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Preface. A significant volume of global trade consists of international transfers of goods and services, capital (such as money) and intangibles (such as intellectual property) within a group of associated companies with business establishments in two or more countries – so called MNE group. Such transfers are called intragroup transactions. There is evidence that intragroup trade has been growing steadily since the mid-20th century and arguably accounts for a high portion of all international transactions.

An entity that is part of an MNE group is a multinational enterprise (MNE). MNE groups create organizational structures and develop strategies to arrange the cross-border production of goods and services in locations around the world and to determine the level of intra-entity or intra-group integration. The structure of transactions within an MNE group is determined by a combination of market and group driven forces which can differ from the open market conditions operating between independent parties. A large number of international transactions within MNEs are therefore not governed directly by market forces but driven by the common interest of the MNE group.

For tax purposes, an MNE group is granted no separate legal personality. The individual entities which are part of the MNE group are therefore taxed as if they were legally and economically independent. In general, each enterprise within the MNE group is a separate entity. Therefore, each individual group member is subject to tax on the income arising to it on a residence or a source basis, depending on whether the country uses a residence-based or a source-based (or both) system. The taxable profits determined by income and expenses of an MNE can be influenced by transfer prices. Transfer prices influence the income of both parties involved in the cross-border transaction. Thus, it becomes important to establish the appropriate price, called the „arm’s length price”, for intragroup transfers of goods, intangibles and services to allocate taxation rights properly between states.

Transfer pricing is the general term for the pricing of transactions between related parties. Transfer pricing therefore refers to the setting of prices for transactions between associated enterprises involving the transfer of physical goods, intangible assets or services. These transactions are also referred to as controlled transactions, as distinct from uncontrolled transactions between parties that are not associated with each other and can be assumed to operate independently (on an arm’s length basis) in setting terms for such transactions.

The conditions of the relations between associated enterprises may differ from those between independent enterprises which are usually determined by external market forces. It should be emphasised that, even if transfer pricing may be used for tax avoidance, it should not be automatically assumed that associated enterprises manipulate their profits in order to decrease their tax burden. Between associated enterprises difficulties can arise to determine a market price. The transfer price must be in accordance with the so-called arm’s length principle (ALP), which is generally understood as the taxpayers applying a constructed (or fictional) market on their non-market transactions. The ALP was established as an attempt to objectify transfer prices and to allocate taxation rights properly between states. The ALP is based on economic principles and ensures a level playing field between associated and unrelated enterprises. Although the ALP has been criticized, it remains (for the time being) the globally accepted standard in this regard.

Transfer prices which are not determined in an adequate manner affect tax liabilities and could lead to distortions. To correct distortions created by inadequate transfer prices, countries – in particular OECD member states – have agreed upon the adjustment of those transfer prices in accordance with the ALP.