The Arm’s Length Principle

The Arm’s Length Principle is the condition aiming that the parties to a transaction treat each other as independent and on an equal terms and conditions

It is broadly used in business law to establish equitable conditions to an agreement that will stand up to legal and tax scrutiny, even when the parties involved are related.

The arm’s length principle requires that any compensation happening between companies of the same group have the same economic value as if it has happen between unrelated parties.

It’s easier said than done. The actual determination and implementation of the arm’s length principle is highly complex and must consider diverse important factors that can influence and determine the fair market value of the compensation including the type of transaction under analysis, the amount of the payment, the form of payment, the time frame for the payment as well as the economic and regulatory environment surrounding the transaction.

The Organisation for Economic Co-operation and development (OECD) has included in its model of tax convention for avoiding double international taxation and promote the exchange of information, in the Article 9, the provision of the Arm’s Length principle when establishing that in such cases where an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or when the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

The above serves the purpose of providing It provides the legal framework for tax authorities and for enterprises and multi-national companies I order to avoid double taxation conflicts and get the proper taxes paid at the fairest rate.

TENDENCIES ON GLOBAL TAX TRANSPARENCY

Since the last couple of years, there has been strong tendency towards tax transparency around the world, with the United States (U.S.) and the G20 Countries as protagonists.

Some of the most important developments so far are the tax information exchange agreements (TIEAs), the Foreign Account Tax Compliance Act (FATCA), the Intergovernmental Agreements (IGAs) and the adoption of a system for automatic exchange of information (EOI).

Under EOI systems and procedures, Tax and Finance Authorities can obtain information through requests made to Authorities in another country or even automatically. This will depend on the kind of agreement that the relevant countries have entered into. The character of the information requested will also determine the procedure to be followed by the requesting Authority and only in those situations where it has strong belief that its local legislation has been breached by certain tax payer.

Once the requesting Authority has submitted its request, the providing Authority will process it in accordance to the IGA or EOI in place. Once the information is furnished, the providing Authority will be granted with reciprocity by receiving the same type of information from the requesting Authority, without using banking secrecy as a reason not to provide such information.

Besides the mechanisms where Authorities are the main characters, countries around the world will also be relying more and more on financial institutions (FI) in order for these to act as cross-border tax agents. FI are, above all, required to provide certain financial information regarding the ultimate beneficial owner (UBO) holding an account or more with them.

As per FATCA, its worth to say that is a mechanism impulsed by the Internal Revenue Service (IRS) of the U.S. having as main objective gathering information of U.S. taxpayers holding foreign accounts. This applies to U.S. passport holders or citizens with green card. These individuals are obliged to report all their financial information to IRS, including details regarding any offshore structure.

Since July 1^st, 2014, any foreign FI (FFI) must be registered with the IRS and report certain financial details regarding their U.S. clients’ accounts. In case that a FFI fails to provide such information, the IRS foresees penalties based on a 30% withholding tax on diverse U.S. sourced payments including bank deposit and other interests, dividends and proceeds from U.S. debt or securities.

In addition, the U.S. government has imposed penalties for those FFI assisting individuals in tax evasion. Such are the cases of UBS fined with $780 Million, Credit Suisse Group AG with $2.6 Billion and the potential $9 Billion to BNP Paribas.

SLR