The Arm's Length Standard in the 21st Century: A Proposal for Both Developed and Developing Countries
Posted: 25 Oct 2004
One recurring question concerning how legal commands should be formulated in a legal system involves whether commands should take the form of rules or standards. The policy option that is at the core of this question is whether the content of the law should be determined and announced in advance, in a rule, or left to an adjudicator, in a standard. This distinction is relevant in the transfer pricing area because the arm's length approach is a standard: its precise meaning can only be determined via adjudication. Thus, the arm's length standard is unworkable unless the legal system in which it operates is prepared to produce case law (or something functionally equivalent to case law) to give guidance to taxpayers on how they are expected to behave.
The purpose of this article is two-fold. First, it attempts to provide an analysis of the dramatic problem faced by the arm's length standard when the legal system in which it works is unable to produce case law capable of showing taxpayers how they are expected to behave in the transfer pricing area (the Problem). The Problem is common to both developed and developing countries. On the one hand, developed countries face the Problem because a variety of reasons have made case law an infrequent element. Moreover, the limited case law available is not a public good: the holdings are too fact-specific to allow predicting the probable outcome of future court decisions. This scenario makes the meaning of the arm's length standard difficult to determine - especially when no comparables are available. On the other hand, developing countries also face the Problem but for an additional reason: their weak rule of law produces, inter alia, frequent violations of stare decisis making case law a negligible source for predicting court decisions. In sum, the meaning of the arm's length standard is largely uncertain in both the developed and developing worlds. This explains the worldwide arm´s length standard crisis.
The second purpose of this article is to suggest a procedural method for inducing a legal system - be it from the developed or developing world - to produce a proxy of case law capable of determining precise meanings of the arm's length standard. The suggested procedure has been written in such a way as to facilitate its addition to article 9 of the OECD or UN Model Tax Conventions on Income and on Capital.
Keywords: Transfer pricing, arm's lenght standard, developed countries, developing countries, United States, Argentina
JEL Classification: K19
Suggested Citation: Suggested Citation