The Arm’s Length Principle – An Adequate Means for Taxing Multinational Corporate Groups?

Abstract

International tax law is characterized by the arm’s length principle. However, the arm’s length principle is highly criticized since it is seen as a major driver of tax avoidance. Although the OECD’s Two-Pillar Solution and EU initiatives seem to indicate that international tax law is in a state of change, the arm’s length principle remains relevant. Therefore, we deal with the question whether it is possible to improve the arm’s length principle. While previous attempts ask, for example, whether it is possible to reduce its complexity, we focus on the aspect that the OECD Transfer Pricing Guidelines do not refer to a theory of the formation of prices in transactions between independent parties. We advocate developing a theoretical substantiation and introduce a new interpretation of the arm’s length principle, based mainly on concepts of a general evolutionary theory and political-cultural market theory. This reference to an adequate market theory leads us to a new interpretation of the arm’s length principle that differs considerably from the current interpretation. Still, we doubt that this new interpretation of the arm’s length principle alone can reduce tax avoidance significantly. However, understood as one instrument in a mix of instruments, we estimate that this interpretation of the arm’s length principle constitutes a more adequate means for fighting tax avoidance of multinational corporate groups than its current interpretation.