Transfer Pricing: Definition, Arm's Length Principle and Intra-Group Use

The arm's length principle, five OECD methods and DEMPE analysis, applied in France and Switzerland.

Introduction: transfer pricing, the rule that governs exchanges between related entities

When a French subsidiary buys products from its Swiss parent company, pays a brand royalty or receives central services invoiced by the group, at what price should these exchanges take place? Transfer pricing refers to the price of transactions between entities of the same group, and its founding rule is the arm's length principle, the price independent enterprises would have agreed. This is not a subject reserved for giant multinationals: as soon as a group holds entities in several countries, or sometimes even in a single one, it sets transfer prices, often without knowing it.

« Where 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 may be included in the profits of that enterprise and taxed accordingly. », Article 9 of the OECD Model Tax Convention.

The stakes in 2026 rest on three converging developments. First, tax authorities have tightened their documentation and consistency requirements, in France as in Switzerland. Second, the OECD's DEMPE analysis has made substance more decisive than legal form, particularly for intangibles. Third, a European directive harmonising transfer pricing is under discussion, which could standardise practices. This article sets out the definition, origin, motivations, methods, the content of a transfer pricing report, the cases of application, the advantages and limits, the five mistakes to avoid, two worked cases, a word from the founder, a ten-question FAQ and an operational summary.

Secure your transfer prices with Hectelion

Setting a defensible transfer price requires a rigorous economic valuation, distinct from tax advice. Hectelion works on the value of assets and flows exchanged within a group, notably the valuation of intangible assets and the structuring of intra-group flows, in France as in Switzerland. To discuss it, book a first thirty-minute call through our online calendar, then read on to understand each mechanism of the subject.

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Definition: what is transfer pricing?

Transfer pricing refers to the price at which one entity of a group sells a good, renders a service, lends funds or grants a right to another entity of the same group. Because the two parties are related, this price is not set by a market, it is decided internally. The risk is obvious: by inflating or understating these prices, a group could artificially shift its profits to low-tax countries. To prevent this, the international rule requires that the intra-group price be the arm's length price, that is, the price independent enterprises would have agreed in comparable circumstances.

The scope is very broad. It covers sales of goods, the provision of services, royalties on brands and patents, financial loans and guarantees, the secondment of staff or the use of an intangible asset. Every flow between related entities is a potential transfer price, one that must be capable of justification. Transfer pricing is therefore not an optimisation technique in itself, but a consistency requirement: invoicing between companies of a group as one would invoice a third party.

Origin: from the OECD's arm's length principle to the BEPS project

The arm's length principle has appeared in Article 9 of the OECD Model Tax Convention for decades and runs through the bilateral treaties that prevent double taxation. The Transfer Pricing Guidelines, published and regularly updated by the OECD, give it operational form, method by method. They form the common reference of tax authorities, including those, like Switzerland, that have no dedicated law.

The recent turning point is the BEPS project, against base erosion and profit shifting, led by the OECD and the G20 and published in 2015. It introduced two major advances now integrated into the 2022 edition of the Guidelines. On one hand, the DEMPE analysis, which attaches the return of an intangible to the entities that actually perform the key functions, and not to its sole legal owner. On the other, a three-tier documentation, the Master File, the Local File and the Country-by-Country Report, which gives tax authorities an overall view of groups. The logic behind it all fits in one sentence: profits must be taxed where value is actually created.

Why transfer pricing is a stake for every group

First, tax security. A poorly justified transfer price exposes a group to a reassessment in one country, with no guarantee of a symmetrical correction in the other, hence double taxation. It is the number one financial risk of international groups.

Second, documentary compliance. Beyond certain thresholds, documentation is mandatory, and its absence is sanctioned as such, regardless of whether the prices themselves are sound. Failing to document is costly, even when prices are correct.

Third, predictability. A clear and stable transfer pricing policy avoids disputes, eases relations with tax authorities and secures the group's financial planning.

Fourth, economic consistency. Aligning internal prices with each entity's real contribution makes the allocation of profits defensible and limits friction between subsidiaries.

Fifth, preparing operations. During a reorganisation, an acquisition or a sale, the transfer pricing policy and the value of the assets transferred are examined closely, and a solid base avoids unpleasant surprises.

How a transfer price is determined: the OECD's five methods

The OECD recognises five methods, split into two families. Traditional transaction methods compare prices or margins directly. Transactional profit methods compare profitability. The choice depends on the nature of the transaction, the availability of comparables and the function performed by each entity. No method is superior in absolute terms: the most suitable one is retained, the one offering the most reliable comparables.

OECD method	Principle	Typical use
Comparable Uncontrolled Price (CUP)	Compare the intra-group price to that of an identical independent transaction	Commodities, listed products, comparable royalties
Resale price method	Start from the resale price to the customer, less a market distribution margin	Distributors who resell without transformation
Cost plus method	Add a market margin to the costs borne by the supplier	Service provision, contract manufacturing
Transactional Net Margin Method (TNMM)	Compare the net margin of the tested entity to that of independent companies	Frequent case when price comparables are lacking
Profit split method	Allocate combined profit according to each entity's contribution	Unique intangibles, highly integrated activities

What a transfer pricing report contains: Master File, Local File and DEMPE analysis

The documentation arising from the BEPS project is organised in three complementary tiers, which every group reaching the thresholds must prepare. The Master File gives an overall view of the group: its structure, its activities, its intangibles and its transfer pricing policy. The Local File details each entity's transactions, the functional analysis, the choice of method and the comparables study that justifies the prices. The Country-by-Country Report (CbCR), reserved for large groups, aggregates the key figures, revenue, profits and taxes, country by country.

Document	Content	Scope
Master File	Overall view of the group, intangibles, pricing policy	Whole group
Local File	Local transactions, functional analysis, method, comparables	Entity by country
Country-by-Country Report (CbCR)	Revenue, profits and taxes by jurisdiction	Large groups only

The valuation of the assets or elements transferred is the foundation of these three documents. Every price entered in the Local File, every royalty rate retained, every recharged flow rests on a defensible value, established under a reproducible financial method, cost approach, market approach or income approach depending on the nature of the asset. Without this independent valuation brick, the Local File documents a chosen method with no proof that the price retained is genuinely at arm's length: it is this brick that turns a statement of intent into a defensible position before the tax authority.

Added to these documents, for intangibles, is the DEMPE analysis, named after the five functions, development, enhancement, maintenance, protection and exploitation. It establishes which entity actually performs and controls these functions, and therefore to whom the return on the brand or patent should go. This is the core of justifying an intra-group royalty, a subject we cover in depth in our dedicated analysis of the transfer pricing of intangible assets. The role of the independent valuer is to provide the value brick and the arm's length rate on which this documentation rests.

When transfer pricing applies

Transfer pricing applies as soon as transactions exist between related entities crossing a tax border. This covers sales of goods between a parent company and its subsidiaries, central services invoiced by headquarters, brand or patent royalties, intra-group loans and guarantees, or the recharging of shared costs. In some countries, it also concerns purely domestic transactions between related entities.

Contrary to a common belief, it does not only concern large groups. An SME with a foreign subsidiary, or a holding company that charges its subsidiaries for services, is concerned, even if its documentation obligations are lighter below the thresholds. The subject becomes particularly sensitive during a reorganisation, an intangible migration, a tax audit or a sale, where price consistency and asset value are examined closely, a point we also address from the angle of the differences between France and Switzerland.

Who to call on

Three areas of expertise combine on a transfer pricing file. The first is tax and legal: defining the strategy, preparing the documentation and managing the relationship with the tax authority, the role of lawyers and tax advisers. The second is economic and financial: establishing the value of assets and flows, building the comparables study and modelling the arm's length rates. The third is practical knowledge of the jurisdictions concerned, here France and Switzerland, whose frameworks differ markedly.

Hectelion works on the second strand, as an independent boutique firm, alongside your tax advisers. Our role is neither to draft the transfer pricing documentation nor to deliver tax advice, but to provide the independent and defensible economic valuation, the value of intangibles and the arm's length royalty rate, using a multi-method methodology aligned with IVSC standards and the OECD Guidelines. We support groups and transactions of 2 to 500 MCHF, in full independence from traditional financial intermediaries. Upstream, a targeted financial due diligence secures the data on which the valuation rests.

Advantages: security, consistency, predictability

The first advantage of a well-built transfer pricing policy is security: it reduces the risk of reassessment and double taxation, and eases obtaining advance agreements with tax authorities. The second is consistency: by aligning internal prices with the reality of functions and risks, the group makes its allocation of profits legible and defensible in every country. The third is predictability: a stable method, documented and applied year after year, avoids costly disputes and secures the group's financial planning. Well conducted, the process turns a regulatory constraint into a clear management framework.

Limits: complexity, documentation, scrutiny

The first limit is complexity. Transfer pricing draws on tax law, finance and comparables analysis, with rules that vary from one country to another despite the OECD's common foundation. The second limit is the cost of documentation, which weighs proportionally more heavily on mid-sized groups, even as large groups have dedicated teams.

The third limit is the intensity of scrutiny. Transfer prices are among the first items checked during an international tax audit, and the uncertainty inherent in comparables and intangibles leaves tax authorities a margin of judgment. Added to this is a moving regulatory landscape, with a proposed European directive still under negotiation. A transfer pricing policy must therefore be reviewed periodically, as the framework and case law evolve.

The 5 mistakes to avoid

Mistake 1: Confusing transfer pricing with tax evasion

Transfer pricing is not in itself a practice of evasion, it is a consistency requirement. Invoicing between companies of a group as one would invoice a third party is perfectly legitimate. Abuse only begins when prices are manipulated to artificially shift profits. Approaching the subject with a presumption of suspicion leads to poor decisions.

Mistake 2: Neglecting documentation

Beyond the thresholds, the absence of a Master File and a Local File is sanctioned as such, regardless of whether the prices themselves are sound. Many groups believe they are compliant because their prices are fair, but get penalised for lack of documentation. The document is not a formality, it is the evidence.

Mistake 3: Applying a price without a comparables study

A price or margin chosen out of habit, with no reference to comparable independent transactions, does not withstand an audit. Selecting and adjusting comparables is the core of the demonstration. A figure without comparables is a figure without a defence.

Mistake 4: Ignoring substance in favour of the legal structure alone

Since BEPS, housing an intangible or a function in an entity solely because of its legal status is no longer enough. The DEMPE analysis attaches the return to the entities that actually perform the functions and control the risks. An entity without substance receives only a financing return, never the residual profit.

Mistake 5: Forgetting multi-year and cross-jurisdiction consistency

Transfer pricing is not a one-off exercise. It must be consistent from one year to the next and symmetrical between the countries concerned, failing which one tax authority adjusts without the other correcting, creating double taxation. Swiss case law indeed recalls that arm's length is assessed year by year.

Case 1: an intra-group service invoiced under the cost plus method

A Swiss parent company provides central services, finance function, information systems and support functions, for the benefit of its French subsidiary. How should these services be invoiced defensibly? The transaction concerns neither a listed good nor a unique intangible, but services whose cost is identifiable. The suitable method is cost plus, which adds a market margin to the costs borne by the provider.

The direct and indirect costs attributable to these services amount to CHF 2,000,000. A comparables study on independent service providers sets the arm's length margin at 5%. The intra-group invoice therefore comes to CHF 2,100,000 for the year. This amount is deductible at the French subsidiary and taxable at the Swiss parent, provided the costs are real, correctly attributed and the margin is documented by comparables. A flat-rate invoice without a cost base or a justified margin would be exposed to a reassessment.

Case 2: a 2% intra-group brand royalty

The same French subsidiary uses the group's brand, developed and held by a Swiss company. It must pay an arm's length royalty for this use. The method retained is the comparable price method, based on licence agreements in the sector, which sets the rate at 2% of revenue generated under the brand. On revenue of EUR 20,000,000, the annual royalty comes to EUR 400,000.

Two conditions frame this result. First, the DEMPE analysis: the Swiss company only legitimately receives this royalty if it actually develops, protects and manages the brand, with the corresponding substance. Second, the value of the brand itself, which underpins both the rate and any transfer, must be established by an independent valuation, generally through the relief-from-royalty method. We detail this valuation in our publication on brand valuation, and its safeguarding through a ruling when the stakes justify it.

A word from the founder

« Transfer pricing suffers from a misunderstanding. Many executives associate it with the aggressive tax optimisation of multinationals, when it is first and foremost a matter of common sense: invoice your subsidiary as you would invoice a third party. As soon as a group has an entity abroad, it is concerned. »

« I see two costly reflexes. Some document nothing, convinced their prices are fair, and get penalised on the sole absence of a file. Others build sophisticated legal structures with no real substance, and the DEMPE analysis catches up with them. Good practice is the reverse: substance, comparables, and clean documentation. »

« Our place is precise. We do not replace the tax adviser, we give them the independent economic value that holds up under an audit, in France as in Switzerland. A substantiated royalty rate, a reproducible asset value, aligned with the OECD. It is this brick that turns a risk into a defensible position. »

Aristide Ruot, Ph.D.
Founder | Chief Executive Officer, Hectelion SA

FAQ: the 10 essential questions on transfer pricing

Introduction: what to remember before the questions

Transfer pricing follows a logic simple to state: invoice between related entities at the arm's length price, justify it with comparables and document it. The following questions answer the most frequent queries of executives and finance departments of groups active in France and Switzerland.

Q1: What is transfer pricing in simple terms?

It is the price at which two companies of the same group exchange a good, a service, financing or a right. Because they are related, this price must be set as if they were independent partners, that is the arm's length principle.

Q2: What is the arm's length principle?

It is the rule that a transaction between related entities must be invoiced at the price independent enterprises would have agreed in comparable conditions. It appears in Article 9 of the OECD Model Convention and underpins the entire transfer pricing framework.

Q3: What are the OECD's five transfer pricing methods?

The Comparable Uncontrolled Price method, the resale price method, the cost plus method, the transactional net margin method and the profit split method. The choice depends on the transaction and the comparables available, no method being superior in absolute terms.

Q4: What are the Master File and the Local File?

The Master File presents the group as a whole, its structure, its intangibles and its pricing policy. The Local File details each entity's transactions, the functional analysis, the method retained and the comparables study. Together they form the base documentation required beyond the thresholds.

Q5: What is the Country-by-Country Report (CbCR)?

It is a statement, reserved for large groups exceeding a consolidated revenue threshold, that summarises revenue, profit and tax country by country. It gives tax authorities an aggregated view to spot inconsistencies, but does not replace the Master File and Local File.

Q6: What is the DEMPE analysis?

DEMPE refers to the five functions related to an intangible: development, enhancement, maintenance, protection and exploitation. It determines which entity, actually performing these functions, is entitled to receive the return on the intangible, beyond legal ownership alone.

Q7: Does transfer pricing concern SMEs or only multinationals?

It concerns any group with transactions between related entities, including an SME with a foreign subsidiary or a holding company that charges its subsidiaries. Documentation obligations are lighter below the thresholds, but the arm's length principle itself applies to all.

Q8: How does Switzerland regulate transfer pricing?

Switzerland has no dedicated law, but applies the arm's length principle through Article 58 of the Federal Act on Direct Federal Taxation, under the heading of assessable benefits, and refers to the OECD Guidelines. Formal documentation is lighter there than in France, and the practice of cantonal rulings is well developed.

Q9: What are the risks of an incorrect transfer price?

A reassessment of taxable profit, penalties, late interest and, absent a correction in the other country, double taxation. The absence of documentation is also sanctioned in itself, regardless of whether the prices are sound.

Q10: Who must prepare the transfer pricing documentation?

Responsibility lies with the group, which relies on its tax advisers for strategy and documentation, and on an independent valuer for the value of assets and the arm's length rates. This separation of roles strengthens the probative force of the whole.

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Conclusion: invoice between related entities as between independents

Transfer pricing is neither an optimisation technique nor a subject reserved for multinationals. It is the application of a single principle, arm's length, to all exchanges between entities of the same group: invoice internally as one would invoice a third party. Mastering it rests on three pillars, a suitable method chosen among the OECD's five, up-to-date documentation made up of the Master File, the Local File and, for large groups, the Country-by-Country Report, and real substance, which the DEMPE analysis comes to verify for intangibles. For a group active in France and Switzerland, security comes from prices justified by comparables, an asset value established by an independent valuer, and consistency maintained over time and across jurisdictions.

Article summary

Transfer pricing is the price of transactions between entities of the same group, subject to the arm's length principle of Article 9 of the OECD Model Convention. It covers goods, services, financing and intangibles, and concerns any group with related entities, SMEs included. Five methods allow it to be determined: comparable price, resale price, cost plus, transactional net margin and profit split.

Compliance rests on three-tier documentation arising from the BEPS project, the Master File, the Local File and the Country-by-Country Report, whose foundation is the valuation of the assets and flows transferred, completed for intangibles by the DEMPE analysis, which attaches the return to the entities actually performing the key functions. The two worked cases illustrate this: central services invoiced under cost plus, CHF 2,000,000 of costs marked up by 5%, that is CHF 2,100,000, and a 2% brand royalty on revenue of EUR 20,000,000, that is EUR 400,000, subject to substance and a documented value.

Success rests on a separation of roles: the tax adviser for strategy and documentation, the independent valuer for the value of assets and the arm's length rates. Hectelion provides this defensible value brick, in France as in Switzerland, for groups and transactions of 2 to 500 MCHF, in full independence from traditional financial intermediaries.