Significance of Risk Analysis in Transfer Pricing

While trying to ensure corporate tax compliance in the UAE, Multinational Enterprises (MNEs) need to consider the transfer pricing rules. Transfer pricing involves the setting of the arm’s length prices of products or services transferred between associated enterprises located in different tax jurisdictions. Arm’s length price means MNEs need to treat transactions between their associated enterprises the way independent enterprises would have dealt in the comparable situation.

MNEs need to identify and consider material risks assumed by each party in a transaction since the actual assumption of risks would influence the prices and other conditions of transactions between the associated enterprises. The level and assumption of risk are economically relevant characteristics (Comparability factors)  that can be significant in determining the outcome of a transfer pricing analysis. This is a complex area of transfer pricing but transfer pricing advisers in Dubai can assist the MNEs to make it simpler.

In this blog, we will guide you on the Significance of Risk Analysis in Transfer Pricing. Read ahead for more information:

Why analyse risks in a Controlled Transaction?

The assumption of risks in a commercial opportunity affects its profit potential in the open market. In addition, the allocation of risks assumed between the parties to the arrangement affects how profits or losses resulting from the transaction are allocated at arm’s length through the pricing of the transaction. MNEs need to compare controlled and uncontrolled transactions to analyse what risks have been assumed, what functions are performed that relate to or affect the assumption or impact of these risks and which party or parties to the transaction assume these risks. Consult with transfer pricing consultants in Dubai analysing risks.

Steps to analyse risk in a Controlled Transaction

The OECD recommends certain steps to help MNEs analyse risk in a controlled transaction so that they can accurately delineate (outline) the actual transaction with respect to that risk. The steps for analysing risk in a controlled transaction are summarised below:

1. Identify economically significant risks with specificity (exactness). There are many definitions of risk, but in a transfer pricing context, it is appropriate to consider risk as the effect of uncertainty on the objectives of the business.  Risks that are vaguely described or undifferentiated will not serve the purposes of a transfer pricing analysis seeking to delineate (outline) the actual transaction and the actual allocation of risk between the parties
2. Determine how specific economically significant risks are contractually assumed by the associated enterprises under the terms of the transaction
3. Determine through a functional analysis how the associated enterprises that are parties to the transaction operate in relation to the assumption and management of the specific, economically significant risks, and in particular which enterprise or enterprises perform control functions and risk mitigation functions, which enterprise or enterprises encounter upside or downside consequences of risk outcomes, and which enterprise or enterprises have the financial capacity to assume the risk
4. Determine whether the contractual assumption of risk is consistent with the conduct of the associated enterprises and other facts of the case by analysing whether the associated enterprises follow the contractual terms and whether the party assuming risk exercises control over the risk and has the financial capacity to assume the risk.
5. If the party assuming risk under steps 1-4 does not control the risk or does not have the financial capacity to assume the risk, MNEs must apply the guidance on allocating risk
6. The actual transaction as accurately delineated (outlined) by considering the evidence of all the economically relevant characteristics (comparability factors) of the transaction, should then be priced taking into account the financial and other consequences of risk assumption, as appropriately allocated, and appropriately compensating risk management functions.

 Risk Management in Controlled Transactions

In terms of transfer pricing, risk management refers to the function of assessing and responding to risk associated with commercial activity. The risk management comprises the following three elements:

(i) the capability to make decisions to take on lay off, or decline a risk-bearing opportunity, together with the actual performance of that decision-making function,

(ii) the capability to make decisions on whether and how to respond to the risks associated with the opportunity, together with the actual performance of that decision-making function, and

(iii) The capability to mitigate risk, that is the capability to take measures that affect risk outcomes, together with the actual performance of such risk mitigation.

Hire the Best Transfer Pricing Advisers in Dubai, UAE

Analysis of risk in controlled transactions is critical for ensuring transfer pricing compliance in the UAE. However, such an intricate process can be simplified by hiring the best transfer pricing consultants in Dubai such as Tax Gian. We are a brand of Jitendra Tax Consultants (JTC), powered by a team of the most experienced tax experts in the UAE. We offer bespoke transfer pricing consulting services in Dubai in line with regulatory expectations and aligned with our client’s global business goals. Tax Gian’s corporate tax professionals can guide you through complex areas of international tax to mitigate the risk of non-compliance.