TRANSFER PRICING METHODS FOR TOLL MANUFACTURING

Transfer Pricing Methods for Toll Manufacturing

Transfer Pricing Methods for Toll Manufacturing

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Toll manufacturing is a widely used business model in the UAE, where multinational companies (MNCs) outsource manufacturing activities to local entities while retaining ownership of raw materials and intellectual property. This approach enables businesses to optimize costs, focus on core competencies, and ensure production efficiency. However, when dealing with related-party transactions, companies must comply with transfer pricing regulations to ensure fair pricing and avoid tax disputes.

The UAE has implemented transfer pricing rules aligned with OECD guidelines to prevent tax avoidance and ensure transparency in intercompany transactions. Understanding transfer pricing methods for toll manufacturing is crucial for businesses operating in the region, as improper pricing can lead to tax penalties and reputational risks.

Understanding Toll Manufacturing in the UAE


Toll manufacturing refers to an arrangement where a manufacturer (toll manufacturer) produces goods on behalf of a principal company. The toll manufacturer does not own the raw materials, finished products, or intellectual property but is compensated for its production services.

Since toll manufacturers and principal companies often belong to the same multinational group, tax authorities scrutinize their transactions to prevent profit shifting. This is where transfer pricing comes into play, ensuring that the toll manufacturer receives appropriate compensation for its services.

To comply with UAE regulations, businesses must apply the right transfer pricing method when determining compensation for toll manufacturing activities. The choice of method depends on factors such as business structure, risk allocation, and the nature of the transaction.

Transfer Pricing Methods for Toll Manufacturing


The OECD Transfer Pricing Guidelines recommend five methods to determine the arm’s length price for intercompany transactions. These methods help businesses establish fair pricing while ensuring compliance with UAE tax regulations.

1. Comparable Uncontrolled Price (CUP) Method


The CUP method compares the price charged for a controlled transaction (between related parties) with the price of a similar transaction conducted between independent parties under comparable conditions.

  • Application in Toll Manufacturing: If a toll manufacturer provides similar production services to both related and unrelated companies, the price charged to independent parties can serve as a benchmark.

  • Challenges: Finding a truly comparable uncontrolled transaction can be difficult, as differences in volume, contract terms, and risk allocation may exist.


2. Cost Plus Method (CPM)


The CPM determines the transfer price by adding a reasonable markup to the toll manufacturer’s cost of production.

  • Application in Toll Manufacturing: The toll manufacturer calculates its total costs (materials, labor, and overheads) and applies a markup that reflects an arm’s length profit margin.

  • Challenges: Determining an appropriate markup can be complex, as it requires benchmarking against similar independent manufacturers.


3. Resale Price Method (RPM)


The RPM sets the transfer price based on the resale price at which a distributor sells the product to an independent customer. A suitable margin is deducted from this resale price to determine the toll manufacturer's compensation.

  • Application in Toll Manufacturing: This method is rarely used for toll manufacturing because the manufacturer does not engage in direct sales.

  • Challenges: The resale price must be adjusted for differences in functions, risks, and economic conditions, making this method difficult to apply.


4. Transactional Net Margin Method (TNMM)


The TNMM compares the net profit margin earned by the toll manufacturer with the net margins of comparable independent manufacturers.

  • Application in Toll Manufacturing: The toll manufacturer’s net profit margin is compared to that of independent manufacturers providing similar services.

  • Challenges: The accuracy of this method depends on the availability of comparable financial data, making benchmarking a critical aspect.


5. Profit Split Method (PSM)


The PSM is used when two or more related entities contribute significantly to value creation. Profits are allocated based on each party’s contribution.

  • Application in Toll Manufacturing: This method is applicable when both the toll manufacturer and principal company play integral roles in production and value addition.

  • Challenges: Properly attributing profits can be subjective and requires in-depth functional and economic analysis.


Compliance with UAE Transfer Pricing Regulations


The UAE has introduced transfer pricing documentation requirements under its corporate tax framework, aligning with OECD guidelines. Businesses engaged in toll manufacturing must:

  • Maintain transfer pricing documentation, including Local File and Master File.

  • Conduct benchmarking studies to justify transfer pricing policies.

  • Disclose related-party transactions in tax filings.

  • Ensure transactions reflect an arm’s length principle to prevent tax disputes.


Failure to comply can lead to penalties, increased tax liabilities, and scrutiny from the UAE Federal Tax Authority (FTA). Companies should seek tax advisory services to navigate compliance complexities effectively.

Tax Implications for Toll Manufacturers in the UAE


With the introduction of a 9% corporate tax in the UAE, proper transfer pricing for toll manufacturing is more critical than ever. The tax implications include:

  • Reduced Risk of Tax Audits: Complying with transfer pricing rules minimizes the risk of audits and disputes.

  • Optimized Tax Liability: Proper structuring of intercompany transactions ensures that businesses do not overpay or underpay taxes.

  • Avoidance of Double Taxation: Accurate pricing prevents double taxation issues between the UAE and other jurisdictions.


Businesses should engage professional tax advisory services to ensure compliance with corporate tax regulations and avoid financial risks.

Best Practices for Transfer Pricing in Toll Manufacturing


To achieve compliance and operational efficiency, businesses should follow these best practices:

  1. Conduct Functional Analysis: Identify risks, functions, and assets involved in toll manufacturing transactions.

  2. Use Appropriate Benchmarking Studies: Ensure pricing decisions are supported by relevant industry benchmarks.

  3. Maintain Comprehensive Documentation: Keep detailed records of intercompany transactions and pricing methods.

  4. Regularly Review Pricing Policies: Update transfer pricing policies to reflect market changes and regulatory updates.

  5. Seek Professional Guidance: Consulting with transfer pricing experts ensures compliance and minimizes risks.


FAQs on Transfer Pricing for Toll Manufacturing in the UAE


1. What is transfer pricing, and why is it important for toll manufacturing?


Transfer pricing refers to the pricing of transactions between related entities. In toll manufacturing, it ensures that the manufacturer is fairly compensated, preventing tax avoidance and compliance issues.

2. Which transfer pricing method is best for toll manufacturing?


The Cost Plus Method (CPM) and Transactional Net Margin Method (TNMM) are commonly used, as they consider the cost structure and profitability of the toll manufacturer.

3. What are the consequences of non-compliance with UAE transfer pricing rules?


Non-compliance can result in tax audits, penalties, and reputational risks. Businesses may also face adjustments to taxable income, leading to higher tax liabilities.

4. How can a company determine an appropriate markup for toll manufacturing?


A benchmarking study comparing similar independent manufacturers helps determine an arm’s length markup. Professional tax advisory services can assist in this process.

5. Does UAE corporate tax apply to toll manufacturing companies?


Yes, toll manufacturers operating in the UAE are subject to the 9% corporate tax if their taxable income exceeds the threshold set by the UAE tax authorities.

6. How can businesses ensure compliance with UAE transfer pricing regulations?


Businesses should maintain proper documentation, conduct regular benchmarking studies, and seek expert guidance to ensure compliance with UAE tax laws.

With the introduction of corporate tax in the UAE, compliance with transfer pricing regulations is essential for toll manufacturing companies. Selecting the appropriate transfer pricing method ensures fair compensation, reduces tax risks, and aligns with international tax standards. By implementing best practices and seeking professional tax advisory services, businesses can optimize their operations while maintaining regulatory compliance in the UAE.

 

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