Intercompany loans in the UAE: arm's length interest

The short answer

A loan between related companies must carry the interest that independent parties would agree in the same circumstances. That is the arm's length standard in Article 34 of the Corporate Tax Law. If the rate is too low, including zero, the FTA can increase the lender's taxable income. If it is too high, it can cut the borrower's deduction. When one UAE company is adjusted, Article 34(10) requires a matching adjustment for the UAE company on the other side.

Between two mainland companies both taxed at 9%, those two adjustments largely cancel out. The money is at stake when the rates differ: a lender taxed at 9% lending interest-free to a free zone company taxed at 0%, a borrower with losses or Small Business Relief, or a foreign party on one side.

First, is it really a loan?

The FTA's Transfer Pricing Guide follows the OECD's approach to financial transactions. Before pricing a balance, establish what it is. A long-standing shareholder balance with no repayment date, no interest and no expectation of repayment may in substance be equity, and an equity contribution carries no interest. A balance that is repaid, has a term and behaves like debt should be priced as debt. Short, two-way balances in a treasury cash pool are priced as deposits and overdrafts, not as term loans.

Setting an arm's length rate

• Start from the borrower's credit standing: its own financial position, adjusted for any implicit support it gets from belonging to the group.
• Match the terms: currency, amount, tenor, fixed or floating, security, subordination and repayment profile.
• Benchmark: comparable loans between independent parties, bank quotes, or a base rate such as EIBOR or SOFR plus a credit spread justified by the credit analysis.
• Write it down before the money moves: a signed loan agreement with the rate, term and repayment schedule, and a short note on how the rate was set.
• Revisit it when the facts change, such as a refinancing, a large draw or a change in the borrower's position.

Guarantees and cash pools

When a UAE parent guarantees a subsidiary's bank loan, the subsidiary usually pays a lower rate than it could get alone. An arm's length guarantee fee is normally limited to the benefit the guarantee gives, not the whole interest saving that comes from simply being part of a group. In a cash pool, the pool leader that runs the pool is paid for its routine function, and each participant should earn or pay an arm's length rate on its deposits and borrowings. Where a pool balance becomes long-term, price it as a loan.

The interest rules that sit on top

• Article 31 denies the deduction for interest on a loan from a related party that funds a dividend or profit distribution to a related party, a share capital redemption or reduction, a capital contribution to a related party, or the purchase of shares in a company that is or becomes a related party. It does not apply where you can show the main purpose was not a Corporate Tax advantage, and no advantage is deemed to arise where the lender is taxed at 9% or more on the interest.
• Article 30 then caps net interest at the greater of 30% of adjusted EBITDA and AED 12 million (see the interest cap). Only arm's length interest counts toward the cap.
• Large groups also report loans in the related-party disclosure and, above the thresholds, in the local and master files. Under Article 55 the FTA can ask for them, or for any information supporting arm's length pricing, with 30 days to respond (see transfer pricing documentation).

Worked example

A mainland parent taxed at 9% lends AED 50,000,000 interest-free to its free zone subsidiary, which earns qualifying income at 0%, for the whole year. Suppose the credit analysis supports EIBOR of 4.2% plus a 2.0% spread, so 6.2%. Arm's length interest: 50,000,000 × 6.2% = AED 3,100,000. The parent's taxable income rises by AED 3,100,000, which is AED 279,000 of tax at 9%. The subsidiary gets a matching deduction under Article 34(10), but at 0% it saves nothing. The group's net cost is AED 279,000 a year.

The reverse case: a UAE subsidiary taxed at 9% borrows AED 20,000,000 from its foreign parent at 12%, when 7% is arm's length. It pays 20,000,000 × 12% = AED 2,400,000 against an arm's length AED 1,400,000. The excess AED 1,000,000 is not deductible, which costs AED 90,000 of tax at 9%. The intercompany loan calculator runs both cases with your figures.

How Hysaab applies this

Hysaab tags related-party flows as they post and keeps the agreement attached to each intercompany balance, so a loan that has drifted into an undocumented, interest-free balance is visible during the year, while it can still be fixed with a signed agreement and an interest charge, rather than at the audit.

Questions people actually ask

Keep reading

• Tool: Intercompany loan interest calculator (UAE TP)
• Guide: Transfer pricing documentation in the UAE: who files what, and when
• Guide: The 30% EBITDA interest cap in UAE Corporate Tax: how much of your finance cost actually deducts
• Guide: Intercompany management fees between UAE group entities: pricing, paper and VAT
• Guide: Free zone 0% Corporate Tax: what a Qualifying Free Zone Person actually is