Arms Length Pricing for Multinationals: OECD Guidelines & Best Practices

What is Arms Length Pricing?

Arms length pricing is a important concept for multinational groups. But what does it actually mean?
In simple terms, arms length refers to dealing with someone as if they were a stranger. When two companies are part of the same larger business group but operate in different countries, tax rules say they must treat each other like strangers when trading goods/services across borders.
The reason is to prevent profit shifting. A group could try to avoid tax by having one member overcharge another for items. Or undercharge to make it look like less profit was earned.
To ensure fair treatment, international laws require prices for cross-border deals within a group to mimic what “unrelated” companies would have agreed. This fair price is called the arms length price.

When Do These Rules Apply?

Anytime businesses within a common ownership structure conduct international transactions, arms length pricing governance kicks in.
This includes routine imports/exports like a US factory shipping parts to its Mexican assembly plant. Or more complex deals like a UK firm licensing patented tech to affiliates in Asia.
Even services need attention. For example, how much a Swiss finance firm charges subsidiaries worldwide for accounting/payroll support.
As long as there is a connection between the entities and a cross-border exchange occurs, arms length valuation is mandated.

Why Follow This Approach?

The overall aim of transfer pricing regulation is to establish a fair allocation of profits between tax jurisdictions. By obligating market-based rates, multiple benefits arise:

• Tax authorities avoid losing income through improperly set transfer charges.
• It prevents potential double-taxation of profits caught in disputes over adjusted valuations.
• Companies face less controversy and can operate with surety their arrangements will hold up under scrutiny.
• Economic distortions are minimized as incentives/disincentives for internal dealing stem from commercial rather than tax-motivated dynamics.

So in the long run, arms length adherence promotes efficient trade and reduces taxation-related conflicts between businesses and governments.

Finding The Right Price

The OECD provides documentation standards and internationally accepted methods to determine the elusive arms length value:

• Comparable Uncontrolled Price Method: Directly comparing prices for similar goods/services traded between unrelated parties.
• Resale Price Method: Calculating suitable margins based on the resale price of purchased goods.
• Cost Plus Method: Adding a routine profit markup to the direct/indirect costs incurred.
• Profit Split Method: Apportioning combined operating profits based on contributions of each related party.

Documents mapping out transfer pricing policies, economic analyses, and benchmarking data must substantiate conclusions on file for audits.

Record Keeping and Reviews

Given tax authorities’ audit adjustment powers years post-filing, meticulous record keeping is pivotal. Contemporaneous documentation establishing how transfer prices were set/supported is crucial to justifying positions to wary examiners.
Methodologies also need re-evaluating as business/market dynamics shift. Most countries require a rebase at minimum every three years to prove prices weren’t arbitrary but based on up-to-date studies and data reviews. Outdated reports invite objection.

Conclusion

Adhering to the arm’s length principle is crucial for multinational businesses to enjoy certainty in their cross-border operations and tax compliance. By demonstrating that prices for internal transactions are fair as if between completely separate entities, companies can minimize controversy with tax authorities.

While determining accurate comparable market rates can present challenges, taking a thorough approach following OECD guidelines helps present a robust defense. Documentation of transfer pricing policies, benchmarking analyses and annual review ensure arrangements remain justified as circumstances evolve over time.

Seeking expert advisory assistance enables groups to fully comprehend compliance obligations across multiple tax jurisdictions. With proactive risk management measures like careful record-keeping and periodic policy reassessment, the arms length standard provides an internationally accepted framework for ensuring fair allocation of profits.

Overall, making good faith efforts to mimic independent party behavior helps assure tax administrations profits are not being arbitrarily siphoned. When transfer pricing arrangements can withstand scrutiny, multinational businesses gain planning certainty and avoid unnecessary tax disputes down the road.

Frequently Asked Questions