Location-Specific Advantages in Transfer Pricing: Emerging Trends

Blog Article

As the global economy becomes increasingly interconnected, multinational enterprises (MNEs) are continuously adapting their tax structures to align with evolving regulatory landscapes. Among the most significant areas of focus is transfer pricing—a mechanism that governs how transactions between related entities in different jurisdictions are priced. The Organisation for Economic Co-operation and Development (OECD) has provided robust guidelines to ensure arm’s-length pricing, but as countries introduce their own interpretations and requirements, a new area of consideration is gaining momentum: location-specific advantages (LSAs).

For businesses operating in the United Arab Emirates (UAE), understanding the implications of LSAs in transfer pricing is vital. The region’s transformation into a global economic hub has led to the rise of unique operational benefits such as favorable tax regimes, access to strategic markets, and world-class infrastructure. These location-specific benefits may influence how intra-group transactions are priced, making LSAs a crucial component in transfer pricing analysis and documentation.

Understanding Location-Specific Advantages

Location-specific advantages refer to the tangible and intangible benefits derived from operating in a particular geographical location. These can include:

Tax incentives or zero-tax jurisdictions

Access to low-cost or highly skilled labor

Strategic geographic positioning

Developed infrastructure and regulatory ease

Intellectual property regimes and legal protections

In the context of transfer pricing, LSAs can significantly impact the allocation of profits among entities in different tax jurisdictions. Traditionally, profits were allocated based on functions performed, assets employed, and risks assumed (FAR analysis). However, LSAs now play an increasingly important role, especially in regions like the UAE where distinct regulatory and economic advantages exist.

The Growing Focus on LSAs in Transfer Pricing

Globally, tax authorities are placing greater scrutiny on LSAs to ensure that MNEs do not artificially shift profits to low- or no-tax jurisdictions without substantiating the economic rationale. Countries like India and China have already integrated LSAs into their domestic transfer pricing rules. While the UAE currently adopts OECD-aligned standards, its recent introduction of corporate tax and the requirement for economic substance compliance indicate a move toward greater scrutiny in cross-border pricing practices.

For MNEs based in the UAE, where the corporate tax regime came into effect in June 2023, transfer pricing has taken on a new level of complexity. LSAs in the UAE—such as zero percent corporate tax on qualifying Free Zone entities or easy access to global trade routes—can impact the profit attribution to UAE-based entities. Therefore, a nuanced understanding of how these advantages are factored into pricing decisions is essential.

Implications for Tax Advisory and Compliance

As LSAs become integral to transfer pricing frameworks, companies in the UAE must rethink their documentation strategies. Traditional methods that only highlight intercompany roles and responsibilities may no longer be sufficient. Instead, a comprehensive analysis of LSAs must be included to substantiate pricing policies.

This is where specialized tax advisory services come into play. UAE-based businesses need advisors who not only understand the local benefits but also have a global view of how LSAs are treated in different jurisdictions. A well-informed tax advisory partner can help in crafting documentation that balances UAE’s regulatory requirements with the expectations of foreign tax authorities.

Moreover, with the UAE becoming a signatory to the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS), local tax authorities are expected to increase their focus on transfer pricing compliance. LSAs will become even more relevant as the Federal Tax Authority (FTA) enhances its audit capabilities.

Emerging Trends in Location-Specific Advantage Application

The application of LSAs in transfer pricing is evolving in several key ways. Below are the emerging trends that businesses in the UAE should monitor:

1. Quantification of LSAs

Tax authorities are increasingly demanding quantitative analysis of LSAs. For example, if a UAE entity enjoys reduced costs due to no import duties or preferential energy rates, those savings must be quantified and incorporated into the pricing model. Failing to account for these could be interpreted as an overstatement of the local entity’s profits, drawing scrutiny from foreign jurisdictions.

2. Comparability Adjustments

Benchmarking studies often rely on data from markets with different economic realities. When comparing a UAE-based company to peers in jurisdictions with higher tax burdens or operational inefficiencies, LSAs must be considered through comparability adjustments. This ensures that the benchmarking remains valid and that profits attributed to UAE entities reflect their true economic contribution.

3. Value Chain and Dempe Analysis

Under the OECD BEPS Action Plan, especially Action 8-10, there is a push to align profit allocation with value creation. The UAE, known for its investment in R&D facilities and growing digital economy, is increasingly home to intellectual property and innovation centers. In this context, the Development, Enhancement, Maintenance, Protection, and Exploitation (DEMPE) functions must factor in the advantages that the UAE location offers, such as low regulatory barriers or state-backed R&D support.

4. Advance Pricing Agreements (APAs)

Given the complexity LSAs introduce into transfer pricing assessments, more businesses are exploring Advance Pricing Agreements (APAs) as a proactive tool. These agreements help reduce uncertainty by setting transfer pricing methodologies in advance. With the UAE gradually building out its corporate tax infrastructure, it may soon follow other countries in offering bilateral or unilateral APAs to address issues related to LSAs.

Sector-Specific Implications in the UAE

Different industries in the UAE benefit from LSAs in varied ways. For instance:

Logistics and Shipping: Entities in Jebel Ali Free Zone benefit from proximity to one of the world’s largest ports, impacting distribution efficiency and cost structures.

Financial Services: Dubai’s position as a financial hub offers regulatory advantages, which should be reflected in pricing intra-group loans or service fees.

Tech and Startups: With strong government backing for innovation, tech firms enjoy funding and infrastructure benefits that influence how profits should be allocated among entities.

Each sector must tailor its transfer pricing approach to reflect these LSAs accurately.

Best Practices for UAE-Based Multinationals

To effectively manage LSAs within the transfer pricing framework, UAE companies should adopt the following best practices:

Conduct LSA Mapping: Identify and document all location-specific benefits derived in the UAE.

Incorporate LSA in Functional Analysis: Go beyond basic FAR analysis to include how LSAs impact risk-taking ability and profitability.

Update Transfer Pricing Policies Regularly: With rapid regulatory developments in the UAE, policies should evolve accordingly.

Engage with Tax Advisory Experts: Tap into professionals who specialize in both UAE and international tax law to stay compliant and optimize tax positions.

Invest in Robust Documentation Systems: Ensure transparency and readiness for audits by maintaining comprehensive transfer pricing files that include LSA assessments.

Looking Ahead: UAE’s Evolving Tax Landscape

The UAE’s journey from a tax-free economy to a jurisdiction with a structured corporate tax regime marks a significant shift. As the country continues to develop its fiscal framework to align with international standards, it is expected that LSAs will receive more formal treatment in local tax regulations.

For forward-thinking businesses, this is an opportunity to gain a competitive edge. By embracing a transfer pricing strategy that accounts for LSAs, companies not only ensure compliance but also unlock greater operational efficiency and strategic alignment.

Location-specific advantages are no longer an abstract economic concept—they are a real, quantifiable factor in modern transfer pricing strategies. For UAE-based businesses navigating the new tax environment, understanding and leveraging LSAs is essential. With guidance from experienced tax advisory partners and a commitment to proactive compliance, organizations can position themselves for long-term success in a competitive global market.

LOCATION-SPECIFIC ADVANTAGES IN TRANSFER PRICING: EMERGING TRENDS

Location-Specific Advantages in Transfer Pricing: Emerging Trends