Navigating Intra-Group Loans – Transfer Pricing Rule in the UAE8 min read
- 04.11.2023
- Posted by: Uwe Hohmann
- Categories: Dubai, Tax
Intra-group loans have become common in today’s business environment, with related parties engaging in various scenarios involving loans. Also, expanding Small and Medium-sized Enterprises (SMEs) should carefully consider the pricing of loans to recently established subsidiaries or branches in the UAE. Under the Corporate Tax Regime, understanding and correctly pricing these loans are essential to ensure compliance with the transfer pricing doctrine.
Today’s article will explore the key aspects of intra-group loans, including determining arm’s length pricing, conducting credit rating analysis, considering implicit support, and searching for third-party loans.
1. Intra-Group Loans: A Diverse Landscape
Intra-group loans can take various forms, from central treasury entity loans to loans between parent companies and operating subsidiaries, loans between operating subsidiaries, or shareholder loans from investors to portfolio companies. The critical point is that these transactions should be priced separately from routine services to ensure fair and accurate pricing.
2. Determining Arm's Length Pricing for Intra-Group Loans
When determining the arm’s length pricing for intra-group loans, the UAE, like many other countries, uses the Comparable Uncontrolled Price (CUP) method, thanks to the abundance of data on third-party loans. The CUP method involves a few essential steps:
Analyzing loan terms: The terms of the loan, such as issue date, tenor, currency, interest rate type, and other factors, are scrutinized.
Borrower’s credit rating: To understand the credit risk the lender bears, the borrower’s credit rating is considered, factoring in implicit support from the group.
Searching for third-party loans: Identifying loans with similar credit ratings and terms.
Comparability adjustments: Making necessary adjustments and calculating the arm’s length range.
3. Credit Ratings: A Key Factor
Credit ratings play a crucial role in assessing the creditworthiness of borrowers and the terms of loans. Determining credit ratings requires considering both quantitative (financial information) and qualitative factors (industry, jurisdiction). It is often useful to replicate the process used by independent credit rating agencies and consider the enhanced creditworthiness a Multinational Enterprise (MNE) may receive due to group affiliation.
It’s important to note that publicly available financial tools may differ from independent credit rating agencies’ methodologies, making it necessary to consider these differences when determining credit ratings for transfer pricing purposes.
For expanding SMEs not within the radar of independent credit rating agencies, proper documentation of previously performed loans or third-party loans will be essential for transparency.
4. Implicit Support: The Group Advantage
Implicit support, in the context of intra-group loans, refers to the benefits an entity receives solely by virtue of its group affiliation. Group membership informs the debt’s form, terms and conditions, and pricing. The entity may receive support from the group in times of financial difficulty, a key aspect of implicit support. This benefit doesn’t require any payment or comparability adjustment and can impact the credit rating of the borrower or debt issuer.
5. Performing a Search for Third-Party Loans
Benchmarking intra-group loan interest rates against publicly available data for other borrowers with similar credit ratings and terms is crucial. When searching for third-party loans, various factors come into play:
Issue date of the loan (interest rates may fluctuate significantly over time)
Currency of the debt (foreign exchange rate fluctuations / lower and higher risk currencies)
Country of the borrower (unique macro-economic factors [inflation, recession, etc.)
The tenor of the loan (higher interest rates to incentivize the lender to extend the loan)
Loan options (Pre-payment option)
Interest rate type (fixed rate and floating rate [LIBOR or EIBOR])
Industry of the borrower (stable or unstable industries, start-ups, etc.)
These factors can significantly impact the pricing of the loan, and a thorough search for comparable loans is essential.
6. Comparability Adjustments for Third-Party Loans
In some cases, finding exact matches for all the key comparability criteria of an intra-group loan may be challenging. Comparability adjustments may be required to enhance the reliability of the third-party loan. This is particularly relevant in regions with limited capital markets or currencies with unique characteristics.
If matching information cannot be found, the authorities may determine the usual interest rate for the loan. Documenting and providing information about previous intra-group loans or similar loans granted to third parties is crucial to minimize that risk. It is important that previous intra-group loans were performed, paid, and had a specific purpose.
How TME Services Can Support Your Business
Intra-group loans are a common feature of MNEs operating in the UAE and around the world. Intra-group loans may affect expanding SMEs. Those will face difficulties regarding the pricing of loans due to a lack of similar third-party loans, given the fact that every loan is individually shaped to the companies’ unique needs. Therefore, understanding how to correctly price these loans according to the transfer pricing doctrine is essential for compliance with the UAE’s Corporate Tax Regime. The CUP method, credit rating analysis, implicit support, and careful consideration of third-party loans are critical in ensuring that intra-group loans are priced at arm’s length, creating a fair and transparent business environment in the UAE.
TME Services is a team of 45 professionals in legal-, tax-, accounting, and compliance with over 18 years of experience. We advised a significant number of SMEs in the context of the implementation of the tax framework in the UAE and KSA over the last decade to make sure that our clients are well-oriented in the new and fast-evolving tax landscape and to reduce the legal liability of managers which may arise in connection with non-compliance.
