What Is Transfer Pricing?The Board of Directors of the Zakat, Tax and Customs Authority (ZATCA) approved amendments to the Transfer Pricing Bylaws to extend all obligations under the Transfer Pricing Bylaws to taxpayers subject to the Zakat Collection Regulations, thereby aligning the treatment of taxpayers subject to the Income Tax Law with Zakat payers.
What Is Meant by Transfer Pricing?Transfer pricing is a concept relating to the pricing of commercial transactions carried out between related persons or persons under common control for the purpose of determining the tax base. It requires that the pricing of goods or services exchanged between companies within the same group, or between related persons, be determined at a fair price, referred to as the “Arm’s Length Price,” as if the transaction had taken place between independent parties.
The concept of transfer pricing emerged as a result of globalization and the growth of multinational enterprises. Such groups generally seek to maximize the profitability of the group as a whole, regardless of the profitability of each individual entity. Consequently, tax authorities became increasingly concerned with practices under which multinational groups may price transactions between their entities on a non-arm’s length basis in order to reduce profits in an entity located in a jurisdiction with a higher tax rate and, conversely, shift those profits to an entity located in a jurisdiction with a lower tax rate.
Transfer pricing is therefore not merely concerned with allocating profits between related persons or companies, but also with the allocation of profits between different countries. The pricing of related-party transactions directly affects the amount of profit reported in a particular jurisdiction and, consequently, the amount of tax revenue collected by that jurisdiction.
Related persons are defined under the Transfer Pricing Bylaws based on the nature of the person, whether an individual or a legal person. The definition includes various forms of relationship, such as kinship, partnership, control, effective control, and other forms of association, as outlined below:
A. An individual is considered related to another individual where they are: - A spouse, relative by marriage, or relative up to the fourth degree. - Partners in a partnership.
B. An individual is considered related to a legal person in any of the following cases: - Where the individual is a partner or shareholder in a partnership or company and, either individually or together with one or more related persons, controls 50% of its rights. - In relation to entities managing endowed funds for specific purposes, where the individual benefits or may benefit from such entity, either individually or together with one or more persons related to them in accordance with this Article. - Where the individual, either individually or together with a related person, participates directly or indirectly in the management, control, or capital of a legal person.
C. Two or more legal persons are considered related in any of the following cases:
- Where they are subject to common management. - Where the person controlling, or having control over, the business decisions of one legal person has, either individually or together with a related person, effective control over another legal person. - Where the person directing, or having the ability to direct, the business decisions of one legal person is related to the person having effective control over another legal person. - Where the same group of persons has effective control over each of the legal persons.
What Are the Transfer Pricing Requirements?Following the expansion of the scope of the Transfer Pricing Bylaws to include Zakat payers, it has become increasingly important for entities that have transactions with related parties to understand the applicable compliance requirements.
Transfer pricing requirements are not limited to ensuring that related-party transactions are conducted in accordance with the Arm’s Length Principle. They also include a number of disclosure and documentation requirements, which vary depending on the value of the transactions, the nature of the entity, and the group to which it belongs.
The main requirements include the following:
1. Transfer Pricing Disclosure Form
The key information required to be disclosed in relation to transactions with related persons includes:- Names of related persons and their countries of incorporation and residence.
- Information regarding the nature of the relationship with related persons.
- A description of the business or commercial activities carried out by the related persons and the transactions entered into between them.
- Details of the transactions, including the total consideration, the nature of revenue and income, and the nature of payments and expenses.
- Details of any transaction entered into between related persons, including transactions undertaken without consideration or for non-cash consideration.
- Information regarding any business restructuring undertaken by the multinational enterprise group or the taxpayer.
- Information regarding the ultimate owner and beneficial owner, where applicable, of the related persons, including their names, country of incorporation and residence, and ownership percentage.
- The transfer pricing method applied to the transactions.
- Disclosure regarding the applicability of Country-by-Country Reporting requirements.
2. Local File
The Local File is a detailed document focusing on the entity operating in Saudi Arabia and the transactions entered into between that entity and its related parties.It typically includes a description of the entity’s business activities and organizational structure, details of related-party transactions, a functional analysis of the relevant parties, related agreements, the transfer pricing method selected, and the economic analysis required to demonstrate that the transactions were conducted in accordance with the Arm’s Length Principle.
For Zakat payers, the Local File requirements are applied in phases:
During Phase One, where the total value of transactions with related parties is SAR 48 million or less, the taxpayer is not required to prepare the Local File or Master File. Where the value of related-party transactions exceeds SAR 48 million but is less than SAR 100 million, preparation of the Local File and Master File is optional. Where the value of related-party transactions is SAR 100 million or more, preparation of both files becomes mandatory.
During Phase Three, where the total value of related-party transactions is SAR 48 million or less, preparation of the Local File and Master File is not mandatory. Where the total value of related-party transactions exceeds SAR 48 million, preparation of both the Local File and Master File becomes mandatory.
Phase One applies to financial years beginning on or after 1 January 2024, while Phase Two begins after three years from the implementation of Phase One.
3. Master File
Unlike the Local File, which focuses on the entity operating in Saudi Arabia, the Master File provides a comprehensive overview of the group to which the entity belongs.It generally includes the group’s organizational structure, the nature of its businesses and activities, the transfer pricing policies applied between group companies, information regarding intangible assets, financing arrangements between related parties, as well as relevant financial and tax information.
For Zakat payers, the same financial thresholds and implementation phases applicable to the Local File also apply to the Master File.
The Local File and Master File are not required to be submitted routinely with the Zakat return. Instead, the taxpayer is required to prepare and retain the relevant documentation and provide it to ZATCA upon request. The deadline specified by ZATCA for submission must be no less than 30 days from the date of the request.
4. Country-by-Country Report – CbCR
The Country-by-Country Report primarily applies to large multinational enterprise groups and is intended to provide tax authorities with an overall view of the allocation of the group’s activities, revenues, profits, and resources across the different jurisdictions in which it operates.The report includes information such as revenues, profits or losses, taxes or Zakat paid and accrued, stated capital, accumulated earnings, number of employees, tangible assets, as well as details of the group entities and the activities they perform in each jurisdiction.
This requirement applies to multinational enterprise groups whose consolidated revenues exceed SAR 3.2 billion, based on the consolidated financial statements for the preceding financial year.
Where the entity in Saudi Arabia is responsible for filing the report, the CbCR must be submitted within 12 months from the end of the group’s financial year. Additional notification requirements also apply in relation to identifying the entity responsible for filing the report and the jurisdiction in which the report will be submitted.
Does the Exemption from Preparing a Local File or Master File Mean That Transfer Pricing Does Not Apply?No. This is one of the most important points that businesses should understand. An entity may not be required to prepare a Local File or Master File because the value of its related-party transactions does not exceed the relevant thresholds. However, this does not mean that its transactions fall outside the scope of the Transfer Pricing Bylaws. The entity must still ensure that its transactions with related parties are conducted in accordance with the Arm’s Length Principle and comply with the applicable disclosure requirements. Accordingly, the first step for any entity that has transactions with related parties is to identify the nature and value of those transactions and then determine the transfer pricing requirements applicable to it.