ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

ARM’S LENGTH RANGE

JULY 2010

Disclaimer: The attached paper was prepared by the OECD Secretariat. It bears no legal
status and the views expressed therein do not necessarily represent the views of the OECD
member states. For a more comprehensive description of the views of the OECD and its
member states in relation to the arm’s length principle and transfer pricing, readers are
invited to refer to the OECD Transfer Pricing Guidelines for Multinational Enterprises and
Tax Administrations which were approved, in their original version, by the Committee on
Fiscal Affairs on 27 June 1995 and by the Council of the OECD for publication on 13 July
1995 [C(95)126/FINAL] and were supplemented and updated since. In particular, a
substantial revision of the Transfer Pricing Guidelines was approved by the Council of the
OECD on 22 July 2010 (see www.oecd.org/ctp/tp or
http://www.oecd.org/document/4/0,3343,en_2649_33753_45690500_1_1_1_1,00.html).

CENTRE FOR TAX POLICY AND ADMINISTRATION

 ARM’S LENGTH RANGE

Introduction

1. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises
and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses
for transfer pricing purposes. The notion of arm’s length range is discussed at paragraphs 3.55-3.66 of
the TPG.

A. Determining an arm’s length range

2. In some cases it will be possible to apply the arm’s length principle to arrive at a single
figure (e.g. price or margin) that is the most reliable to establish whether the conditions of a
transaction are arm's length. However, because transfer pricing is not an exact science, there will also
be many occasions when the application of the most appropriate method or methods produces a range
of figures all of which are relatively equally reliable. In these cases, differences in the figures that
comprise the range may be caused by the fact that in general the application of the arm’s length
principle only produces an approximation of conditions that would have been established between
independent enterprises. It is also possible that the different points in a range represent the fact that
independent enterprises engaged in comparable transactions under comparable circumstances may not
establish exactly the same price for the transaction.

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3. In some cases, not all comparable transactions examined will have a relatively equal degree
of comparability. Where it is possible to determine that some uncontrolled transactions have a lesser
degree of comparability than others, they should be eliminated.

4. It may also be the case that, while every effort has been made to exclude points that have a
lesser degree of comparability, what is arrived at is a range of figures for which it is considered, given
the process used for selecting comparables and limitations in information available on comparables,
that some comparability defects remain that cannot be identified and/or quantified, and are therefore
not adjusted. This is often the case in practice where the comparables are extracted from a database. In
such cases, if the range includes a sizeable number of observations, statistical tools that take account
of central tendency to narrow the range (e.g. the interquartile range or other percentiles) might help to
enhance the reliability of the analysis.

B. Selecting the most appropriate point in the range

5. If the relevant conditions of the controlled transactions (e.g. price or margin) are within the
arm’s length range, no adjustment should be made.

6. If the relevant conditions of the controlled transaction (e.g. price or margin) fall outside the
arm’s length range asserted by the tax administration, the taxpayer should have the opportunity to
present arguments that the conditions of the controlled transaction satisfy the arm’s length principle,
and that the result falls within the arm’s length range (i.e. that the arm’s length range is different from
the one asserted by the tax administration). If the taxpayer is unable to establish this fact, the tax
administration must determine the point within the arm’s length range to which it will adjust the
conditions of the controlled transaction.

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7. In determining this point, where the range comprises results of relatively equal and high
reliability, it could be argued that any point in the range satisfies the arm’s length principle. Where
comparability defects remain, it may be appropriate to use measures of central tendency to determine
this point (for instance the median, the mean or weighted averages, etc., depending on the specific
characteristics of the data set), in order to minimise the risk of error due to unknown or unquantifiable
remaining comparability defects.

C. Extreme results: comparability considerations

8. Extreme results might consist of losses or unusually high profits. Where one or more of the
potential comparables have extreme results, further examination would be needed to understand the
reasons for such extreme results. The reason might be a defect in comparability, or exceptional
conditions met by an otherwise comparable third party. An extreme result may be excluded on the
basis that a previously overlooked significant comparability defect has been brought to light, not on
the sole basis that the results arising from the proposed “comparable” merely appear to be very
different from the results observed in other proposed “comparables”.

9. An independent enterprise would not continue loss-generating activities unless it had

reasonable expectations of future profits. Simple or low risk functions in particular are not expected to
generate losses for a long period of time. This does not mean however that loss-making transactions
can never be comparable. In general, all relevant information should be used and there should not be
any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts
and circumstances surrounding the company in question that should determine its status as a
comparable, not its financial result.

10. Generally speaking, a loss-making uncontrolled transaction should trigger further

investigation in order to establish whether or not it can be a comparable. Circumstances in which loss-

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making transactions/ enterprises should be excluded from the list of comparables include cases where
losses do not reflect normal business conditions, and where the losses incurred by third parties reflect
a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transactions.
Loss-making comparables that satisfy the comparability analysis should not however be rejected on
the sole basis that they suffer losses.

11. A similar investigation should be undertaken for potential comparables returning abnormally
large profits relative to other potential comparables.

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