Transfer Pricing in China 2016
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1.2 Arm’s length principle
Taxpayers rely on the arm’s length principle in order to demonstrate that transactions among group
/ affiliate companies are appropriate. According to the arm’s length principle, a transfer price is
acceptable if all transactions between related parties are conducted at the arm’s length price,
which is the price which would have been determined if such transactions were made between
independent entities under the same or similar circumstances. In other words, the application of
the arm’s length principle requires a comparison between what the taxpayer has done and what
an independent party would have done under the same or similar circumstances.
The arm’s length principle has a long history, dating back to the League of Nations Model Tax
Conventions that formed the international consensus in the first half of the last century. In 1963,
the arm’s length principle made its way to Article 9 of the OECD Model Tax Convention. In 1980, the
United Nations also adopted the arm’s length principle, which is reflected in Article 9 of the United
Nations Model Double Taxation Convention between Developed and Developing Countries. As a
result, the arm’s length principle has universal application today. It forms the basis of an extensive
network of bilateral income tax treaties between OECD member countries and between OECD
member countries and non-OECD economies.