Transfer pricing is the price one company charges a related company for goods, services, loans or the use of a brand. Because the two companies share an owner, they could set almost any price on paper. That price decides how much profit each company reports, and so how much tax each one pays. Transfer pricing rules make related companies price these deals as if they were strangers.
This guide explains the idea in plain terms, with examples. If you need the UAE filing rules and thresholds, read our UAE transfer pricing guide.
What Is Transfer Pricing?
A transfer price is the price set for a transaction inside a group. The group could be a parent and its subsidiary, two sister companies with the same owner, or a head office and its branch abroad.
Common examples:
- A factory in one country sells parts to a related assembly plant in another.
- A holding company charges its subsidiaries a management fee.
- A parent company licenses its brand to an operating company for a royalty.
- A shareholder lends money to the company, or one sister company lends to another.
None of these prices comes from an open market. That is why tax authorities check them.
A Simple Example
A manufacturer makes a product for USD 50. It sells it to a related distributor in another country for USD 55. The distributor sells it to customers for USD 100.
At USD 55, the manufacturer keeps USD 5 of profit and the distributor keeps USD 45. If the distributor sits in the lower-tax country, most of the profit is taxed there. If the price were USD 90, the split would flip.
Tax authorities want evidence that USD 55 is what an independent distributor would have paid. If it is not, they adjust the price and tax the difference.
Need Expert Advice?
Contact the team at Farahat & Co. for professional support and expert insights for businesses operating in the UAE.
Why Transfer Pricing Rules Exist
Countries tax profit at different rates. Without rules, a group could move profit to the cheapest country just by changing its internal invoices, even if the staff, factories and customers are somewhere else.
Transfer pricing rules tie profit to where the real work happens. Each country taxes the share of profit earned from activity inside its borders.
The Arm’s Length Principle
The arm’s length principle is the core rule. A deal between related parties must be priced the way two independent businesses would price it in the same situation.
Independent companies each protect their own interest, so neither accepts a price that clearly hurts it. Related companies do not have that tension, so the law asks them to act as if they did.
Example. Independent distributors of a product usually earn a gross margin of about 20%. A related distributor of the same product earning 2%, or 45%, will draw questions. Neither result looks like a deal between strangers.
Most countries, including the UAE, follow the OECD Transfer Pricing Guidelines on how to apply this principle.
Which Transactions Are Covered
Related party transactions are deals between businesses linked by ownership, control or family. The main types are:
- Goods: buying and selling stock, parts or finished products.
- Services: shared admin, IT, HR or technical support.
- Loans and interest: shareholder loans and loans between group companies. The interest rate and terms must both be at market level.
- Guarantees: a parent guaranteeing a subsidiary’s bank loan. An independent guarantor would charge a fee.
- Royalties and licences: payments for using a brand, patent, software or know-how.
- Management fees: charges from a head office for strategy, oversight or central functions.
- Restructuring: moving functions, assets or risks from one group company to another.
How the Right Price Is Found
Setting an arm’s length price usually takes three steps.
1. Functional analysis
A FAR analysis looks at the Functions each company performs, the Assets it uses and the Risks it carries. The company that does more, owns more and risks more should earn more.
Example. Two group companies are both called “distributors”. One holds stock, sets its own prices and carries bad debts. The other just passes orders to the parent for a fixed fee. They are different businesses and should not earn the same margin.
2. Choosing a method
There are five recognised transfer pricing methods:
| Method | What it compares | Typical use |
|---|---|---|
| Comparable Uncontrolled Price (CUP) | The price with the price between independent parties | Commodities, standard goods, loans |
| Resale Price | The reseller’s gross margin | Distributors buying from a related supplier |
| Cost Plus | The mark-up on costs | Contract manufacturing, group services |
| Transactional Net Margin (TNMM) | Net profit margin against comparable companies | Most distribution and service cases |
| Profit Split | How combined profit is shared | Both parties add unique value, such as joint IP |
TNMM is used most often because it works with less perfect comparables. Another method is allowed only if none of the five gives a reliable result.
3. Benchmarking
A benchmarking study searches databases for independent companies doing similar work. Their margins over several years give an arm’s length range. If your result falls inside the range, the price is supported. If it falls outside, it is usually adjusted to the median.
Transfer Pricing Adjustments
An adjustment corrects a price that was not at arm’s length.
- Primary adjustment: the tax authority raises taxable profit to the arm’s length figure.
- Compensating adjustment: the company corrects its own figures before filing.
- Year-end true-up: the company reconciles budgeted internal prices to actual results at the year end.
The biggest risk is double tax. If one country raises the profit and the other country does not lower it, the same profit is taxed twice. For how the UAE treats downward adjustments, see documenting transfer pricing adjustments.
Transfer Pricing and Customs Value
One related-party import can be valued twice: once for income tax and once for customs duty. Customs prefers a higher value, because duty goes up. Income tax rules may support a different price. Keep the two positions consistent, or explain the difference, because a gap can draw questions from either authority.
Transfer Pricing in the UAE
Since UAE Corporate Tax started, the arm’s length principle is part of UAE law under Article 34 of Federal Decree-Law No. 47 of 2022. It applies to deals with related parties and connected persons, whatever their size.
The UAE rules on who files the Disclosure Form, who needs a Local File and Master File, and how tax groups and free zone companies are treated are covered in our UAE transfer pricing guide. For an expert review of your group’s pricing, see our transfer pricing services.
Frequently Asked Questions (FAQs)
What is transfer pricing in simple words?
Why do tax authorities care about transfer pricing?
What is the arm's length principle?
What are the five transfer pricing methods?
What is FAR analysis?
Does transfer pricing only apply to big multinationals?
What are the UAE transfer pricing thresholds?
Need Expert Advice?
Contact the team at Farahat & Co. for professional support and expert insights for businesses operating in the UAE.
How Farahat & Co. Can Help
Our tax team reviews intercompany pricing, prepares FAR analyses and benchmarking studies, and builds transfer pricing documentation for UAE companies.
Contact Farahat & Co. to review your related-party transactions.
