On Application Of The Arm's Length Principle In The Transfer Pricing Taxation System

Transfer pricing refers to the internal transaction pricing system between subsidiaries within the same multinational corporation group on transfer their tangible property, intangible property, finance and provisions of services. It is a normal, legal as well as a necessary act. However, the multinational corporation often takes advantage of its internal control and does not make the price in accordance with the market price when pricing its internal transaction, i.e., improper manipulative the transfer price, which is part of transfer pricing. In fact, the transfer pricing regulation is in its essence to correct this act of improper manipulative transfer price. As a concomitant of the multinational corporation's business operation, the emergence of transfer pricing is objectively inevitable. First of all, transfer pricing is an inevitable product of the internalization of the multinational corporation's transaction. Meanwhile, it is an important method for a multinational corporation to deal with the incompleteness of international market. With the enlargement of a multinational corporation's international business, the conflict between its dependence on cross-regional and cross-departmental cooperation and the incompleteness of international market has become more prominent. In order to overcome this incompleteness of the international market, the multinational corporation's internal market replaces the external one on which it has depended before. The formation of this internal market is the presupposition of the emergence of the multinational corporation's transfer pricing. Secondly, transfer pricing is an essential strategy for a multinational corporation to practice its global strategic management, which breaks through the national and racial boundary and treats international resources from a global view. This global strategy adopts the unified allocation of commodity resource and distribution to reinforce the corporation's unification, flexibility and efficiency. It can make the most use of capital, technique, and labor and material resources to achieve global unification. At the same time, this strategy tactfully avoids many exterior risks. In a word, transfer pricing is an effective tool for multinational corporations to pursue the maximum profit. The influence of the transfer pricing within a multinational corporation exerts both positive and negative on the external economy. Firstly, through transfer pricing the multinational corporation optimizes the allocation of internal resources and makes up the loss brought by the self modulation seizes up of the market economy, which consequently influences the benign circulation of the market economy. Secondly, by making use of the discrepancy of tax system in different countries, the multinational corporation might minimize the global taxation obligation via controlling the transfer pricing unlawfully. The negative influence it has brought about has two aspects. First of all, the profit transferred via the improper transfer price between the multinational associate enterprises among different taxation entities in different countries violates the principles of tax equality. Secondly, the improper transfer price between the multinational associate enterprises also violates the international tax convention of fair distribution. In order to protect their interests, many governments adopt actions to restrict and control the improper manipulative transfer pricing from taxation prospective and to correct the distortion it causes on the interest allocation of international taxes. This practice links transfer pricing with tax system, and thus comes up transfer pricing tax system. The key of transfer pricing is arm's length principle, so the most important standards to establish and improve transfer pricing is whether it is in accordance with the arm's length principle. Arm's length principle, which is also called fair and independent assessing principle, requests that the transfer price for any inter-company transaction as if they were unrelated entities but all other aspects of the relationship were unchanged. If it is not the case, the tax authorities of relevant nations are entitled the right to adjust the price. The arm's length principle offers the same tax opportunity for affiliated enterprises and independent ones. It tries to prevent the multinational corporations from reducing their tax burden by means of transfer pricing, and to eliminate the impact of tax on the international economic entities that make the distorted choice in business organizing form. The method of transfer pricing is the key to the system of transferpricing taxation system, which is the practical application of arm's length principle in the process of transfer pricing adjustment. Guided by this principle, multinational corporations and tax authorities have gradually developed six kinds of transfer pricing methods according to the different characteristics of various transactions. These methods are mainly divided into two categories, the first of which is the traditional transaction method represented by the comparable uncontrolled price method, the resale price method and the cost plus method. The second category is the profit pricing method or transactional profit method represented by the profit-split method, the comparable profit method and the transactional net margin method. These three kinds of traditional transaction methods are all the practical application of the arm's length principle. They define the transfer price on the basis of the price in the marketplace or the operation cost respectively. These three methods have the longest history and the most extensive application among the present transfer pricing methods. The traditional transaction method is the most direct method to judge whether the transaction between the affiliated enterprises follows the arm's length principle, so it is more effective. However, the complexity of the actual economical situations add a lot of difficulties to the traditional transaction method, such as the lack of comparable data or the poor quality of the available comparable data. In this case, we should turn to the transactional profit method. The transactional profit method is based on the net profit which is more acceptable compared with the method based on the gross profit since it can remove the influence of functional differences on the comparability. With the development of science and technology and the arrival of knowledge economy, intangible properties are playing an increasingly important role in the production and marketing of products; with the rapid development of network economy, the issue of transfer pricing in electronic commerce also draws people's attention. Meanwhile, the arm's length principle which is mainly applicable to the transaction of tangible properties confronts with an unprecedented challenge. Therefore, the application of arm's length principle in such fields as intangible properties, cost sharing and electronic commerce naturally becomes the research direction of transferpricing taxation system. Compared to the transfer pricing policies of developed nations, China's current transfer pricing rules and regulations are considered rudimentary. Therefore, the application of arm's length principle in the transfer pricing taxation system in China is still lacking in theoretical instruction and practical operation. As a result, China needs to draw on the scientific and operational lawmaking experience of those developed countries so as to perfect the application of arm's length principle in the tangible properties in China. As for the application of arm's length principle in intangible property, research and practice are to be actively carried out so that the current developing steps of transfer pricing taxation system will be closely followed. The arm's length principle becomes quite common in the world-wide practice of transfer pricing and it has achieved common understanding in international business world and tax authorities of different countries. This common understanding is of great practical significance in enhancing the construction of transfer pricing taxation system in China. In the process of perfecting the transfer pricing taxation system in China, the policy of the integrating theory and practice should be firmly insisted on; a selective adoption of the advanced experience and mature practice of western countries is absolutely necessary, while equal importance should be paid to the fulfillment of arm's length principle in the practice of transfer pricing taxation system in our practical situation.