Transfer price is the price at which transactions are carried out between companies part of the same group (i.e. related companies or related parties; see Frequently asked questions for the definition of "related companies").

The transactions carried out between related companies must comply with the arm’s length principle, which is at the heart of any transfer pricing analysis. This means that the prices applied in transactions between companies from the same group must be the same with the prices charged by independent companies in comparable economic conditions. Otherwise, profits will not be correctly reflected in the jurisdiction of each related company involved in the transaction.

Transfer pricing is a system of laws and practices used by countries to ensure that goods, services, intellectual property and resources transferred or shared between affiliated companies are appropriately priced based on market conditions. This is important as transfer pricing may inflate profits in low tax jurisdictions and decrease profits in high tax countries – the so called “base erosion and profit shifting” concept.

Transfer pricing and… "arm’s length"

In order to tackle the issues that arise in the transfer pricing area, the OECD has issued guidelines which contain recommendations for multinational companies and tax authorities; OECD international guidelines are based on the arm’s length principle. What is the connection between arm’s length and the requirement that a transfer price between affiliated parties should be similar with the market price for similar transactions?

There’s a simple explanation – when two people are close (affiliates) they tend to hug each other. The TP theory states that these two individuals should act as if they did not know each other (independents) and during a transaction just shake hands and keep each other…at arm’s length.

Video: What transfer pricing is all about?