Low-Value-Adding Services: Simplified Approaches to Transfer Pricing

Blog Article

In an increasingly globalized world, multinational enterprises (MNEs) operate across multiple jurisdictions, often sharing services among their related entities. To ensure that profits are accurately allocated and that taxable income is reported where economic value is created, transfer pricing rules play a critical role. Among the types of intercompany transactions subject to transfer pricing scrutiny, low-value-adding services are a common but often misunderstood category.

Low-value-adding services typically involve routine support functions that do not significantly contribute to the business's profit generation. Examples include accounting support, IT maintenance, human resources, and administrative functions. These services, while essential for operations, do not require significant customization, proprietary knowledge, or strategic involvement. Given their routine nature, international tax bodies and regulatory frameworks, such as the OECD Transfer Pricing Guidelines, propose simplified approaches for pricing these services to reduce compliance burdens and disputes.

For businesses operating in the UAE—a region that continues to integrate deeper into the global tax framework—understanding and applying the correct transfer pricing methodologies for low-value-adding services is critical. Leveraging the right transfer pricing services in UAE can help businesses remain compliant while optimizing administrative efficiency and tax positions.

Understanding Low-Value-Adding Services

Low-value-adding services, as defined by the OECD, are intra-group services that:

Are of a supportive nature;

Are not part of the core business of the group;

Do not require the use of unique and valuable intangibles;

Do not involve significant risks for either the service provider or the recipient.

Examples often include services like payroll administration, legal advisory (for internal corporate matters), routine IT support, and procurement administration. Since these services typically do not generate a large profit margin, applying a simplified pricing mechanism ensures compliance without overly burdening tax departments or creating prolonged disputes with tax authorities.

Importance of Simplified Approaches

One of the key challenges for MNEs, especially those with entities in the UAE, is the documentation and benchmarking burden involved in traditional transfer pricing models. Each intercompany transaction must be justified through a detailed comparability analysis, functional profile, and financial benchmarking—a process that is time-consuming and often costly.

The OECD recommends a simplified approach for low-value-adding services, which includes:

A standard mark-up of 5% on costs incurred;

No need for a detailed benchmarking study;

Reduced documentation requirements.

This approach is designed to offer relief to both businesses and tax authorities by promoting administrative ease and reducing audit risk. For companies relying on transfer pricing services in UAE, this is a key area where experienced consultants can help align internal policies with international best practices while staying compliant with local regulations under the UAE Corporate Tax Law.

UAE Transfer Pricing Landscape

As of June 2023, the UAE has formally adopted transfer pricing regulations under its Corporate Tax regime, in alignment with the OECD BEPS Action Plans. This includes the requirement for MNEs to maintain a Master File and a Local File if they meet specific thresholds and to document the arm’s length nature of all intercompany dealings.

With this regulatory shift, low-value-adding services—which were previously not scrutinized as heavily—now fall within the purview of formal transfer pricing audits and documentation. Businesses are advised to carefully review all intercompany service agreements and ensure proper categorization and pricing.

Seeking support from qualified tax advisors in UAE becomes essential at this stage. These professionals can assess whether services qualify as “low-value-adding” and guide the application of simplified transfer pricing methods, while also considering local UAE nuances that may impact compliance.

Benefits of the Simplified Approach

Adopting the simplified method for low-value-adding services offers multiple benefits to UAE businesses:

1. Cost Efficiency

The 5% mark-up mechanism removes the need for detailed financial comparables, eliminating significant consultancy and compliance costs. For UAE-based groups with several entities across borders, this can mean substantial savings.

2. Compliance Confidence

Regulatory clarity reduces the likelihood of disputes or adjustments by the Federal Tax Authority (FTA). Properly applied, the simplified method meets OECD and UAE compliance requirements, reducing audit risks.

3. Administrative Ease

By streamlining internal documentation and minimizing the need for exhaustive data collection, businesses can focus resources on higher-value compliance areas or strategic tax planning.

Key Implementation Steps

To successfully adopt simplified transfer pricing for low-value-adding services, UAE businesses should consider the following actions:

A. Service Identification

Begin by reviewing all intercompany service transactions. Identify services that qualify as low-value-adding based on the OECD’s four key criteria. Avoid including services that carry strategic, operational, or proprietary value.

B. Cost Pooling and Allocation

Establish a clear mechanism to pool costs associated with these services and allocate them among group entities based on appropriate allocation keys (e.g., headcount, usage, revenue).

C. Apply Standard Mark-Up

Once costs are identified and allocated, apply the 5% standard mark-up across the board. Ensure consistency and documentation to defend this pricing if audited.

D. Intercompany Agreements

Formalize the services through robust intercompany agreements that outline the nature of the services, pricing methodology, allocation keys, and responsibilities. This provides legal backing and transparency.

E. Documentation and Local File Integration

Even under the simplified method, the documentation should include a clear description of the services, justification for the mark-up used, and the basis for classification as “low-value-adding.” Tax advisors in UAE can help tailor this documentation to meet the FTA’s expectations.

Potential Pitfalls and Considerations

Despite its benefits, businesses must be cautious when applying the simplified approach. Misclassification of services can lead to non-compliance and tax exposure. For example, services involving strategic decision-making or the use of valuable intellectual property cannot be classified as low-value-adding, even if they appear routine.

Also, some jurisdictions may not fully accept the simplified approach or may demand additional substantiation. Thus, UAE businesses with operations across diverse tax environments should consider the views of foreign tax authorities as well.

Engaging specialized transfer pricing services in UAE allows businesses to perform a comprehensive risk analysis, ensuring that global policies align across all relevant jurisdictions and remain defendable during tax audits.

As the UAE continues its transition to a modern tax jurisdiction, aligning with global standards such as the OECD Transfer Pricing Guidelines, businesses must re-evaluate their intercompany service arrangements—particularly those considered low-value-adding. By leveraging the simplified approach, companies can significantly reduce compliance costs and administrative burdens, while ensuring adherence to the UAE’s transfer pricing regulations.

However, the success of this approach depends on correct implementation, rigorous documentation, and strategic oversight. This is where experienced professionals offering transfer pricing services in UAE and knowledgeable tax advisors in UAE provide vital support, helping businesses navigate this complex area with clarity and confidence.

By embracing best practices and tapping into the right advisory expertise, UAE businesses can stay ahead of regulatory changes, reduce risk, and position themselves for sustainable cross-border growth in an increasingly transparent tax landscape.

LOW-VALUE-ADDING SERVICES: SIMPLIFIED APPROACHES TO TRANSFER PRICING

Low-Value-Adding Services: Simplified Approaches to Transfer Pricing