Arm's length principle and EU law

The arm’s length principle has now been for almost eighty years the basis for business income allocation in international tax. The principle permeates many of the provisions of the OECD Model, and in particular those who concern the attribution of income to permanent establishments, the relationship between associated enterprises and certain source tax limitations. Also, it is remarkable that, within the OECD Model, the arm’s length principle is attributed, explicitly or implicitly, predominance over non-discrimination provisions. In more recent years, the arm’s length based rules of the OECD Model have been progressively implemented in EU directives and in the Arbitration Convention. Not least, the arm’s length standard has lately become, even though in circumscribed instances, part of the VAT system. Notwithstanding this wide recognition, some difficulties have arisen in the coordination of such principle with the fundamental freedoms guaranteed by the EC Treaty (now TFEU). The Court of Justice, after having initially considered arm’s length based thin capitalization rules as being in breach of the freedom of establishment, has afterwards recognized that a difference in treatment between domestic and cross border transactions can be justified on the basis of the purpose to prevent tax avoidance. However, having framed national arm’s length based legislation in the scheme of the abuse of law may endanger the effectiveness of such legislation and, at the same time, seems to underestimate the necessity to find adequate remedies to double taxation which may derive from unilateral arm’s length based income adjustments.status: publishe