The Arm’s Length principle is a “tool” used by related companies to set and is a “ruler” to assess whether the transfer prices for transactions between them are correct and appropriate or not. The mechanism of this principle is as direct as its name. If two companies are very close that they are almost touching each other, push them out to “the end of an arm’s length” by way of setting the prices of goods, assets or services as if they were strangers, i.e. equal to the prices resulting from negotiations, or the so-called “market price”.
Why must prices be arm’s length?
When independent companies buy and sell goods or services with each other, both companies agree on the purchase prices or service prices through “market force”, i.e. negotiations. In terms of economic theory, the price mechanism is a tool for allocating limited resources to produce goods or services that are in line with consumer demand efficiently. In terms of taxes, if the transfer price does not reflect the price mechanism and the arm’s length principle, the company’s expenses or income will be distorted. (Profits flow from countries with high tax rates to countries with lower rates.) The OECD members agreed that tax authorities in each country can adjust their income and expenses to be in line with the arm’s length principle for tax collection [OECD Guidelines, Chapter 1, paragraphs 1.2-1.3].
How to determine arm’s length prices?
Setting transfer prices to be equivalent to market prices can be done by simulating market mechanism through negotiations. Initially, Departmental Instruction No. Paw.113 accepted and recommended that officials check "documents that can be used as evidence to show the basic principle and the grounds of negotiations of taxpayer for the transaction made with businesses in the same group." However, explaining this to Officers may not be easy, and currently, there is no such requirement. The instruction under the Director-General's Notification No. 400 stipulates that related companies set transfer prices equal to those determined by independent companies, using one of the five recognized pricing methods, which will be explained in future opportunities.
[Contact Person: Mr. Phongnarin Ratarangsikul | Partner]