The Economics of Transfer Pricing Methods & Management of Tax Risk

Abstract

In this paper I derive a straightforward condition, which I call the Arm’s Length Dual Condition (ALD), for a controlled price to be, or not to be, arm’s length. A proof of the validity of this condition is carried out with respect to the Resale Price, the Cost Plus and the Transactional Net Margin pricing methods and it shows that contrary to general belief all transfer pricing methods should be treated as being two-sided, i.e. assessment of arm’s length compliance should be based on benchmarking both parties involved in the controlled transaction. The ALD Condition brings about a change in how tax administrations carry out tax audits and corporations manage their transfer pricing tax risk, the final paragraph explains the consequences of a new approach to risk management based on the ALD Condition.