Chief Financial Officer: Always Connected Person or Not?

Key Provisions and Legal Context

Article 36(1) of the Corporate Tax Law could be availed for a solution. It refers to Article 34 to ‘determine that a payment or benefit provided by the Taxable Person corresponds with the Market Value of the service or otherwise provided by the Connected Person’, which ‘shall apply as the context requires’. Clause 2 of Article 34 states that ‘a transaction or arrangement between Related Parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realised if Persons who were not Related Parties had engaged in a similar transaction or arrangement under similar circumstances’.  Therefore, a transaction that could be used to compare the controlled transaction with the arm’s length principle should not itself be treated as a controlled transaction (i.e., a transaction with a Related or Connected Person). The key distinction between comparable transactions and controlled transactions lies in the potential to influence the counterparty. If no such potential exists in the transaction, it should be considered a comparable transaction rather than a controlled one.

Indeed, the FTA describes “Transfer Pricing” as ‘a tax concept, … which … refers to the pricing of transactions or arrangements between Related Parties or Connected Persons that are influenced by the relationship between the transacting parties’. The FTA further explains that ‘when independent parties transact with each other, the conditions of their commercial and financial relations (for example, the price of goods transferred, or services provided and the conditions of the transfer or provision) ordinarily are determined by market forces and negotiations. On the other hand, Related Parties or Connected Persons may not be subject to the same external market forces in their dealings and may be influenced by the relationship between the parties involved. As a result, Related Parties or Connected Persons can use non-arm’s length pricing in their Controlled Transactions in order to alter the profits reported in the relevant jurisdiction or entity and thus optimise the resulting tax liabilities’. Therefore, the arm’s length principle must apply where the controlled relationship could influence the terms of the transaction.

This aligns with paragraph 3.26 of the OECD Transfer Pricing Guidelines, which suggests that the potential of a party to influence the terms of a transaction is a key factor in distinguishing a comparable uncontrolled transaction from a controlled one: ‘The presence of minority shareholders may be one factor leading to the outcomes of a taxpayer’s controlled transactions being closer to arm’s length, but it is not determinative in and of itself. The influence of minority shareholders depends on a number of factors, including whether the minority shareholder has a participation in the capital of the parent company or in the capital of a subsidiary, and whether it has and actually exercises some influence on the pricing of intra-group transactions’.

Analysis of CFO’s Role in Determining Compensation

Can a CFO influence their own salary and benefits? This depends on how the authorization rules are established. It looks like a CFO is not in a position to influence their compensation in the following cases:

• The CEO has the authority to define the CFO’s compensation unilaterally.
• The CEO determines the salary but must obtain approval from the shareholder(s), board of directors, a committee, or another independent party, provided neither the CFO nor individuals influenced by the CFO are involved in the decision-making process.
• The board of directors, committee, or another governing body is authorized to decide the CFO’s salary, but the CFO does not have voting rights or authority in such meetings.

Defining Affiliates and Related Parties

This logic can be evaluated against the original definition of Connected Persons, as outlined in Article 1 of the Corporate Tax Law. The article defines Connected Persons as ‘Any Person affiliated with a Taxable Person as determined in Clause 2 of Article 36 of this Decree-Law’. This suggests that the Relevant Connection Test should include the following steps:

• Affiliation sub-test to determine whether a Person is affiliated with the Taxable Person, and
• Role evaluation, i.e. for those who pass the affiliation sub-test, further assessment should be conducted under Article 36(2) to determine whether these Persons are directors, officers, or not.

However, the tax regulations do not provide a clear definition of "affiliates." Non-tax definitions of the term vary, creating some ambiguity in interpretation.

Article 1 of the CBUAE Corporate Governance Regulation provides relevant definitions for terms “Affiliate”, “Related Parties”, “Senior Management”, and “Stuff”:

“Affiliate” is ‘an entity owned by another entity by more than 25% and less than 50% of its capital’.

• “Related Parties” are ‘the Group and its Controlling Shareholder’s Members of the Board and Senior Management (and their First-Degree Relatives) and persons with control, joint control or significant influence over the Bank (and their First-Degree Relatives)’.
• “Senior Management” comprises ‘the executive management of the Bank responsible and accountable to the Board for the sound and prudent day-to-day management of the Bank, generally including, but not limited to, the Chief Executive Officer, chief financial officer, chief risk officer, and heads of the compliance and internal audit functions’.

On the one hand, this regulation distinguishes between affiliates and related parties, explicitly excluding a CFO from the definition of  “affiliates”. On the other hand, it includes the CFO within the scope of “Related Parties”. However, since the Corporate Tax Law provides its own definition of “Related Parties”, the general definition from the regulation may be disregarded for corporate taxation purposes. On balance, the CFO does not qualify as an “affiliate”, which suggests that the first sub-test of the Relevant Connection Test is not met.

ADGM Takeover Regulations Rules 2015 (Takeover Code) define an “affiliated person” as ‘any undertaking in respect of which any person:

• has a majority of the shareholders’ or members’ voting rights;
• is a shareholder or member and at the same time has the right to appoint or remove a majority of the members of its board of directors;
• is a shareholder or member and alone controls a majority of the shareholders’ or members’ voting rights pursuant to an agreement entered into with other shareholders or members; or
• has the power to exercise, or actually exercises, dominant influence or control. For these purposes, a person’s rights as regards voting, appointment or removal shall include the rights of any other affiliated person and those of any person or entity acting in his own name but on behalf of that person or of any other affiliated person’.

DMCCA defines its affiliates as ‘any entity that directly or indirectly controls, is controlled by, or is under common control with DMCCA’.

Despite the variety of definitions, they all emphasize the ability to exert influence or control over relevant operations. Therefore, in our view, a CFO whose role does not involve such influence should not be treated as an “Person affiliated with the Taxable Person”.

IFRS Guidance

IFRS does not single out affiliates in its definition of Related Parties. Instead, the definition encompasses a broader range of relationships. Key management personnel are explicitly included in the definition of Related Parties. Paragraph 9 of IAS 24 “Related Party Disclosures” defines “Key management personnel” as those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity’. Generally, the CFO would fall within this definition, as the standard links authority to the overall activity of the reporting entity rather than to specific transactions or arrangements defining the amount of compensation.

Paragraph 17 obliges a reporting entity to ‘disclose key management personnel compensation in total and for each of the following categories: (a) short-term employee benefits; (b) post-employment benefits; (c) other long-term benefits; (d) termination benefits; and (e) share-based payment’. Furthermore, Paragraph 18 requires the reporting entity to ‘disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements…’.

This standard mandates the disclosure of all relevant transactions, regardless of whether key management personnel have the potential to influence the reporting entity's independent determination of the terms of these transactions. This could seem unfavorable to the interpretation that an officer of an entity should only be considered affiliated and Connected in cases where one party can influence the independent decision-making of another regarding a particular compensation or benefit.

However, it could be advantageous for the company to include additional disclosures in its financial statements, specifying the “potential effect of the relationship”. For instance, the company could disclose that the officer had no authority to influence the terms of their compensation due to the company's established authorization procedures for determining or approving such transactions. Providing such context can help users better understand the safeguards in place and reduce potential concerns about conflicts of interest. On the other hand, it provides additional evidence to the company to substantiate that:

• transactions paid fell outside the scope of the relationship between dependent parties,
• these transactions should be rather considered as comparable transactions between independent persons rather than controlled transactions between Connected Persons.

Recommendations and Risk Mitigation

The absence of clear definitions of affiliates or Related Parties under the Corporate Tax Law requires reliance on practical considerations and industry practices. Publicly available internal policies and guidance from companies and institutions often provide their own definitions of “affiliate” in the context of internal rules governing transactions with affiliated persons. Such policies could serve as valuable support in a potential dispute over whether a CFO or another officer qualifies as an affiliate of the company. Accordingly, it would be prudent to consider introducing similar guidance as part of corporate management practices to strengthen a company’s position on this matter.

As previously mentioned, disclosing the safeguarding policies that protect against officers' influence on transactions and arrangements with the reporting entity can provide additional support for excluding such transactions from the scope of controlled transactions.

As with all scenarios where there is no clear-cut guidance in the law, regulations, public clarifications, or authorized guides, there is a risk of disagreement with the FTA. Therefore, it is advisable to seek verification of the above position through a private clarification with the FTA. When doing so, the taxpayer must present a favorable tax position, propose alternatives (where applicable), and provide a detailed analysis of these positions. A relevant tax opinion should also be submitted. The arguments outlined above can support a favorable interpretation, but additional arguments tailored to the specific facts of each case should be thoroughly developed and included in the technical position.

Conclusion

While the literal interpretation of Article 36(2)(b) of the Corporate Tax Law suggests that CFOs qualify as Connected Persons, this designation should not automatically apply in scenarios where the CFO lacks influence over their compensation or other financial transactions. A nuanced approach that considers the specific authorization structures and governance rules is essential. Taxpayers are encouraged to proactively seek clarifications and implement robust internal policies to mitigate risks and ensure compliance.

The disclaimer

Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.

The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.

You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the author’s opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.