Low-Value-Adding Services: Simplified Approaches in Transfer Pricing
In today’s increasingly globalized business environment, multinational enterprises (MNEs) are under heightened scrutiny from tax authorities across the world, including in the United Arab Emirates (UAE). One key area of focus is the proper pricing and documentation of intra-group transactions—commonly known as transfer pricing. Among these transactions, low-value-adding services (LVAS) represent a category that, while small in cost, can create significant compliance complexity. This article explores simplified approaches to handling such services, with a particular focus on guidance under OECD principles and local adaptations relevant to the UAE market.
Low-value-adding services are typically routine support functions provided by one group entity to another, such as administrative, financial, IT support, or HR-related services. These services do not contribute significantly to the group’s core business value and are not linked to unique or valuable intangibles. However, due to regulatory changes and the Base Erosion and Profit Shifting (BEPS) project initiated by the OECD, tax authorities have increasingly called for substantiation of charges for these services, prompting companies to seek structured and compliant methodologies. This is where expert transfer pricing advisory plays a critical role in identifying risks and ensuring proper documentation.
Defining Low-Value-Adding Services
According to the OECD Transfer Pricing Guidelines, low-value-adding services are intra-group services that:
- Are of a supportive nature;
- Are not part of the core business;
- Do not use or contribute to unique or valuable intangibles;
- Do not involve significant risk to the service provider.
Examples include bookkeeping, invoicing, IT support, and employee training services. These are services that businesses would typically outsource or procure from external providers if they weren’t available internally.
The key challenge for businesses operating in or from the UAE is how to price these services in a way that aligns with both OECD guidelines and the UAE’s transfer pricing regulations under the Federal Corporate Tax framework introduced in June 2023. Since MNEs in the UAE are now required to justify their related-party transactions and maintain robust documentation, understanding LVAS and their simplified treatment is essential.
OECD’s Simplified Approach
The OECD recommends a simplified approach to pricing LVAS, which offers a relief mechanism for both taxpayers and tax administrations. This approach is particularly helpful in reducing the compliance burden without compromising transparency.
Under the simplified approach:
- A standard mark-up of 5% on cost is applied for low-value-adding services.
- No detailed benchmarking or functional analysis is required, provided certain documentation and disclosure requirements are met.
- The service recipient must benefit from the service, and the cost allocation method must be reasonable.
For businesses in the UAE, applying this simplified method can serve as a compliance-friendly strategy that reduces disputes and audit risks. However, it’s essential to have adequate internal systems to capture and allocate costs correctly. This is another area where transfer pricing advisory can assist in tailoring appropriate cost allocation keys and ensuring regulatory compliance.
Compliance and Documentation in the UAE
The UAE’s corporate tax regime, although new, is aligned in principle with OECD standards. The UAE Ministry of Finance requires companies that meet specific thresholds to prepare and maintain Local Files and Master Files for transfer pricing compliance.
In the context of LVAS, the following documentation should be maintained:
- Intercompany service agreements outlining the nature, scope, and pricing of services;
- Clear cost allocation methodologies;
- Evidence of actual provision of services (emails, reports, etc.);
- Demonstration of the benefits received by the service recipient.
From a tax advisory perspective, the documentation requirement cannot be understated. Failure to properly document LVAS charges may lead to adjustments, penalties, or double taxation. Taxpayers must therefore work closely with professionals who can ensure that documentation standards are met and properly aligned with both UAE and international expectations.
Benefits of Using the Simplified Approach
Adopting the simplified approach for LVAS offers several benefits:
- Reduced Compliance Burden: The 5% mark-up eliminates the need for time-consuming benchmarking studies.
- Lower Audit Risk: Standardized treatment reduces the scope for disputes during tax audits.
- Administrative Efficiency: Streamlined record-keeping and simplified documentation support business scalability.
- Cross-border Consistency: Aligns intra-group pricing with global standards, which is beneficial for UAE-based companies with international affiliates.
Nevertheless, businesses should be cautious in applying the simplified method indiscriminately. Not all services qualify, and incorrect classification could lead to recharacterization by tax authorities. An experienced transfer pricing advisory team can help assess eligibility and design internal policies to apply the method correctly.
Key Considerations for UAE-Based MNEs
The UAE presents a unique transfer pricing landscape. While the country’s new tax framework is modern and business-friendly, its implementation brings fresh compliance responsibilities. MNEs operating in free zones or mainland jurisdictions must consider:
- Economic Substance Regulations (ESR): These often overlap with transfer pricing compliance. Businesses offering shared services must prove economic substance locally.
- Documentation Deadlines: Compliance is annual, and filing timelines are tight. Failure to submit transfer pricing documentation timely can result in penalties.
- Audit Preparedness: As the FTA (Federal Tax Authority) ramps up enforcement, transfer pricing audits will become more common. Ensuring that LVAS are well-documented and justified is crucial.
In this context, working with a tax advisory professional helps ensure not only accurate documentation but also strategic alignment with broader corporate tax goals.
Best Practices for Managing LVAS
To optimize compliance and reduce exposure, UAE-based businesses should follow these best practices:
- Create a Centralized Services Policy: Define the scope of services considered as LVAS across the group.
- Document Cost Allocation Methods: Be transparent in how costs are pooled and distributed.
- Establish Intercompany Agreements: Clearly outline service terms, mark-ups, and invoicing frequency.
- Maintain Proof of Benefit: Collect and retain records showing the service recipient derived value.
- Review Annually: Conduct regular reviews of services provided, costs incurred, and benefit received.
These practices, supported by experienced transfer pricing advisory firms, help companies manage LVAS confidently and avoid regulatory pitfalls.
Future Outlook and Strategic Implications
As transfer pricing enforcement becomes stricter across the globe, including in the UAE, MNEs will be compelled to proactively manage all intercompany transactions, including LVAS. The simplified approach provides an effective and compliant framework for handling these transactions but requires careful implementation.
From a strategic standpoint, investing in technology and systems to capture service transactions and support documentation will provide long-term benefits. Integrated ERP systems, time-logging tools, and shared service centers with clear SLAs (Service Level Agreements) will become critical enablers of compliance.
Moreover, as UAE tax authorities gain more experience in interpreting and enforcing the corporate tax law, it is expected that focus on LVAS will increase. Proactive engagement with transfer pricing professionals will therefore be key in navigating this evolving landscape.
Low-value-adding services, though routine in nature, require careful treatment under transfer pricing regulations to ensure compliance and mitigate risk. For UAE-based businesses, the OECD’s simplified approach offers a practical path forward, provided it is applied correctly and supported with robust documentation.
As the UAE’s transfer pricing framework matures, businesses must align their internal processes, governance, and documentation with international best practices. Leveraging professional transfer pricing advisory and tax advisory services will not only safeguard compliance but also enhance business resilience and operational efficiency in an increasingly regulated tax environment.