Transfer Pricing and Value Creation

1. S. 94The tree pillars of the arm‘s length principle

Already in 1933, the League of Nations introduced the arm’s length principle as the most appropriate way to allocate the profit of an MNE to different states.

The arm’s length principle is based on the following three pillars:

• the separate entity approach;

• the relevance of contractual arrangements; and

• the comparability of transactions.

Nowadays, the arm’s length principle has been stipulated in Art 9 OECD MTC and Art 9 UN MTC and is further explained in the 2017 OECD TPG and the 2017 UN Manual, respectively.

From its beginning in 1933 until the publication of the 2017 OECD TPG and the 2017 UN Manual, the arm’s length principle evolved from a legal fiction into a principle reflecting economic reality. This can be seen when analyzing the changes of the three pillars.

Although the separate entity approach has been slightly adapted by introducing the concept of implicit support and group synergies, this pillar still seems to be rock solid.

The relevance of the contractual arrangement has been restricted, in particular, by the functional analysis that allows tax authorities to deviate from the contractual arrangements if the conduct of the parti...