OECD - Transfer Pricing

• At a primary level, the taxing rights that each country asserts depend on whether the country uses a system of taxation that is residence-based, source-based, or both.
  
  
  1. In a residence-based tax system, a country will include in its tax base all or part of the income, including income from sources outside that country, of any person (including juridical persons such as corporations) who is considered resident in that jurisdiction.
  2. In a source-based tax system, a country will include in its tax base income arising within its tax jurisdiction, irrespective of the residence of the taxpayer.
  As applied to MNEs, these two bases, often used in conjunction, generally treat each enterprise within the MNE group as a separate entity.


• The separate entity approach has been choosen by OECD as the most reasonable means for achieving equitable results and minimising the risk of unrelieved double taxation.


• Thus, each individual group member is subject to tax on the income arising to it (on a residence or source basis).

• However, as earlier noted, the relationship among members of an MNE group may permit the group members to establish special conditions in their intra-group relations that differ from those that would have been established had the group members been acting as independent enterprises operating in open markets.


• In order to apply the separate entity approach to intra-group transactions, individual group members must be taxed on the basis that they act at arm's length in their dealings with each other.


• As a means of dealing with this issue, OECD member countries have adopted the arm's length principle, under which the effect of special conditions on the levels of profits should be eliminated.


• The foregoing principles concerning the taxation of MNEs are incorporated in the OECD Model Tax Convention on Income and on Capital (OECD Model Tax Convention), which forms the basis of the extensive network of bilateral income tax treaties between OECD Member countries and between OECD Member and non-Member countries. These principles also are incorporated in the Model United Nations Double Taxation Convention between Developed and Developing Nations.