Connected Person and Key Management Personnel (KMP) Remuneration under UAE Transfer Pricing Regulations
28 Jan 2025
As the UAE integrates corporate taxation into its economic framework, Transfer Pricing (TP) regulations have emerged as a cornerstone of financial transparency and compliance. One of the critical areas of focus under these regulations is the treatment of Connected Persons, particularly in the context of Key Management Personnel (KMP) remuneration. The nuances of defining connected persons, ensuring compliance, and addressing benchmarking challenges for KMP remuneration require a structured and practical approach. This article explores the TP considerations for such payments, practical challenges in benchmarking, and potential solutions for businesses in the UAE.
Definition of Connected Person under UAE Transfer Pricing Regulations
Under the UAE Corporate Tax Law, a Connected Person is defined broadly to include individuals and entities with direct or indirect control or significant influence over the taxable entity. These typically include:
1. Individuals who own or control the taxable entity: Shareholders, directors, or partners.
2. Relatives with influence: Immediate family members (parents, spouses, children, siblings, grandparents, and grandchildren) of the owners or key decision-makers in the business.
3. Entities controlled by the taxable entity or vice versa: Subsidiaries or related entities involved in shared ownership structures.
The intent behind this definition is to ensure that transactions between related entities and individuals do not distort taxable profits through non-arm’s length arrangements.
Applicability of Transfer Pricing Provisions to KMP Remuneration
Key Management Personnel (KMP) are individuals responsible for strategic decision-making and governance within an organization. Their remuneration—whether in the form of salaries, bonuses, or benefits—falls under the purview of UAE TP regulations when such individuals qualify as connected persons.
Key considerations for applicability include:
• Arm’s-Length Requirement: Remuneration to KMP must be consistent with market standards and reflect the value of services provided.
• Documentation and Justification: Businesses must maintain robust documentation to demonstrate that payments to KMP are in line with comparable market benchmarks.
• Disclosure Obligations
Taxable persons are required to disclose transactions with connected persons in their annual TP Disclosure Form (where the materiality threshold is breached). For transactions exceeding specified thresholds, detailed documentation (Local File, Master File) may also be required.
• FTA Compliance: The Federal Tax Authority (FTA) is likely to scrutinize excessive or unwarranted payments to connected persons as potential profit-shifting mechanisms.
Challenges in Benchmarking KMP Remuneration
1. Lack of Practical Guidance:
Unlike traditional intercompany transactions, there is limited guidance in the UAE regarding the benchmarking of KMP remuneration. The unique nature of each role, combined with variations in responsibilities, complicates the benchmarking process.
2. Subjectivity in Comparability:
- Nature of Roles: KMP roles often combine strategic oversight and operational responsibilities, making it difficult to find external comparable.
- Family-Owned Businesses: In closely-held businesses, owner-directors often assume dual roles, leading to challenges in distinguishing between remuneration for operational and strategic functions.
3. Insufficient Market Data:
UAE-specific market data for benchmarking KMP remuneration is limited, especially in sectors with unique business models or organizational structures.
4. Potential Audit Risks:
Payments to KMP that deviate significantly from market norms are likely to attract FTA scrutiny, leading to potential disputes, penalties, or adjustments.
5. FTA Scrutiny of Profit Shifting Risks
Payments perceived as excessive or below market rates may raise concerns about profit shifting or erosion of the UAE tax base, leading to potential adjustments and penalties.
Practical Solutions for Benchmarking KMP Remuneration and Compliance
1. Conducting a Functional Analysis (FAR):
Begin by assessing the functions performed, assets utilized, and risks assumed by the KMP. This analysis provides a basis for determining the appropriate level of remuneration.
2. Identifying External Benchmarks:
Utilize publicly available data, such as:
- Industry reports, salary surveys, or databases to identify reasonable compensation ranges for comparable roles.
- Comparable positions in similar-sized businesses within the same sector and geography.
- Executive compensation reports for listed companies.
3. Internal Comparables:
Where external benchmarks are unavailable, consider comparing KMP remuneration to other senior management positions within the organization. Ensure that the differences in compensation are justified based on the level of responsibility and contribution.
4. Testing Company Margins: Analyze the margins of the Company at the net level using Transactional Net Margin Method (“TNMM”) by aggregating all the transactions, including KMP remuneration/ benefits and comparing it with the arm’s length inter-quartile range of net margin earned by similar comparable companies operating in similar industry.
5. Use of Allocation Keys:
For owner-directors in family-owned businesses, remuneration can be allocated proportionately based on the time spent on strategic vs. operational functions.
6. Documentation and Justifications:
- Prepare detailed agreements specifying the scope of the KMP’s responsibilities.
- Clearly document the rationale for any bonuses, director fees, or consulting payments.
- Maintain records of board resolutions or performance appraisals to justify remuneration.
- Ensure alignment between KMP pay structures and the organization’s profitability, industry norms, and strategic contributions.
7. Independent Expert Opinions:
In ambiguous cases, businesses can engage external consultants to provide independent evaluations of KMP remuneration. This adds credibility and mitigates audit risks.
8. FTA Readiness
- Prepare for potential FTA audits by maintaining a comprehensive transfer pricing policy that includes KMP remuneration.
- Regularly update documentation to reflect changes in roles, responsibilities, and market conditions.
How Arm’s-Length Justification Benefits Compliance
By benchmarking KMP remuneration to arm’s-length standards, businesses can:
1. Mitigate Audit Risks: Proactively addressing FTA concerns reduces the likelihood of disputes or adjustments.
2. Enhance Corporate Governance: Transparent remuneration practices foster trust among stakeholders, including investors and regulators.
3. Support Strategic Decision-Making: An accurate assessment of KMP compensation ensures alignment between remuneration policies and the organization’s strategic goals.
Way Forward for the Businesses
As UAE businesses adapt to the evolving TP landscape, a proactive approach to KMP remuneration and payments to connected persons is essential. Key steps include:
1. Conducting Regular TP Reviews:
Periodically assess all related-party and connected-person transactions to ensure compliance with the arm’s-length principle.
2. Implementing Operational Transfer Pricing (OTP):
Integrate TP policies into day-to-day operations, ensuring real-time compliance and reducing reliance on year-end adjustments.
3. Engaging Independent Experts:
Seek advice from TP specialists to navigate complex areas such as KMP benchmarking, documentation, and FTA audit readiness.
4. Staying Aligned with Global Best Practices:
While adhering to UAE TP regulations, businesses should align their policies with global standards to enhance transparency and credibility.
5. Promoting Governance and Accountability:
Strengthen internal controls and establish dedicated TP teams to oversee compliance efforts related to KMP remuneration and other related-party transactions.
Conclusion
The UAE Transfer Pricing regulations mark a significant shift toward fiscal transparency and alignment with global tax standards. Addressing the complexities of KMP remuneration under these regulations requires businesses to adopt a strategic, data-driven approach. Key
To navigate these challenges:
• Invest in robust systems for tracking and analyzing remuneration structures.
• Leverage both internal and external benchmarks to support arm’s-length compliance.
• Maintain detailed documentation to justify payments to connected persons.
By taking these steps, businesses can not only achieve compliance but also enhance their reputation as transparent and trustworthy entities in the global marketplace.
