LESSON 2

ARMS LENTH PRINCIPLE

 Arm’s-Length Principle states that the amount charged for transfer of goods or
services between related parties should be the same as would be charged in the open
market.
 Therefore arm’s-length is applied in transfer pricing to determine the independent
price of transactions between two related parties.
 This helps tax administration to deter tax avoidance by related companies.
 However this anti-avoidance aspect of arm-length principle may not be sufficient to
deter tax avoidance in international transactions arena though being a prerogative of
domestic law of a specific country like Kenya, as per book written by Marta Pankiv:
Contemporary Application of Arm’s-Length Principal in Transfer Pricing.
 Internationally, Arms-Length principle is a bilateral concept that is aimed at
appropriate allocation of profit between source and recipient countries
 Accordingly therefore, the Arms Principle cannot be used to deal with abusive tax
practice internationally.
 Internationally Arms-Length principle is a general principle of tax treaties between
tax administrations.
 We should avoid limiting interpretation of Arms-Length principle to the OCED
guidelines contained in transfer pricing guidelines and instead we interpret this
principle using general principles of interpretation laid down by Vienna convention
on the Law of Treaties.
 As a matter of tax treaty interpretation the contracting state, under Arm’s – Length
Principle is allowed to adjust the profit of a group entity by adjusting transfer pricing
to ensure that the correct profits are taxed in that state pursuant to article 9(9) of
OECD.
 To mitigate economic double taxation, tax authority of contracting state is authorized
by arm-length principles to make corresponding adjustment under article 9(2) of
OECD.
 The above two adjustments are profit adjustments and should not be confused with
the price adjustment or transactional adjustment.
 The profit adjustment is the only effective method of applying the Arms –Length
nature related engagement because:
i. Price adjustment cannot serve as the only proxy of the profit of the whole
group of companies as per OECD guidelines of company prices.
ii. Transactional adjustment may render the Arms-Length Principle inapplicable
article 9 of OCED model by a contracting state.
Pankiv hereby concludes that the arm’s length principle as stated in article 9 of the
EOCD Model is not an anti-avoidance rule and has been misinterpreted as a primary tool
to tackle abusive practices of multinational enterprises. In his article, International
Transfer Pricing Journal, he refers to the new OECD guidelines on intangibles as the
background and provides an overview to the new approaches to transfer pricing analysis
in the context of intellectual property.

BY :Marta Pankiv
May 2017
Price >11,000/=

EOCD
 We have mentioned a number times the term EOCD. It stands for Organization of
Economic Cooperation and Development.

 It was started in 1961 by a total of 31 member countries. This forum was set up for
the following purposes:
(i) To discuss, develop and perfect economic and social policy of member
countries.
(ii) To compare experiences, seek answers to common problems
(iii) To coordinate domestic and international policies in the globalized world to
achieve even practices across nations
(iv) Through exchanges to guide in the creation of agreements to act in a formal
manner
(v) For member countries to understand the impact of their national policies on
the international community.
(vi) A forum of member countries to reflect and exchange ideas with countries
similar to them.

NB: The OECD convention came up with articles on taxation on income and capital
which are continually being updated with developments.