Corporate tax in the UAE: “Cross charge” is an area that will require additional input

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Many corporate groups operate across multiple entities, sometimes involving more than one tax jurisdiction or, in some cases, between free zones and the mainland. It is not profitable to have teams for different support functions in each entity of the group.

A group operating in multiple countries will have a single team providing IT support to the group. Functions such as legal, accounting, finance, HR, suppliers and R&D are usually centralized. The entity that provides the support services is called the “service center” and the entity that uses the services is called the “recipient of the services”.

“Cross charge” is a mechanism by which the costs incurred by the service center are recovered from the recipient of the service, generally on the basis of a distribution key. In the case of IT support services, the costs incurred by the service desk (hardware, software and staff costs) can be allocated to other entities depending on the number of tickets created. Similarly, costs incurred on the legal function can be allocated based on the time spent by the legal team, or costs incurred on the accounting function can be recovered based on the number of accounting entries made.

Having proper allocation keys is essential. Generally, the workforce, the area occupied and the income are used as distribution keys. Cross charges are subject to audit by the tax authorities of both locations – i.e. the country/free zone of the service center and the country of the recipient of the service, particularly under price regulations of transfer.

In the country of the service centre, the tax authorities will examine whether appropriate profits have been made and offered for tax by the service centre. The arm’s length test is applied in such a case, in which the tax authorities seek to compare the profits made by the service center with those made by other third-party service providers engaged in the provision of similar services.

“arm’s length” approach

Essentially, it is checked whether the service centers have recovered full costs, plus an appropriate mark-up from associated companies, after considering factors such as the nature of the services, the functions performed, the assets used, the risks assumed, extent of participation by associated companies. Where profits are not arm’s length, a transfer pricing adjustment is made whereby profits equivalent to arm’s length profits are subject to tax.

In the country in which the service recipient is based, payments made to the service center are subject to the benefit test and the arm’s length test by the tax authorities. As part of the benefit test, the authorities verify whether the service recipient has actually used and benefited from the services provided by the service center. A deduction of profits from payments made at the service center is only permitted by the tax authorities to the extent that the benefits have been used.

Framework service contracts

The service recipient usually proves that the benefits resulted in either cost savings or increased revenue. If the payments are found to be excess, a transfer pricing adjustment is made, whereby the excess payments made are disallowed as a deduction from profits and subject to tax.

Tax authorities perceive SSC/group cost payments as “profit repatriation” or excessive arm’s length price, hence the need to defend with facts and documents when confronted with them. request to do so.

The UAE would provide credits if tax was deducted in a foreign jurisdiction. The OECD has encouraged countries to levy withholding tax only on the profit element in cross-taxation.

Given the overall risk of tax litigation in the event of cross-charging, overseas or between free zones/mainland entities, it is necessary for organizations to have a robust pricing policy in place. A “master service agreement” or separate agreements must be concluded between the service center and the recipients of the service.

A regular study should be undertaken to test the compliance of the pricing policy with the arm’s length principle. This will help organizations defend and mitigate litigation risk. In some cases, where complex issues such as the development of intellectual property or the commercialization of intangible assets are at stake, organizations may also consider seeking clarification from the federal tax authority once the rules are known.

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