Reforming transfer pricing with outdated ideas

In Spencer’s paper he quotes Michael Durst who from 1994 to 1997 served as Director of the U.S. Internal Revenue Service’s Advanced Pricing Agreement (APA) Program who in turn extends Spencer’s argument against the OECD’s position on transfer pricing. Durst explains that the main weakness of the “arm’s length” principle is that “the basic tenet of arm’s-length transfer pricing – the availability of  ‘uncontrolled comparables’ for transactions between commonly controlled parties – is based on a fundamental misunderstanding of practical economics”.

Multinationals form precisely because it’s economically better off as an integrated unit. This is common in some industries where manufacturers and distributors are integrated. It makes no economic sense to have these functions as distinct entities. 

That means that for transactions between different elements of the one multinational – namely the transactions for which transfer pricing rules are important – the comparable prices on which the current rules try to depend seldom if ever exist.

But according to Durst, a veteran of 20 years working in the transfer pricing space,  “the inescapable problem, however, is that the failure of the arm’s length system is not rooted merely in the particular way the system is implemented. The problem lies in the assumption, on which the entire system is based, that the tax results of multinational groups can be evaluated as if they were aggregations of unrelated independent companies transacting with one another at arm’s length”.

One can only conclude that its very complexity and difficulty in enforcing are the reasons why so many tax authorities worldwide embrace the arm’s length principle.