The arm's length principle requires entities of the same group to transact on the terms that independent parties would have agreed in comparable circumstances. It is the foundation of transfer pricing worldwide, set out in article 9 of the OECD Model Tax Convention and transposed into most national tax codes.
It answers a specific question. Two related entities can set any price they like between themselves, and the choice moves taxable profit from one country to another without changing anything economically. The principle removes that discretion by referring the price to an external standard: not what the group finds convenient, but what a third party would have accepted.
Applying it means running a comparability analysis, and it rests on five factors. The contractual terms agreed. The functions performed, assets used and risks assumed by each party. The characteristics of the goods or services. The economic circumstances, including market and geography. The business strategies pursued. Two transactions are comparable only when no difference between them would materially affect the price, or when reliable adjustments can correct for it.
The practical hurdle is finding comparables at all. For a routine service the cost-plus method with a benchmarked margin usually works. For a unique intangible or an integrated activity, external comparables may not exist, which is why profit-based methods were developed.
The consequence of a breach is an adjustment: the authority restates the price, taxes the profit it considers wrongly shifted, and adds penalties. In France, article 57 of the tax code carries that power. What defends a position is not the elegance of the method but the evidence behind it, which is where an audit trail and cross-entity finance control become the practical answer.
