The future of arm’s length principle – Is there a need to revisit the principle?

Under existing laws and tax treaties of most countries, TP rules are predicated on the ALP. The principle
requires the terms and conditions of transactions and the allocation of profit among members of a
controlled group, to be consistent with those established among similarly situated unrelated entities.
Thus, the international standard is a ‘separate entity’ centric approach that evolved in response to
changing global conditions over the last century.

However, the principle has received a lot of criticism, one reason for which is the evolution of innovative
business models. Several proposals have been discussed in past which completely overlook the ALP (for
ex. earlier US proposal for a Border-Adjusted Tax, the European Commission’s proposal for the CCCTB and
the India’s draft proposal of fractional apportionment for profit attribution to PE’s etc.). It seems that it is
difficult to argue with the conclusion that there remains a significant level of concern about the current
ALP system, a matter that has been accentuated by the changing techniques in demand generation.

The purpose of this paper is to discuss the concept of ALP, analyze the feasibility of applying the ALP,
identify the strengths and weakness of ALP and enlist some ways in which such weakness may be
addressed. An attempt has been made to highlight the broad criticism that ALP, comments on the
alignment of ALP with holistic value creation. The paper ends up with some open questions for the readers to ponder upon.

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The views in all sections are personal views of the author.