thought

Transfer Pricing methods are used to establish whether Controlled Transactions are conducted at arm’s length. There are five internationally accepted Transfer Pricing methods detailed in the OECD Transfer Pricing Guidelines, and these are also accepted by most of the tax authorities. These include three traditional transaction methods and two transactional profit methods. In general, the traditional transaction methods are preferred over the transactional profit methods and the CUP method over any other method. Cost Plus Method and Resale Margin Method are not much used methods.

In most circumstances, the use of one of the recognized Transfer Pricing methods will provide a sufficient accurate basis for determining the Arm’s Length Price of a transaction. However, Transfer Pricing is not an exact science so in some specific cases where the application of one of the Transfer Pricing methods proves inconclusive than a combination of methods can also be applied for more accuracy.

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4, Certified Forensic Accountant (USA), Six Sigma & Oracle Certified.

Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a Tax and IFRS coach and the founder of accountingblogger.com