The basis of transfer pricing is the Arm’s Length Principle, as it is known internationally. This principle states that the price agreed in a transaction between two related parties must be the same as the price agreed in a comparable transaction between two unrelated parties.
The Arm’s Length Principle was agreed upon by all OECD member countries and adopted as an objective guideline for use by multinational companies and tax administrations in international taxation. Its objective is to avoid the erosion of the tax base or the transfer of profits to low tax jurisdictions.
When unrelated companies carry out transactions with each other, market forces normally determine the terms of the commercial and financial relationships (e.g. the price of goods transferred or services rendered). However, when transactions take place between related companies, external market forces may not directly affect prices, either because of corporate synergies, economies of scale or tax planning.
As a consequence of the above, the following points should be evaluated when analyzing transactions carried out by related companies:
- The agreed price of the goods and/or services
- The margins obtained in the purchase and sale of goods and/or services
- Assets used and risks assumed
- The agreed terms and conditions of the transactions.
The evaluation is carried out by means of a comparability analysis, from an economic and legal point of view, to verify whether or not the related companies comply with the arm’s length principle. In other words, to ensure that the related companies are agreeing their transactions as independent companies would do in comparable circumstances.
In Spain, the rules on transfer pricing are regulated in Law 27/2014, of November 27, on Corporate Income Tax (CIT) and its implementing regulations in Royal Decree 634/2015, of July 10, approving the Corporate Income Tax Regulations (CITR), as well as the guidelines issued by the OECD applicable to transfer pricing.