How to Justify Related Party Pricing

Introduction

Related-party transactions are common in multinational groups, involving the exchange of goods, services, financing, and intellectual property among subsidiaries and affiliates. However, these transactions raise Transfer Pricing (TP) concerns, as they may shift profits across jurisdictions if not properly structured.

Under the UAE Corporate Tax Law (Federal Decree-Law No. 47 of 2022), businesses must ensure that related-party transactions comply with the arm’s length principle, meaning they are priced as if they were carried out between independent parties in comparable circumstances. Justifying related-party pricing is therefore essential to avoid FTA scrutiny, adjustments, and penalties.

Why Justification is Important

Ensures compliance with UAE TP rules and OECD guidelines.

Reduces exposure to disputes with the Federal Tax Authority.

Provides evidence of fairness and commercial rationale in intercompany dealings.

Strengthens corporate governance and transparency.

Steps to Justify Related Party Pricing

1. Conduct a Functional Analysis (FAR)

Identify the Functions performed, Assets employed, and Risks assumed by each related entity.

Example: A distribution subsidiary performing routine sales functions with limited risks should earn only a modest margin compared to the parent company providing strategic intangibles.

Outcome: Helps determine which party deserves a higher or lower share of profits.

2. Select the Appropriate TP Method

OECD and UAE TP rules prescribe recognized methods to test pricing:

Comparable Uncontrolled Price (CUP) – Comparing related-party prices with similar third-party transactions.

Resale Price Method (RPM) – Benchmarking gross margins in resale activities.

Cost Plus Method – Adding a mark-up to costs for service providers or manufacturers.

Transactional Net Margin Method (TNMM) – Comparing net margins of related entities with independent companies.

Profit Split Method – Allocating combined profits based on contributions.

Outcome: Using the right method ensures credibility and defensibility.

3. Use External Benchmarking Data

Access independent databases (e.g., Orbis, RoyaltyStat, Bloomberg) to obtain comparable margins, royalty rates, and interest rates.

Apply appropriate filters (industry, geography, size, risk) to ensure reliable results.

Outcome: Provides objective market-based evidence for pricing justification.

4. Align Legal Agreements with Substance

Draft intercompany agreements that clearly define terms such as pricing, payment terms, responsibilities, and risks.

Ensure actual business conduct matches contractual terms (substance-over-form principle).

Outcome: Strengthens the legal and commercial basis for related-party transactions.

5. Consider Economic Circumstances

Adjust pricing for factors like market conditions, currency risks, business cycles, or geographic differences.

Example: A related-party loan priced in AED should reflect UAE market interest rates at the time of issuance.

Outcome: Ensures comparables are adjusted for real-world differences.

6. Document the Justification Thoroughly

Maintain a Local File with details of related-party transactions and benchmarking.

Prepare a Master File for group-level policies and intercompany arrangements.

Where applicable, ensure Country-by-Country (CbC) reporting is consistent.

Outcome: Creates a strong defense file in case of FTA audits.

Common Pitfalls to Avoid

Using arbitrary mark-ups without benchmarking support.

Charging for shareholder or stewardship activities that provide no real benefit.

Overstating the value of intangibles or guarantees.

Inconsistencies between agreements, conduct, and documentation.

Failing to update benchmarking annually.

Best Practices

Review related-party pricing annually to reflect market updates.

Consider Advance Pricing Agreements (APAs) for certainty in complex cases.

Involve professional TP advisors for high-value transactions.

Ensure consistency across contracts, financial statements, and tax filings.

Conclusion

Justifying related-party pricing is about more than compliance—it is about ensuring that intercompany dealings are transparent, defensible, and commercially rational. By conducting a functional analysis, applying the right TP method, using reliable external benchmarks, and maintaining robust documentation, businesses in the UAE can safeguard themselves from regulatory challenges and build a resilient tax strategy.

✍️ Prepared by Sheikh Anwar Accounting and Auditing LLC – Registered Auditor with the Ministry of Economy (Auditor Entry No. 5817, Company Entry No. LC4695-01). We are UAE specialists in Corporate Tax, Transfer Pricing, VAT, and AML Compliance, supporting businesses across diverse industries.

🌐 Visit us: www.sa-auditors.com