The Arm's Length Standard: Making it Work in a 21st Century World of Multinationals and Nation States

Abstract

Many transfer pricing experts argue the arm’s length standard (ALS) is “dead” and should be replaced by a formulary apportionment system that allocates the profits of a multinational enterprise among its home and host countries using a formula based on capital, labor and sales. Criticisms of the arm’s length standard fall into two categories: concerns that (1) abusive transfer pricing by multinationals is rampant, unfair and draining development; and (2) the current transfer pricing rules are difficult to implement in theory and in practice. I assume that, at least for the foreseeable future, the arm’s length standard will be the predominant method for taxing related party transactions within multinational enterprises. My focus in this paper is therefore to recommend changes within the current ALS system to improve its workability in a world of 21st century multinationals and nation states.

Keywords: transfer pricing, arm's length standard, tax avoidance, multiantionals

JEL Classification: f23, e62, h26, h25