The main object of international taxation is how to manage cross boarder taxation of a commercial transaction or taxable income which involves more than one country. A system is created mutually by different countries to share the international tax base by assigning tax jurisdiction, preventing tax avoidance, facilitating international trade and finance, and avoiding the burden of double taxation.
To fight against tax evasion, end bank secrecy, and tax havens, and address tax avoidance by multinational corporations a group of 19 countries and European Union (G20) came together to achieve the above goals on an ongoing basis.
The purpose of OECD Transfer Pricing Guidelines
OECD Transfer Pricing Guidelines[1] may be regarded as the “holy book” for transfer pricing. The first draft of the guidelines[2] was published on 27 June 1995, and it was a revision of the OECD Report from 1979[3]. The guidelines have been modernized routinely and the current version is from 2017[4].
The purpose of the guidelines is mainly to give guidance on the applicability of the arm’s length principle. Another fundamental purpose is to achieve two goals. Firstly, the legal authorities in their jurisdiction should make sure that the Multinational Enterprises do not artificially shift the taxable profits out of their juridical influence, and that the mentioned tax base (by the Multinational Enterprises) accurately reflects the economic activity undertaken in the said country.
Secondly, it is to reduce the risk of economic double taxation arising from disputes between two countries regarding the amount of compensation based on the arm’s length principle for their cross-border transactions with associated enterprises.
Arm’s Length Principle
The legal authority for the Arm’s Length principle is stated in Para 1 of Article 9[5] of the OECD Model Tax Convention as “where conditions […] taxed accordingly”[6]. It arranges the basis of mutual treaties between countries that are members of the OECD and expanding countries outside the OECD member group. Entities that are connected through management, control, or capital in a controlled transaction need to have similar terms and conditions to an agreement between non-connected entities in an uncontrolled transaction.
Comparability Analysis
The analysis of comparing the controlled transaction with the uncontrolled transaction is known as comparability analysis.[7] It is essential to make a comparison to identify the appropriate profit which should have accumulated at arm’s length and determine the amount of any revision of accounts.
It includes functional analysis[8] which locates the meaningful economic activities and any other form of liabilities, assets handled or provided, and risks undertaken by the parties to the transactions.
Hritik Raina
Bachelor’s in law at the University of Birmingham & Master’s in International Tax Law at the King’s College London
[1] OECD Transfer Pricing Guidelines 2017
[2] OECD Transfer Pricing Guidelines 1995
[3] OECD Transfer Pricing Guidelines 1979
[4] OECD Transfer Pricing Guidelines 2017
[5] OECD Model Tax Convention Article 9
[6] ibid
[7] OECD Transfer Pricing Guidelines 2017
[8] ibid
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