While no standard approach for management purposes has evolved to set transfer prices ex ante,in the tax-world(ex post)the Arm's Length Principle(ALP)is the internationally accepted benchmark.Interestingly,as our case studies indicate many of MNEs make use of one or the other Transfer Pricing Method(TPM),actually designed for tax purposes,to derive ex ante transfer prices with the consequence that the incentive features within the organization are distorted.In addition,an increasing criticism on the theoretical foundations and practical merits comes with the use of the ALP. In particular, one can argue that a too narrow,or even often inappropriate,interpretation of the ALP causes shortcomings in the mainstream transfer pricing approach and the corresponding use of TPM.7
For example, mainstream transfer pricing often
does not reflect the facets of governing uncertainty, market size, internal knowledge, and
incentives from residual income.
For us, the most obvious reason for this inadequacy of the mainstream approach in transfer
pricing seems to be the discrepancy between the multilaterally value-adding business processes
through various degrees of integrated multinational organizations versus the existing tax-world
model of bilateral cross-border transactions which are deemed œ according to this tax-world
model œ identifiable and, hence, separable from each other, and, hence, comparable with stand-
alone firms. However, insights from organization theory tell a different story on the governance
and pricing of intra-organizational transactions.
Though tax-world transfer pricing with its ex post nature of defending arm´s length behaviour
resorts, at least to some degree, to internationally practised standard procedures to value business
processes (e.g. function and risk analysis; applying a certain TPM for the transaction type
considered; identifying a corresponding set of comparables; establishing the interquartile Arm´s
Length Range; documentation), tax practitioners are in search of more sound concepts to allocate
income in such a way that business economics of the underlying multi-functional value-adding
processes is more accurately accounted for.8For business-world transfer pricing with its ex ante
nature, it is arguable to what extent transfer pricing should reflect arm´s length features.