Transfer pricing: Fundamentals of the arm’s length principle and pricing of intercompany loans

Rasmus Steiness

Student thesis: Master thesis


Transfer pricing regulations has been around for more than 100 years; it was and still is envisioned to act as a tool to prevent tax planning by multinational enterprises. Since the introduction of the OECD Guidelines and article 9 of the OECD model for tax convention, it has however also proved to create uncertainty for these enterprises. Still more complicated transactions are challenging the interpretation of the arm’s length principle, leaving companies in an ever changing environment. Especially transactions involving intercompany financing have caused different interpretations across jurisdictions when applying the arm’s length principle. This thesis examines the main value drivers behind loan arrangements and especially focuses on the effect the relationship between two related parties, can have on the pricing of intercompany loans. The insight and control a parent company can excise over a subsidiary is considered important, when evaluating the risk inherit in a loan arrangement. Thus applying an interest rate based on a stand-alone credit assessment of the loan taker, would not reflect the actual risk carried by the loan provider. Supported by recent case law, an analysis of the principles behind establishment of an arm’s length price is done in order to evaluate the effect the relationship should have. Applying the separate entity approach in the assessment, would require the parties to act in an economical rational manner. By exercising their bargaining power, they explore secondary realistically options available, implied by the notion that each involved party will seek to maximize their profit. The thesis concludes that only effects available to third parties should be included in the risk assessment and eventually the determination of the arm’s length price. Finally the thesis investigates the most appropriate method to examine an arm’s length price, based on the above conclusion. Comments made by the Danish Minister of Taxation are used in order to examine accepted approaches. It is concluded that, if possible, the CUP method is the most appropriate method to use, which is proven by a benchmark study. However, it is difficult to adjust for the effect that the relationship will have on the price, one approach is to support the benchmark by an offer from a bank. A bank offer cannot stand alone as there has not been an actual transaction, but it can be used as a way to determine the value of being part of a group, i.e. determine the needed adjustment that has to be made to the benchmark results.

EducationsMSc in Accounting, Strategy and Control, (Graduate Programme) Final Thesis
Publication date2012
Number of pages103