TPG1995 Chapter I paragraph 1.10

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A practical difficulty in applying the arm’s length principle is that associated enterprises may engage in transactions that independent enterprises would not undertake. Such transactions may not necessarily be motivated by tax avoidance but may occur because in transacting business with each other, members of an MNE group face different commercial circumstances than would independent enterprises. For example, an independent enterprise may not be willing to sell an intangible (e.g. the right to exploit the fruits of all future research) for a fixed price if the profit potential of the intangible cannot be adequately estimated and there are other means of exploiting the intangible. In such a case, an independent enterprise may not want to risk an outright sale because the price might not reflect the potential for the intangible to become extremely profitable. Similarly, the owner of an intangible may be hesitant to enter into licensing arrangements with independent enterprises for fear of the value of the intangible being degraded. In contrast, the intangible owner may be prepared to offer terms to associated enterprises that are less restrictive because the use of the intangible can be more closely monitored. There is no risk to the overall group’s profit from a transaction of this kind between members of an MNE group. An independent enterprise in such circumstances might exploit the intangible itself or license it to another independent enterprise for a limited period of time (or possibly under an arrangement to adjust the royalty). However, there is always a risk that the intangible is not as valuable as it seems to be. Therefore, an independent enterprise has to make the choice between selling the intangible and so diminishing the risk and safeguarding the profit, and exploiting the intangible and taking the risk that the profit will vary from the profit which could be gained by selling the intangible. Where independent enterprises seldom undertake transactions of the type entered into by associated enterprises, the arm’s length principle is difficult to apply because there is little or no direct evidence of what conditions would have been established by independent enterprises.






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