The question has to be considered whether, in an arm’s length situation, goods might be supplied for no payment or an unusually low payment, or might be supplied at a price producing less than the usual profit, or even a loss. It would not be unusual for an independent enterprise to do this if the goods were samples or advertising offers, but associated enterprises are not likely to be in a parallel situation. The question is more likely to arise in connection with goods sold to an associate in financial difficulties when some or all of the payment might be waived. It would be very exceptional for this to occur in transactions between independent enterprises, though the possibility cannot be wholly discounted (for example a supplier might to some extent be prepared to waive payment by an independent customer in temporary difficulties in order to preserve a potentially valuable outlet for his goods). But tax authorities could properly require very convincing proof that this situation would arise before accepting a nil or reduced payment between associated enterprises as equivalent to the arm’s length price. Payment might be deferred in such circumstances in the arm’s length situation but this would normally affect the price or be compensated for under a credit arrangement of some sort ...

The application of the arm’s length principle to the prices charged within MNEs is based on the assumption that prices are determined on the markets in the different countries by ordinary market forces. There may, however, be factors of various kinds, as discussed in the rest of this Section and, more generally, in Chapter I, which modify the operation of the normal rules of a market economy. Each of these factors is considered separately, but it can be expected generally that they would all have a similar effect on sales between unrelated enterprises in similar conditions and tax authorities should take this into account when considering adjustment of transfer prices ...

In applying this rule, however, there are a number of general points which have to be borne in mind. One is that it should not be assumed that the prices actually charged within an MNE will never be arm’s length prices. The transfer pricing policies of multinational enterprises may in fact be market-oriented and, where the different entities within such groups have their own profit responsibility, they may be free to contract either with an associated enterprise or with a third party with the result that there is a degree of bargaining within the group which produces a price effectively indistinguishable from an arm’s length price. (The full implementation of such a policy may, however, be difficult when, for example, components or semi-finished products are sold within the group which are not available on the market). Another point which it is necessary to bear in mind is that the transactions within MNEs may not be directly comparable with those which take place between independent enterprises so that allowances have to be made in comparing their transfer prices with the prices payable between independent enterprises. For example, entities within MNEs tend to render a wide range of additional technical and management and other services to their associates in connection with the sale of goods – a feature which is less common in transactions bet ween independent enterprises. Similarly, the production facilities of a group may be largely integrated with the consequence that the production arrangements are divided up among different group members in a way which would not be paralleled by independent enterprises. For example, these arrangements may involve long-term buy and supply agreements or agreements to use combined production plants under an obligation to buy from them (” joint facility arrangements “) ...

As in other areas of transfer pricing the arm’s length principle as expressed in the OECD Model Double Taxation Convention has to be followed in the evaluation for tax purposes of transfer prices for goods. Following this principle, prices paid for goods transferred bet ween associated enterprises should be, for tax purposes, those which would have been paid between unrelated parties for the same or simi lar goods under the same or similar circumstances ...

Section I deals with the arm’s length principle in general and with its application in special situations. Problems such as supply of goods for less than normal payment, sustained losses, pricing for market penetration and Government interventions in the market are dis cussed in this context. The different methods of estimating the arm’s length price are discussed in Section II ...

It may happen that a transaction which is in law a sale of goods may on close examination appear to be more akin to the provision of services. For example the functions of some distributors may be so minimal and the risks and responsibilities which they undertake so small that their profit is more akin to an agency fee or commission than the profit on a sale. Similarly the production and sale of a turn key factory may have involved the seller in fact in no more than the organisation of the project, the risks and responsibilities being carried elsewhere. In such circumstances too it may be more appropriate to measure the profit on the transaction on the basis of treating the payment as if it were a payment for services ...

Another feature of the transfer of goods which is not dealt with in this report except incidentally is the provision, which is not unusual in some branches of industry, of entire production facilities and their plant and equipment. Such transactions may present special problems because the provision of such facilities may be linked with the transfer of intangible property such as patents and know-how and with general service contracts as well as engineering contracts and long-term supply agreements. Also the value of the provision to both contracting parties may be primarily related to the benefits expected to arise from the long-term economic exploitation of the plant rather than to the original price and installation costs, so that the transaction has some analogy with investment in real estate or perhaps shares or bonds ...

This Chapter seeks to elucidate some of the problems facing tax authorities in relation to transfer prices for goods. It concentrates on sales of raw and processed materials, semi-manufactured products and finished manufactured products including mass-produced goods and custom-made products, but does not deal with problems relating to certain items of tangible property, such as immovable property and shares and bonds. Nor does it deal with the special problems which may arise in relation to ores and: minerals. Leasing contracts and similar arrangements are not dealt with either though there may be cases where long-term leasing contracts are very similar to sales ...