The 5% Mark-Up You Can Use, and the Services You Cannot Use It On

Group service charges are the most common related party transaction in UAE-headquartered groups and the one most often documented after the fact. Two questions decide the outcome, and they run in order: was a service actually provided, and if so what should it cost.

First the benefit test, which can end the analysis

Before any pricing question arises, the charge has to represent a service that conferred a benefit. The FTA transfer pricing guide works through the ways a charge fails that test, and two of them account for most disputes.

Duplication is the first. Where a service is provided to a related party that has already incurred costs for the same activity, performed itself or by an independent provider, there is no commercial or practical necessity for it and, applying the benefit test, no service is considered provided.

The guide also warns against reading duplication too quickly. A local entity performing marketing in-house while also being charged for group marketing services is not duplication in itself — the local entity may be executing a local strategy while the group company executes a global one, which are different activities. What the FTA expects is a clear rationale, documented, for bearing any apparently duplicative cost.

Incidental benefits are the second. Where a service is provided to some group members and others benefit only incidentally — a group-wide study on restructuring, or on acquiring or terminating a line of business — the incidental beneficiaries have not received a chargeable service.

Then the pricing, and the pass-through point

Not every cost recharged carries a mark-up. Pass-through costs are expenses incurred on behalf of the service recipient, where the exact amount is passed on without any mark-up or profit margin. The guide's illustration is a company arranging a lease for a subsidiary: it applies a mark-up to the costs of providing the procurement support, and recovers the lease rental cost itself without one.

The safe harbour: 5% on cost, no benchmarking

For services that are low value adding, the guide sets out a simplified approach that removes the need for a comparability search. The steps are to categorise, calculate and pool all the costs associated with the low value adding services, allocate that pool among group members on an appropriate allocation key, and apply a profit mark-up, which for this safe harbour is 5%.

The allocation key depends on the nature of the service. The guide's examples are IT services allocated on number of users, and employee-related costs allocated on headcount. It also makes the point that a safe harbour is pragmatic by design, so a balance has to be struck between theoretical sophistication and practical administration.

The simplification is not unconditional. Taxpayers should maintain sufficient documentation to support the conclusion that the services included really are low value adding in nature.

The list of services that cannot use it

The guide names the categories that do not qualify for the safe harbour, and the list is worth reading against a real recharge schedule rather than in the abstract.

• Services constituting the core business of the group
• Research and development services
• Manufacturing and production services
• Purchasing activities relating to raw materials or other materials used in manufacturing or production
• Sales, marketing and distribution activities
• Financial transactions
• Extraction, exploration or processing of natural resources
• Insurance and reinsurance
• Services of corporate senior management

The FTA's own worked example splits one headquarters in two

The guide takes a chemicals group with its regional headquarters in the UAE, supporting group entities in the region, and separates what it supplies into two services.

Technical services — guidance on testing and inspection techniques used when servicing third-party customers — relate to the core business activities of the entities and contribute economic value to the group. They are not low value adding, the safe harbour is unavailable, and a detailed comparability analysis in the example produced a mark-up range of 8% to 12%.

Support services — bookkeeping, processing invoices, recruitment and onboarding, and IT — are supportive in nature and do not result in direct revenue generation. They can be treated as low value adding, and the safe harbour 5% mark-up on cost applies.

What to check

1. Break each intra-group recharge into identifiable services before pricing anything, because the tests apply service by service.
2. Run the benefit test first: was a service provided, and did the recipient receive a benefit it would have paid an independent party for?
3. Where a service looks duplicative, document the rationale — temporary centralisation and second opinions are both accepted, but they have to be evidenced.
4. Separate pass-through costs in the accounting so they can be recovered without a mark-up and shown to have been.
5. Test each service against the excluded list before assuming the 5% safe harbour is available, and pay particular attention to senior management time.
6. Where the safe harbour is used, keep the documentation showing the services are low value adding, and record the allocation key and why it fits the service.

The FTA Transfer Pricing Guide (CTGTP1) is guidance rather than legislation, and the underlying obligation is in Articles 34 and 55 of the Corporate Tax Law. Confirm the position for your own facts before relying on it.