Arm's length.
The heart of the OECD regime.

Origin and basis of the principle

The arm's length principle emerged in the first half of the 20th century, when tax authorities realised that multinationals could manipulate intercompany prices to shift profit between jurisdictions. The conceptual solution was to treat each subsidiary as if it were an independent company, pricing intercompany transactions at the “market price” between unrelated parties.

The concept is consolidated in Article 9 of the OECD Model Convention (Model Tax Convention on Income and on Capital), the reference for double-taxation treaties worldwide. The OECD Transfer Pricing Guidelines (2022 update) detail its practical application.

Comparability analysis — 5 factors

To apply the arm's length principle, comparable transactions between independent parties must be identified. The OECD defines 5 comparability factors:

Perfect comparables rarely exist — the norm is to find “approximate” comparables and apply comparability adjustments to neutralise differences.

The arm's length range

Comparables do not necessarily generate a single price — they may generate a range of prices or margins consistent with the arm's length principle.

Article 47 of IN RFB 2,161/2023 uses the full range when every result has an equal degree of reliability. When the results have different degrees of reliability, the rule uses the interquartile range. A defensible application therefore starts with the quality of the comparable set, not with an automatic quartile calculation. See how that analysis is documented in a Brazil TNMM benchmarking study.

Numerical example

Assume, only for illustration, that differences in reliability make the interquartile range applicable to the following tested set:

• 10 comparables with net margins: 2%, 3%, 4%, 5%, 6%, 7%, 8%, 9%, 10%, 12%
• Median: 6.5%
• Interquartile range: 4% (Q1) to 9% (Q3)
• Tested company with a 3% margin: outside the range → adjustment required
• Tested company with a 5% margin: within the range → compliant

Comparability adjustments

When comparables have material differences from the tested transaction, adjustments are applied to neutralise them. The most common ones:

Working-capital adjustment

Companies with different receivable/payable terms have different profitability. Standard adjustment: apply an opportunity cost (the Selic rate or similar) to the working-capital difference.

Country-risk adjustment

Transactions in emerging markets carry more risk. Comparables from mature markets need an adjustment to reflect Brazil's risk.

Capacity-utilisation adjustment

Companies operating at suboptimal capacity have reduced profitability. The adjustment neutralises utilisation differences between comparables.

Each adjustment must be quantitatively justified. Excessive adjustments without robust justification leave the Local File fragile under audit.