Question

Is arm's length principle enough to prevent tax avoidance through transfer pricing? (please explain thoroughly, inluding your own opinion, examples..etc)

Answer 1

Transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a parent company, the cost of those goods paid by the parent to the subsidiary is the transfer price. Legal entities considered under the control of a single corporation include branches and companies that are wholly or majority owned ultimately by the parent corporation. Certain jurisdictions consider entities to be under common control if they share family members on their boards of directors. Transfer pricing can be used as a profit allocation method to attribute a multinational corporation's net profit (or loss) before tax to countries where it does business. Transfer pricing results in the setting of prices among divisions within an enterprise.

In Arm’s length pricing the buyers and sellers of a product act independently and have no relationship to each other. The concept of an arm’s length transaction is to ensure that both parties in the deal are acting in their own self interest and are not subject to any pressure or duress from the other party.

In short, Arm’s Length Price is the price applied (or proposed to be applied) when two unrelated persons enter into a transaction in uncontrolled conditions, the persons said to be unrelated if they are not associated or deemed to be associated enterprise.

Arm’s Length Price can be computed by the following methods;

1. Comparable Uncontrolled Price Method;
2. Resale Price Method;
3. Cost Plus Method;
4. Profit Split Method;
5. Transaction Net Margin Method;

So we can say that, Transfer pricing multi-nationally has tax advantages, but regulatory authorities frown upon using transfer pricing for tax avoidance. When transfer pricing occurs, companies can book profits of goods and services in a different country that may have a lower tax rate. In some cases, the transfer of goods and services from one country to another within an interrelated company transaction can allow a company to avoid tariffs on goods and services exchanged internationally. The international tax laws are regulated by the Organization for Economic Cooperation and Development (OECD), and auditing firms within each international location audit financial statements accordingly.