Transfer Pricing: International Practice and Guidelines

The Arm’s Length Principle: The Standard in Transfer Pricing

The arm’s length principle is the international standard on which OECD member countries have agreed to be used for determining transfer prices. The transfer pricing regulations and rules try to determine the price that the related parties would have agreed to if they had dealt with each other at arm’s length as unrelated parties.

According to Article 9 of the OECD Model Tax Convention, the arm’s length principle is defined as follows: where ‘conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly’.

The OECD has stated that the arm’s length principle provides broad parity of tax treatment for members of MNE groups and independent enterprises because it puts associated and independent enterprises on a more equal footing for tax purposes by treating the members of an MNE group as operating as separate entities rather than as inseparable parts of a single unified business. Attention is focused on the nature of the transactions between those members and on whether the conditions thereof differ from the conditions that would be obtained in comparable uncontrolled transactions. Such an analysis of the controlled and uncontrolled transactions, which is referred to as a ‘comparability analysis’, is at the heart of the application of the arm’s length principle.

What guidelines does the OECD offer regarding transfer pricing?

The Organisation for Economic Co-operation and Development (OECD) first published its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in 1995. Reflecting an ongoing focus on international tax challenges including transfer pricing issues. The OECD has since continuously revised and supplemented the guidelines.

The guidelines include a preface, a glossary and 10 topical chapters, which have been supplemented with a number of annexes. The most recent edition of the guidelines, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, was published in January 2022, following a substantial revision and expansion as part of the Base Erosion and Profit Shifting (BEPS) initiative. This latest version consolidates changes since the 2017 edition of the guidelines, including guidance on the Transactional Profit Split Method, hard-to-value intangibles, and financial transactions.

The OECD employs the arm’s length principle because it ‘provides broad parity of tax treatment for members of [multinational enterprise] groups and independent enterprises’, avoiding the creation of ‘tax advantages or disadvantages that would otherwise distort the relative competitive positions of either type of entity’. The guidelines state that the arm’s length principle ‘has also been found to work effectively in the vast majority of cases’.

Aside from updating its official transfer pricing guidelines, the OECD continues to carry out significant work related to transfer pricing issues, including recent guidance on the transfer pricing implications of the COVID-19 pandemic.

Subscribers Only: Portfolio 6936-2nd: Transfer Pricing – OECD Transfer Pricing Guidelines

This portfolio describes and interprets the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as in effect on June 21, 2018.