Transfer Pricing And Its Effect On Financial Reporting

June 16, 2022Dated:  | |

The number one objective of transfer pricing is to reduce tax liability by finding loopholes in the taxation regime in different countries. Parent companies and their subsidiaries overprice the products and services they transport to countries with high-income tax rates to bring down the profits below taxable limits before reallocating them to countries with lower tax rates.

Please continue reading to know what transfer pricing is and how it affects financial reporting.

What is Transfer Pricing?

When an organization transfers goods or services to its affiliates, subsidiaries, or joint ventures in another country, it fixes a price for the commodities. Such a price is the transfer price. 

Let us suppose that a parent company XYZ has subsidiaries or affiliates in other countries. Suppose XYZ wants to have the lowest tax liability, it will instruct the subsidiary X, where the income tax levy is high, to transfer goods to Its subsidiary Company Y where the tax rates are lower at a lower price. 

The price fixed for the transfer of merchandise from Company X to Y is the transfer price. That will bring down the revenue earning in company X and reduce the tax liability there, and Company Y’s earnings will increase. Still, they will be charged taxes at a lower rate, lowering overall tax liability for the parent company.

However, there are regulations for transfer pricing mechanisms.

How Does Transfer Pricing Affect Financial Reporting?

All individuals or businesses that run in the UAE must file their financial reports, audit reports, and VAT returns at the end of the financial year. However, UAE has no specific regulations relating to transfer pricing until recently. 

However, as FTA will soon implement the corporate income tax regime in the UAE, they will also have to adapt to the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Rules. The transfer pricing adherence will also apply to domestic transactions. Hence, all business entities in the UAE need to be compliant in terms of documentation and transfer pricing regulations.

Intercompany sales of goods and services among UAE corporates are a regular feature in the UAE. The businesses did not closely monitor the payments for such transactions in the past. They took care of them by collecting all transfer pricing-related financial data from the subsidiaries or joint ventures and rolling it back to the parent company.

But such a practice cannot continue in the UAE in the future after the implementation of corporate taxes. The organization will have to carry out such business transactions relating to transfer pricing by taking its face value into account and satisfying the documentation requirements.

Conclusion

As stated in the article, transfer pricing can significantly affect the financial reports of a business irrespective of its size. Hence, it is the right time for all UAE business entities to consider how they are applying transfer pricing presently and analyze the impact of the new tax regime on their domestic and international intercompany pricing arrangements.

Flyingcolour experts can help you with the complex transfer pricing methodology so that you can work in harmony with your subsidiary as a parent company.  

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