To avoid double taxation, reduce conflict between tax authorities, and promote international trade and investment, the Organization for Economic...
To avoid double taxation, reduce conflict between tax authorities, and promote...
To avoid double taxation, reduce conflict between tax authorities, and promote international trade and investment, the Organization for Economic Co-operation and Development (“OECD”) member countries adopted the arm’s-length principle, which provides that individual group members should be taxed on the basis that they act at arm’s length in their dealings with each other.
In applying the arm’s-length principle, the difficulty lies in determining an arm’s-length price. The OECD "Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations" (“OECD Guidelines”) contain guidance for establishing an arm’s-length price.
The OECD Guidelines deal with or govern the resolution of transfer pricing disputes between the tax authorities of OECD member countries. OECD member countries draft their legislation to incorporate the guidelines, and they are encouraged to follow them in their domestic transfer pricing law and practice.
The OECD guidelines provide for a comparison of the conditions in a controlled transaction (a transaction between related parties) with the conditions in an uncontrolled transaction (a transaction between unrelated parties). For such comparison to be useful, the economically relevant characteristics of the transactions being compared must be sufficiently similar.
In dealings between two unrelated parties, compensation will usually reflect the functions that each performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, a comparison of the functions performed and the risks assumed by each party is necessary.
The guidelines set out a number of methods that can be used to determine whether the conditions imposed in the commercial or financial relations between related parties are consistent with the arm’s-length principle:
1. Traditional Transaction Methods
2. Transactional Profit Methods
The OECD Guidelines are not a frozen concept and are constantly reviewed to better adapt to the evolution of the economic reality faced by multinational enterprises and tax authorities. Recent work performed by the OECD in this respect can be found here.
Table of Content of the OECD Guidelines (July 2010 version):