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Tax planning disclosure and the arm’s length principle

In her recent blog on the Commission’s proposal on transparency rules for intermediaries, Paulina Szotek raises the interesting question whether this proposal embodies a separate EU concept of the arm’s length principle, distinct from that in the OECD’s transfer pricing guidelines.

The question arises in the context of the following specific hallmark of potentially aggressive tax planning: ‘An arrangement or series of arrangements which does not conform with the arm's length principle or with the OECD transfer pricing guidelines, including the allocation of profit between different members of the same corporate group’ (Category E in the Annex to the draft Directive). Referring to the Commission’s recent State aid decisions and how they apply an arm’s length principle derived from EU law rather than from the OECD’s rules , Paulina suggests that the reference to that principle in this hallmark is a reference to such a distinct EU version rather than that of the OECD.

I believe in ‘clear tax communication’, and the Commission’s drafting on this point is anything but clear! I also agree with Pauline that if their intention is to include a deviation from an EU arm’s length principle as a hallmark, before the existence and scope of such a principle is settled before the EU Court of Justice in the State aid cases, this would not be a good thing. However, there is some reason to question whether this is in fact their intention.

The basis for suggesting that the hallmark refers to a separate EU arm’s length concept appears to be the use of the word ‘or’, in the phrase ‘An arrangement or series of arrangements which does not conform with the arm's length principle or with the OECD transfer pricing guidelines’. The word ‘or’ is notorious for its ambiguity and should always be used with great care in legal drafting. Under one approach it could be used in the sense of ‘either… or’, i.e. either the arm’s length principle or the OECD guidelines are not being followed. The word ‘or’ can however also be used in the sense of ‘and’ to indicate a cumulative condition, i.e. does not conform with the arm’s length principle and also not with the OECD guidelines. Neither interpretation is particularly satisfying simply because both suggest that the arm’s length principle is not found in the OECD guidelines; while there may or may not be a separate EU concept, it is at any rate clear that an arm’s length principle is to be found in the OECD guidelines. Thus it is tempting to conclude, as Pauline does, that what is meant here by the arm’s length principle is a distinct ‘EU’ version, that can be used in the alternative to that found in the OECD guidelines. Certainly looking at the state aid decisions – albeit they arise in a different legal context - that would not be an unreasonable conclusion. An alternative approach could be to read the reference to the arm’s length principle as referring to that in the OECD guidelines and the reference to the OECD guidelines as referring to any other aspect of those guidelines – i.e. apart from the arm’s length principle itself, such as country-by-country reporting. Both approaches would be consistent with the use of ‘or’ in the sense of ‘either….or’. Interestingly the Commission’s public consultation questionnaire employed the ‘and/or’ formulation, so the shift to just ‘or’ would also support that view. But this sheds no light on whether the intention is to limit the hallmark to the OECD guidelines (including the OECD’s arm’s length principle) or to extend it to include, by way of alternative, an EU version of the arm’s length principle.

With a small amount of drafting effort this could have been made clear.

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