Reporting Related Party Transactions in UAE

Definition of Related Party Transactions

Transactions between persons or entities considered related parties under UAE Corporate Tax rules, typically due to ownership, control, or certain family relationships, are called related party transactions (RPTs). The definition of RPTs covers transfers of resources, services, as well as obligations between a reporting entity and a related party, regardless of whether a price was charged.

Why do related party transactions attract scrutiny?

In most jurisdictions, RPT regulations are meant to ensure that these transactions happen at market value to prevent profit shifting and financial misrepresentation.

Related parties may not always enter into transactions with the objective of maximizing their own profits. There’s a possibility of misreporting transaction values to artificially lower tax obligations or to favor company insiders.

In the case of simple single-entity business structures, manipulating transaction values typically affects only a single entity’s financial statements. However, RPT manipulation leads to misleading financial statements for multiple connected entities, making it difficult for authorities to detect tax evasion.

Disproportionately large or frequent RPTs may signal favoritism, misuse of resources, or potential fraud, as seen in the notorious Enron scandal. The scandal led to Enron’s bankruptcy, the closure of auditor Arthur Andersen, and the introduction of the Sarbanes-Oxley Act of 2002 to limit conflicts of interest from related-party transactions.

Hence, RPTs are subject to arm’s length requirements and can attract additional scrutiny from tax authorities.

RPT Reporting Considerations

Under IFRS, related party disclosures must be recorded in line with IAS 24. This accounting standard defines the purpose of related party disclosures to highlight the potential impact of related party relationships and transactions on the company’s financial position and performance, thereby ensuring accurate financial statements.

Like various other tax jurisdictions, the UAE government requires businesses to recognize RPTs as per a stringent set of regulations that fall under the corporate tax law.

RPTs’ shareholders also benefit from accurate RPT recognition. Inaccurately recorded RPTs distort key financial metrics and ratios, sending false signals about profitability and liquidity, and ultimately, making it harder for investors to compare companies with industry peers.

Also, as an investor, you should remain vigilant about related-party transactions due to the potential conflicts of interest and resulting impact on shareholder value.

RPT Regulatory Framework

Chapter 10 of the Federal Decree Law No. 47 of 2022 governs related party transactions. Such transactions must be recorded in accordance with the arm’s length principle, and businesses are required to provide a considerable set of documentation to prove that this principle was applied. Companies must also comply with the requirements of company law and governance frameworks regarding related party transactions, which detail the rules, liabilities, and disclosure obligations.

RPT compliance determines whether your corporate tax returns are filed accurately and on time. That, and given the additional scrutiny such transactions attract, is why reporting entities can benefit greatly by establishing corporate tax law-compliant RPT internal controls.

Additionally, the International Accounting Standard (IAS) 24 of the IFRS framework requires reporting entities to disclose the nature of related party transactions, transaction information, outstanding balances, and commitments with related parties. The IFRS framework also recommends identifying and disclosing relationships, transactions, and balances with related parties, including key management personnel and parent or subsidiary companies.

Who Qualifies as a Related Party?

In Article 35 of the Corporate Tax Law, related party relationships are defined as:

As per these rules, entities within the same group, such as subsidiaries, sister companies, and affiliates, are considered related parties due to their ownership and control relationships (see ‘Two legal entities’).

UAE law defines control as:

1. Ability to exercise at least 50% of the voting rights
2. Ability to determine the composition of at least 50% of the board of directors
3. Right to receive at least 50% of the profits
4. Ability to decide or significantly influence how a business is conducted

Examples of Related Party Transactions

Here are some examples:

Each RPT triggers disclosure requirements under IFRS. For instance, under IAS 24, you are required to report the total as well as categorized management compensation and any arrangements involving third-party management services.

Transfer Pricing and Arm’s Length Principle

The arm’s length principle dictates that related-party transactions must be recorded as if the parties were unrelated, independent entities entering into the transaction under similar circumstances.

This principle ensures that all related parties (RPs) in a group recognize profits and losses accurately, and companies do not manipulate transfer pricing to reduce their tax obligations artificially.

For instance, suppose you own a manufacturing group, which has one main operating company and several wholly owned subsidiaries that handle procurement. In the UAE, the corporate tax rate for income up to AED 375,000 is 0%, and 9% above that. Then, you might be tempted to set intercompany prices such that each company reports profits close to AED 375,000.

However, the arm’s length principle defined in the UAE corporate tax law prevents such tax evasion.

Businesses must prove that they abided by the arm’s length principle using any one or a combination of the following methods:

1. Comparable uncontrolled price method
2. Resale price method
3. Cost-plus method
4. Transactional net margin method
5. Transactional profit split method

You can also use an alternative method if you can prove that none of these listed methods can reasonably capture the realities of a transaction. But the alternative method should be appropriate, considering transaction terms and characteristics, economic circumstances, business strategies of the RPs, as well as the assets used, risks assumed, and functions performed by the RPs.

Related Party Transaction Documentation Requirements

Owners and managers are responsible for ensuring that all related party transactions (RPTs) are properly disclosed. Instead of simply listing RPTs in the financial statements, you must also recognize the hidden risks arising out of these transactions. This will help stakeholders discover contingent liabilities that are not immediately evident.

Compliance with the UAE’s corporate tax laws regarding transfer pricing requires you to prepare the following documents:

1. Transfer pricing disclosure schedule

If the total recorded or market value of all related party transactions in a tax period exceeds AED 40 million, you must fill out the transfer pricing disclosure schedule. You will need to disclose related party transactions where the total value per category exceeds AED 4 million. In this schedule, you will need to disclose the following details:

1. RP name
2. Transaction type
3. RP’s tax residence
4. RP’s Corporate tax TRN or TIN
5. Gross income or expense from the transaction
6. Prescribed transfer pricing method chosen (or description of any other transfer pricing method applied)
7. Arm’s length value
8. Tax adjustment (difference between field 6 and 7)

Also, for every connected person (and their respective RPs) where the total transaction value exceeds AED 500,000, the following details must be disclosed:

1. Connected person’s name
2. Connected person’s Corporate tax TRN/TIN
3. Whether the transaction is classified as a payment or a benefit
4. Transaction description
5. Value of payment/benefit extended to the connected person
6. Market value of the service/benefit provided by the connected person
7. Tax adjustment (difference between field 5 and 6)

2. MNE group documentation

If a multinational enterprise (MNE) group’s revenue is at least AED 3.15 billion or if an MNE group’s member’s revenue is at least AED 200 million in the relevant tax period, they are required to prepare a master file and a local file. Businesses that are a part of UAE-headquartered non-MNE groups are required to maintain only the local file if they cross the above thresholds.

Additionally, UAE-headquartered MNE groups must maintain country-by-country reporting (CbCR).

Here’s an overview of the master file, the local file, and CbCR:

3. Additional supporting information

The Federal Tax Authority may request you to provide supporting documents other than the ones listed above in connection with your related party transactions.

Risk Management in Related Party Transactions

Related parties, such as key management personnel, directors, and shareholders, are in a position to exert significant influence over a company’s operations, accounting, and reported profits. Hence, you must develop robust internal processes to identify, assess, and mitigate risks associated with such transactions. Doing so will safeguard the integrity of your financial statements and protect the interests of all stakeholders.

Fortunately, you do not have to start from scratch. Regular updates and annual improvements to UAE regulations and international accounting standards provide valuable guidance on disclosures. These frameworks are generally centered around transparent disclosure of details like key management personnel compensation, outstanding balances with related parties, and the nature of any significant influence or control.

The first step you must take is to store all contracts, agreements, and supporting documents for RPTs in a secure and accessible location.

If your firm engages accounting firms for external audits, you could request them to comment on your RPTs. This will give you written confirmation from an independent third party that all RPTs were conducted at arm’s length.

However, merely complying with regulations and accounting standards is not enough. The board must ensure that all RPTs are in line with the interests of the company’s shareholders. If shareholders suspect conflicts of interest have played a part in these dealings, they may call upon a competent court to review RPTs.

So, to summarize, when you are setting up internal controls for governing related party transactions, you must aim to:

1. Record and disclose RPTs as per UAE regulations and IAS 24
2. Detect any potential conflicts of interests
3. Detect any signs of favoritism towards any key management personnel

Penalties and Tax Implications

Related party transactions attract a great deal of scrutiny from tax authorities in the UAE. After all, if transfer pricing manipulation goes unnoticed, the government loses key tax revenue from multiple entities at once.

Under UAE regulations, there are no separate penalties for violating the transfer pricing rules. But non-compliance can trigger general Corporate Tax penalties.

For example, if you fail to keep required records, you will have to pay AED 10,000 per violation (AED 20,000 for repeated violations within 24 months). And late payment of payable tax can attract a monthly penalty calculated at 14% per annum on the unpaid amount.

At Skrooge, we check if your books are maintained as per FTA standards and determine filing requirements by verifying if your business crossed the relevant revenue/transaction thresholds. You could contact us anytime you have a question.

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