Dealing with Arm's Length and Comparability in the Years 2000
1 December 2003
By Pim Fris
Transfer pricing has grown to be the most important issue on the tax agenda of multinational enterprises. However, transfer pricing is inherently complicated because it makes active use of concepts from different disciplines, namely economics, management and law. Its implementation is labor-intensive because multiple parties (both inside and outside companies) are involved, each with conflicting interests, differing views and thus diverging approaches. NERA Special Consultant Pim Fris notes in this article that it is reassuring to know that there is at least one starting point that all parties involved in judging the tax effects of transfer pricing agree on: the principle of dealing at arm's length. Finding transfer-pricing solutions acceptable for tax purposes, all over the world, is therefore dependent upon developing realistic, workable and equitable applications of the arm's length principle.
While the U.S. has developed its own standard for transfer pricing, the comparable profits method, Mr. Fris is not convinced that following the U.S. lead is in the best interests of Europe. With a far more complex tax environment than the U.S.--25 distinct countries/tax jurisdictions compared to just one--Mr. Fris asks for a different, more refined approach. Present practices seem to be uncapable of doing justice to the arm's length principle, which requires to compare how parties deal in their commercial and financial relations.
Mr. Fris argues that more attention is needed to the economics and business issues faced by multinational enterprises, and that any standard adopted should be based upon this framework. In the article he elaborates on the economic backgrounds of multinational enterprises and of markets, in order to define how "arm's length" can be approached in the practice of both establishing and testing the tax consequences of transfer pricing. As a conclusion he develops a new application of the arm's length principle, using game theory to identify how parties behave in the market in the absence of common control. It is noteworthy that this approach reveals the phenomenon of cooperative behaviour of non-related parties in the market. In his view, this is the relevant reference for understanding how related parties shape their relationship--in a sense much wider than at individual transaction level.
This abstract is republished with permission from the International Transfer Pricing Journal, Volume 10, Number 6, December 2003, Copyright (c) 2003 International Bureau of Fiscal Documentation. All rights reserved.
