A parent company incurs AED 100,000 on behalf of its subsidiary. Should it recover AED 100,000, AED 105,000, or a different amount altogether?
The answer depends not merely on who receives the invoice, but on the commercial substance of the arrangement.
Under the UAE Transfer Pricing framework, related-party transactions must satisfy the arm’s length principle. For intra-group services, an important consideration is whether the entity recovering an expense has actually performed functions that justify earning a profit.
Understanding pass-through costs
Section 7.2.2.3 of the Federal Tax Authority’s Transfer Pricing Guide (CTGTP1) addresses the reimbursement of expenses incurred on behalf of related parties and connected persons. The Guide recognizes that a group company may incur expenses for goods or services requested by another group entity without necessarily adding economic value to those goods or services. A reimbursement without a mark-up can be appropriate when the relevant conditions are satisfied, including that:
- The acquired goods or services are requested by and benefit the recipient entity.
- The intermediary acts merely as a paying agent and does not enhance the value of the acquired goods or services.
- The underlying cost is the recipient's legal or contractual liability, including where an intercompany agreement establishes the required arrangement.
However, an intermediary’s own procurement or coordination activities may themselves warrant arm’s length remuneration.
A practical example
Suppose Parent Company P engages an external consultant to prepare an operational efficiency report for Subsidiary S. The consultant charges AED 100,000. Parent Company P additionally incurs AED 5,000 in internal coordination costs.
Two scenarios are possible.
Scenario 1: Parent acts primarily as an intermediary
Subsidiary S identifies the requirement, determines the scope, directs the consultant and approves the final deliverable. Parent Company P merely facilitates procurement, processes payments and coordinates communication. Assuming the relevant contractual and economic conditions are met, the external consultant’s AED 100,000 fee may qualify as a pass-through cost. The parent would separately determine appropriate remuneration for its own coordination services.
For illustration, assuming a 10% mark-up on the AED 5,000 coordination cost is supported by a reliable arm’s length analysis:
| Component | Amount |
|---|---|
| Consultant cost reimbursed | AED 100,000 |
| Parent’s own coordination cost | AED 5,000 |
| Illustrative 10% mark-up | AED 500 |
| Total intercompany charge | AED 105,500 |
The 10% rate is hypothetical, not a prescribed UAE rate.
Scenario 2: Parent assumes substantive responsibility
Now suppose the parent independently determines the scope of the engagement, appoints and directs the consultant, manages the assignment, integrates the consultant’s findings and assumes responsibility for delivering the advisory solution to its subsidiary. In this situation, the parent may be performing a substantive service rather than merely reimbursing a third-party expense. The consultant’s fee may form part of the relevant service cost base, subject to a proper functional analysis and an appropriate transfer pricing methodology.
It would therefore be incorrect to assume automatically that the AED 100,000 must be passed through without a mark-up.Similarly, applying a mark-up to the entire consultant fee simply because the contract is in the parent's name would not, by itself, establish an arm's length charge.
Why the contract is not the complete answer
A contract helps identify the legal obligations of the parties. However, transfer pricing also requires examination of their actual conduct. Key questions include who selects the consultant, directs the work, controls significant decisions, bears relevant risks, receives the service and is responsible for the final outcome. The answers help determine whether the parent is acting as an intermediary or as the actual service provider.
Practical considerations for UAE businesses
Businesses should distinguish third-party pass-through costs from costs incurred in providing their own value-adding services. Relevant supporting documentation may include intercompany agreements, consultant contracts, correspondence, work orders, invoices, evidence of service delivery, and the rationale for the selected mark-up or pricing methodology.
Conclusion
The critical transfer pricing question is not simply who paid the third-party invoice. It is what each entity actually did, what responsibilities it assumed, and whether the resulting charge reflects an arm’s length outcome. A defensible policy should establish the nature of the underlying arrangement before determining the cost base and any applicable mark-up.
