ARM’S LENGTH PRINCIPLE:
The arm’s length principle is a fundamental basis for internationally accepted transfer pricing. This principle requires that transactions and accounting operations between related entities, whether directly or indirectly owned by each other, be priced as if the parties were unrelated and independent of one another.
The main objective of the arm’s length principle is to prevent the supply of goods or services at prices below market value, thereby ensuring that each country receives its fair share of taxes. When applied correctly, the arm’s length principle promotes fiscal fairness and corporate transparency.
FAMILY BUSINESSES IN THE GULF COOPERATION COUNCIL COUNTRIES
Family businesses have long dominated the economies of the Gulf states, operating through structures that are directly or indirectly interconnected. These structures often expanded without formal agreements between companies or specific pricing mechanisms between the parties, largely due to the previous absence of taxation in the region.
Previously, there was no need to document transactions between related parties due to the absence of corporate tax. However, under the new tax laws and regulations, documenting these transactions has become extremely important to avoid any administrative penalties for non-compliance with tax requirements.
COMMON PITFALLS IN TRADITIONAL GULF STRUCTURES
The following transactions are considered indicators of non-compliance with tax laws during tax audits:
- Loans between affiliated companies without interest charges or open-ended loans without specified repayment terms.
- Administrative services, human resources services, or IT services priced at undocumented rates or rates that do not conform to market transfer pricing.
- Royalty payments in amounts that do not reflect their true market value.
These transactions listed above require necessary adjustments to avoid any penalties or administrative violations if they are not addressed before any tax audit by the tax authorities.
RISKS AND CONSEQUENCES OF NON-COMPLIANCE WITH TAX LAWS AND REGULATIONS.
Tax authorities have broad powers to audit transfer pricing between related companies at any time they deem appropriate and may do so without prior notice if tax evasion is suspected. Such tax audits may result in an increase in the declared taxable income for prior periods, leading to additional taxes due for those periods, as well as penalties for non-compliance with applicable tax laws.
In some cases, the financial burdens associated with administrative penalties may exceed the cost of ensuring tax compliance proactively, as a tax audit can significantly impact a company’s cash flow.
STEPS TO TAX COMPLIANCE:
STEP 1: IDENTIFY ALL TRANSACTIONS BETWEEN RELATED PARTIES
All transactions between related parties within the group must be identified, and this is done by identifying the entities that supply the goods and services and the companies that receive these supplies.
STEP 2: FORMAL DOCUMENTATION OF TRANSACTIONS BETWEEN RELATED PARTIES
Previously established verbal agreements between parties are no longer sufficient or acceptable to the tax authorities. With the implementation of corporate tax, agreements between companies must be documented through clear transfer pricing policies, terms, and conditions in accordance with policies that comply with the Organization for Economic Cooperation and Development (OECD) guidelines and must be signed and sealed by the parties involved.
STEP 3: ADOPTING A TRANSFER PRICING METHODOLOGY APPROVED BY THE TAX AUTHORITIES
Companies must apply transfer pricing methods approved by both the country’s tax authorities and the OECD, by comparing prices to reliable market benchmarks. They must also maintain documentation supporting the chosen pricing method and ensure that the services or goods mentioned in the agreements were provided.
For more information on how Creation Business Consultants can assist with tax advisory and support services, contact us at [email protected].
