When companies do not understand how to check the contractual terms of a transaction, they miss key details that show whether the price is at arm’s length. By examining the written terms and the real actions of the parties, a business can understand the true nature of a controlled transaction and bring it closer to what independent parties would agree to.
In this blog, Tax Gian explains how to do that in a simple and practical way. You can seek further assistance from our corporate tax agents in the UAE.
What Contractual Terms Mean in an Arm’s Length Review
Contractual terms describe what each party agreed to do. They show who is responsible for what, who carries which risks, and what benefits each party expects.
In transfer pricing, these terms help define the controlled transaction before comparing it with similar dealings between independent companies.
Most groups record these terms in written contracts. These documents give structure to the deal and make the roles of each entity clear. They usually explain:
- The product or service involved
- The price or pricing approach
- Delivery terms
- Risk allocation
- Rights and obligations
- Expected outcomes
But the contract is only the starting point.
Why Written Contracts Are Not Enough
Many businesses think a signed contract settles everything. But tax authorities do not rely on the written contract alone. They examine what the parties actually did in practice.
A contract may look perfect on paper yet tell only half the story. Emails, meeting notes, internal approvals, and accounting entries often reveal the real conduct between the parties.
These additional sources help clarify:
- Who performed the actual functions
- Who used or maintained the assets
- Who carried real economic risks
If these do not match the written terms, then the written terms lose importance.
When Conduct Is Different from the Contract
Sometimes the behaviour of the entities does not follow the contract. In such cases, the analysis must focus on the actual conduct, not the written document.
Here are common situations:
- The contract shows one party taking a risk, but the conduct shows otherwise
Risk must be backed by real capacity and control. If a contract states that a distributor bears inventory risk, yet the supplier controls all inventory decisions, then the supplier holds the real risk.
- The contract describes functions that do not happen in practice
A contract may say one entity provides marketing support. But if the group’s head office runs the entire marketing activity, the written terms cannot be used.
- The contract does not reflect the full picture
Sometimes the contract is too brief or outdated. The real operations expand over time, leaving the contract behind.
When this happens, the transfer pricing analysis must outline the actual transaction using conduct as the main indicator.
Still confused? Seek assistance from expert corporate tax agents in Dubai.
How to Determine the True Transaction
To correctly outline the transaction, the analysis should check three key aspects:
- Functions Performed
Look at what each party actually does. Examples include manufacturing, procurement, product design, order handling, sales efforts, or logistics.
Actual work talks more about the deal than any clause in a contract.
- Assets Used
This includes physical assets like machinery and warehouses, and intangible assets like trademarks, software, and know-how.
The party that uses and controls important assets usually holds stronger economic weight in the transaction.
- Risks Assumed
Risk must be real. A party can claim a risk only if it has the capacity to manage it and the financial strength to bear losses.
These three elements help uncover the factual substance of the controlled transaction.
Changes in Contractual Terms
Sometimes companies update their agreements. When this happens, the reason behind the change must be checked.
A change may signal:
- A new transaction
- A shift in roles
- A change in functions or risks
- A correction of an earlier mistake
But if the change happens after the outcome is already known, it cannot be treated as a real shift in risk. For instance, moving a loss to another entity after the loss has already occurred does not count as risk-taking.
Every change must be tested to confirm whether it represents genuine commercial intent. Learn more about the matter from our professional corporate tax agents in the UAE.
How can Tax Gian help?
Contractual terms play a major role in arm’s length comparability analysis. They guide the process, but they cannot stand alone. The real actions of the parties, the assets they use, and the risks they manage must confirm the written terms. When contracts and conduct move together, transfer pricing becomes easier to defend and easier to explain.
If you found the blog useful, feel free to seek guidance and knowledge from our qualified corporate tax agents in the UAE. We provide comprehensive corporate tax and transfer pricing services in the UAE.
