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Arm’s length principle in tax law

What is the arm’s length principle in transfer pricing in plain language? How is it applied in tax law? Detailed analysis in the article by the expert of Sterngoff Audit
Mr. Andrey Slesarev
Head of Saint Petersburg division. Lead project auditor.

According to the Cambridge dictionary the set English expression “arm’s length” is defined as “a situation in which two people, companies, etc. operate separately from each other.”

Arm’s length principle in taxation

It is believed that the “arm’s length” principle concept when applied to taxation was first introduced in the OECD model income and capital tax convention of 1963 and subsequent versions of that convention (the last version was issued in 2017).

According to paragraph 1, Article 9 of the convention, if a legal entity or individual from the same country directly or indirectly participate in management, control or capital of a legal entity from any other country and conditions of transactions between them differ from such conditions, if they were independent, the profit undercharged as a result of such difference could be charged and subjected to tax.

In simple terms, the price of transactions between the related parties must be similar to the price of transactions concluded between independent contractors.

Принцип «вытянутой руки»

Why the arm’s length principle is applied

The purpose of application of the arm’s length principle is to avoid the understatement of tax base or transfer of profit to jurisdictions with low taxes. The arm’s length principle was approved by all OECD countries and adopted by national tax bodies to develop documents governing taxation of transactions with related parties.

The prices set for transactions with related parties are the transfer prices.

What is transfer pricing

According to the definition published by the Inspectorate of the Federal Tax Service of the Russian Federation, the transfer price is the price determined by various divisions of a company or between the participants of the same group of companies. The activities connected with determination of prices between such companies are called transfer pricing (TP).

2 aspects of transfer pricing:

  • transfer prices are controlled by the tax bodies (“controlled transactions”),
  • development of transfer prices by economic entities is based on application of provisions of the Russian Federation Tax Code and transfer policy governing the specific features of practical application of the transfer pricing methods in conditions of a specific company (group of companies) and control over compliance with provisions provided for by the policy.

Законодательные основы

Legal framework for transfer pricing in the Russian Federation

Russian tax laws contain regulations complying with regulations of the OECD model convention related to income and capital taxes. The transfer pricing issues are analysed in Section V.1 of the Russian Federation Tax Code. In particular, Article 105.3 of the Russian Federation Tax Code (cl. 1) contains the provision, which is actually identical to the aforementioned arm’s length principle in the Convention.

Transactions between related parties where the amount and other additional criteria are met are considered controlled (Art. 105.14 of the Russian Federation Tax Code).

What parties are recognized as related

Taxpayers of any category may be considered related taxpayers: individuals, legal entities, sole proprietors.

The relation is defined based on criteria provided for by Art. 105.1 of the Russian Federation Tax Code, which set forth the degree of impact on the parties when concluding transactions or making decisions. 

The main criteria include:

  • a company or individual holding a share above 25% in the authorized capital of a legal entity;
  • an individual or legal entity holding powers related to company management;  
  • any kinship between the individuals (e. g. a married couple, parents).

In addition, the parties my be considered related based on a court decision.


What transactions are considered the controlled transactions

According to Art. 105.14 of the Russian Federation Tax Code, transactions between related resident and non-resident parties of the Russian Federation are controlled transactions, if the transaction amount exceeds 120 mlnrubles during a legal year. 

In addition, the following types of transactions are considered controlled transactions upon the amount control compliance: 

– transactions, where two related parties engage an independent agent, who serves as a formal mediator;

– foreign trade transactions on the sale of oil and oil products, ferrous and non-ferrous metals, mineral fertilizers, precious metals and stones;  

– transactions involving a resident of a special list country 

It should be noted that if previous version of that list included countries offering the preferential tax treatment (offshore areas), the list approved by the Ministry of Finance of the Russian Federation on 05/06/2023 and effective from 01/07/2023, in addition to the “traditional offshore” jurisdictions provides for the states put on the list of unfriendly states (i.e. EU countries, the Great Britain, the USA and Japan).  

Where the transaction amount exceeds 1 blnrubles during a legal year, transactions between related Russian Federation resident parties are controlled transactions in any of the below circumstances:

– transaction parties apply different corporate profit tax rates;

– one of the parties is a payer of the mineral extraction tax assessed as a percentage, and the transaction subject is a recovered mineral product;

– at least one of the parties is a taxpayer applying the unified agricultural tax;

– one of the parties is released from the obligations of a payer of the corporate profit tax;

– one of the parties is a payer of the profit tax specializing in production of raw hydrocarbons in a new offshore field;

– at least one of the parties is a research corporate centre specified in the Federal Law “On “Skolkovo” Innovation Centre” enjoying the release from obligations of a VAT payer;

– at least one of the parties applies the investment tax deduction for corporate profit tax within a tax period;

– at least one of the parties is a payer of a windfall profit tax from the extraction of hydrocarbons

The Tax Code also sets froth the list of transactions, which are not considered controlled under any circumstances (cl. 4, Art. 105.14 of the Russian Federation Tax Code), e.g.:

  • transactions in the field of military and technical cooperation of the Russian Federation with foreign states,
  • granting of interest-free loans between the related parties registered in the territory of the Russian Federation.


Transfer pricing methods

The understanding of the transfer pricing method for the controlled transactions is required both to the tax bodies to carry out the tax control and to organizations and groups of companies applying the transfer pricing to avoid disputes with tax bodies and additional charge of tax. 

The basic tool to control the market nature of prices under the concluded transactions is the methods contemplated by the Russian Federation Tax Code (cl. 1, Art. 105.7 of the Russian Federation Tax Code):

  • comparable uncontrolled price method (a top priority method for establishing the correspondence of transfer prices to market prices);
  • resale price method;
  • cost method;
  • transactional net margin method;
  • profit split method.

The above-listed transfer pricing methods correspond to methods described in OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2010. 

Based on the foregoing documents, the transnational corporations develop their own transfer policies specifying peculiarities of application of the transfer pricing methods of specific organizations and groups. In some cases, say, the comparable uncontrolled price method is unacceptable, e.g. due to unique nature of the supplied goods and services or due to the lack of open data about market conditions of transactions concluded by other market participants. In these cases, the transfer policy establishes the procedure for application of the pricing methods for any particular goods and services supplied within a group of companies.  

When using these methods during tax control, the tax bodies analyse transactions comparable with taxpayer’s transaction, or accounts of comparable organisations.  Use the publicly available sources to find the relevant information.

Based on results of transfer price control, the Russian Federal Tax Service may adjust the tax bases for the following taxes (see cl. 4, Article 105.3 of the Russian Federation Tax Code):

  • corporate profit tax;
  • personal income tax;
  • VAT;
  • mineral extraction tax;
  • a windfall profits tax on hydrocarbon production. 

Special aspects of transfer pricing in 2023

As mentioned above, in 2023 the list of countries the transactions with residents of which are considered the controlled transactions, was substantially expanded. In addition, from January 1, 2023, the threshold amount of income gained during a calendar year, upon which the transactions concluded with non-resident related parties and similar transactions are considered controlled transactions, was increased from 60 mln rubles to 120 mln rubles.

Рабочий стол

Arm’s length principle in transfer pricing

The current tax legislation (both Russian and that of OECD member states) includes provisions based on the arm’s length principle. In order to avoid disagreements with tax bodies, the transfer pricing methods used by organisations and groups of companies must be based, in particular, on the arm’s length principle (taking the specifics of application of the transfer pricing methods established by the Russian Federation Tax Code into account).

The proper use of the arm’s length principle in transfer pricing enables the development of prices as close as possible to those, which would be applied between the independent market participants. Where it is impossible to use the priority method (comparable uncontrolled price method) for a certain organisation, other methods may be applied. The rationale for and peculiarities of application of any particular methods are provided for by the transfer policy or by any other similar document.


In general, the arm’s length principle is logical and intuitive in the context of use in transfer pricing. At the same time, its practical application manifested in the use of transfer pricing methods described in the Russian Federation Tax Code may cause some difficulties.

For the purpose of standardization and simplification of activities connected with determination of transfer prices by economic entities, it is reasonable to develop, approve and apply in own activities the local regulatory acts governing the specific aspects of application of the transfer pricing methods according to peculiarities of their activities. Such documents may help the taxpayers both in practical pricing activities and in maintaining their position in disputes with tax bodies.