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Post By: admin February 24 2024

How to Select Appropriate Transfer Pricing Methods?

Transfer pricing is an important section under the UAE CT law that focuses on the pricing of the various transactions between the related parties or any of the connected persons. The understanding of transfer pricing rules is of high importance due to the increase in cross-border business transactions and globalization. Every entity that is carrying out transactions that require knowledge of transfer pricing principles must be aware of the basic rules and requisites of transfer pricing. In this blog, we will shed light on the selection of the most appropriate transfer pricing method.

The Importance of Transfer Pricing Methods

The main objective of using the transfer pricing methods is to evaluate whether the controlled transactions are conducted at arm’s length or not. The transfer pricing methods provide the tax authorities and the MNEs with instructions and assistance for the determination of the pricing of controlled transactions. In total, there are five transfer pricing methods available.

These methods are:

  • Comparable Uncontrolled Price Method
  • Resale price method
  • Cost-Plus Method
  • Transactional Net Margin Method
  • Profit Split Method

Comparable Uncontrolled Price Method

Under this method, the price of the services or property that are transferred in a controlled transaction will be compared with the price of the property or service charged in a comparable uncontrolled transaction. If the prices are quite identical, then the transaction is considered to be performed as per the arm’s length principle, or if there is any significant difference, then the price in the controlled transaction must be adjusted accordingly.

You can also read: Application of Arm's Length Principle for Transfer Pricing under Corporate Tax

Resale Price Method

This method is dependent on the price of the product, which is purchased from the related party and then resold to an independent party. The resale price charged might fall by the gross RP margin along with any of the miscellaneous costs related to the transaction in order to ascertain the arm’s length price for the original transaction that takes place between the related or connected persons.

Cost-plus Method

This transfer pricing method considers the direct and indirect costs that might be incurred by the supplier while supplying the goods and services under a controlled transaction, and it applies an adequate markup to the cost on the basis of the functions that are carried out by the supplier along with the profit earned from the arm’s length transaction based on market conditions. The arm’s length price under this method will be the amount calculated by adding the cost-plus markup to the said direct or indirect cost'.

Transactional Net Margin Method

This method evaluates the net profit that is earned under the controlled transaction in connection with a proper basis, like costs, sales, or assets; hence, in this manner, this method works exactly like CPM and RPM.

Profit Split Method

This method aims at identifying the different divisions of profits that might be expected by the independent parties to be realised from engaging in comparable transactions. Under this method, the combined profit of the connected or related parties is identified first from the controlled transaction, and then the profit is split on an economically viable basis. The conclusive split should approximate the division of profit, which is then anticipated as the arm’s length of an agreement between independent parties.

Other methods

The UAE CT provides the entities with the option to utilise any other applicable and appropriate methods as per the law if the above-listed methods cannot be used reasonably to satisfy the arm’s length principle.

How To Choose The Most Appropriate Method?

The selection of the most appropriate transfer pricing methods is the most crucial part of the transfer pricing operation. While selecting the appropriate method, certain things must be kept in mind. The main highlight points include:

  • The entity must consider the pros and cons of the method that is to be selected.
  • The nature of the controlled transaction as per the functional analysis and its appropriateness must be kept in mind in relation to the method to be chosen.
  • The adequacy and availability of the relevant and accurate information must be assessed before selecting the appropriate method.
  • The accuracy and degree of comparison between the controlled and independent transactions, along with the reliable adjustment required for eliminating differences, must be considered before selecting the correct method.

Application of a Combination of Methods

In rare scenarios, there might be a situation where the use of a single method may not provide an accurate and reliable solution; in that case, the entities are allowed to use a combination of methods with the primary aim of acquiring a reliable conclusion.

CDA as Your Tax Guide

CDA has been providing various tax-related services to its clients in the UAE for more than a decade. After the introduction of the new tax regime in 2023, CDA has geared up and trained its professional team to provide expert guidance to its clients in the UAE. Our team can help you get clear insights into the new tax regime and the complexities hidden in it. We assure you quality tax assistance and a stringent tax compliance framework for your firm in the UAE. To explore more, contact our experts now.