Transfer Pricing in China 2016 (3rd Edition)

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12 - Transfer Pricing in China 2016
There are several reasons why countries (irrespective of whether they are an OECD member or not)
have adopted the arm’s length principle. A major reason is that the arm’s length principle provides
broad parity of tax treatment for members of multinational groups and independent enterprises.
Because the arm’s length principle puts associated and independent enterprises on a more equal
footing for tax purposes, it avoids the creation of tax advantages or disadvantages that would
otherwise distort the relative competitive positions of either type of entity. In so removing these
tax considerations from economic decisions, it is believed that the arm’s length principle promotes
the growth of international trade and investment.
When applying the arm’s length principle, a firm may encounter companies within a corporate
group that engage in transactions that independent enterprises would not. An example of such a
transaction is the provision of intercompany loans. A cash-rich group company would be willing
to lend funds to a group company, but such a transaction will not occur between third parties that
are not in the business of borrowing and lending money.
There may be other cases where entities within a group may price their transactions differently
from third parties. Such transactions may not necessarily be motivated by tax avoidance but may
occur because, in routine business transactions with each other, members of a group face different
commercial circumstances than independent enterprises. Where independent enterprises seldom
undertake transactions of the type entered into by associated enterprises, the arm’s length principle
is difficult to apply because there is little or no direct evidence of what conditions would have been
established by independent enterprises. Themere fact that a transactionmay not be found between
independent parties does not in itself mean that it is not arm’s length.
Another key difficulty with the application of the arm’s length principle is the fact that it is a
separate entity approach. Such an approach may not always account for the economies of scale
and interrelation of diverse activities created by integrated businesses. Within the arm’s length
principle, there is currently no widely accepted objective criteria for allocating the economies of
scale or benefits of integration between associated enterprises.