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Are Days Numbered for the Arm’s Length Principle?

15th March 2022

As transfer pricing economists, we’re all slaves to the arm’s length principle (ALP). Any goods bought or sold between related parties must resemble pricing that would exist between unrelated parties. And as tax professionals, we jump through a lot of hoops—and construct a lot of analyses—to prove arm’slength pricing, which can be subjective, unreliable, and depending on the transaction, complicated. So, it should come as no surprise that not every tax expert is a fan of the ALP. In fact, this month, the European Network on Debt and Development (Eurodad) and the Global Alliance for Tax Justice (GATJ) published a civil society proposal for a United Nations Convention on Tax that motioned to do away with the ALP altogether. The idea of the convention is that the needs of all countries—developing and established—would be addressed by making the global tax arena more transparent and less complex. In terms of transfer pricing, the proposal moves to replace the ALP with a formula, taxing multinational corporations based on where profits are earned, and value is created. Sound familiar? It should. The OECD’s Pillar One proposal—also a departure from the arm’s length principle—works similarly, but with a smaller scope: Pillar One would only affect 100 of the world’s top companies. The UN convention, however, would apply to all multinational companies, cutting out unnecessary complexity by applying a single system to all cross-border taxpayers. It may not be the right move for transfer pricing purists who prefer to adhere to a principle over a formula, but you can see there is at least some upside. The proposal also focuses on enhancing tax transparency through the automatic exchange of information and public country-by-country reporting. Whether or not it moves forward remains to be seen, but the goal, like the proposal itself, is simple and clear: to make sure everyone pays their fair share of tax.