The arm's length principle and comparability

Australia's double-tax agreements and domestic law require that pricing of goods and services and allocation of income and expenses between related parties comply with the arm's length principle.

The arm's length principle uses the behaviour of independent parties as a guide or benchmark to determine in international dealings between related parties:

• the pricing of goods and services
• how income and expenses are allocated.

It involves comparing what a business has done and what an independent party would have done in the same or similar circumstances. This principle is supported by all Organisation for Economic Co-operation and Development (OECD) countries.

Many factors may influence prices or margins, so you need to closely examine the dealings you're comparing and the circumstances of the parties involved. This comparison with arm's length activity means it is difficult to achieve absolute precision and certainty.

For dealings to be comparable:

• none of the differences between the situations should be material
• reasonably accurate adjustments can be made to eliminate the effect of any such differences.

The materiality of any differences depends on the facts and circumstances of each case and recognising that there's likely to be some uncertainty in the judgments that must be made.