According to the arm's length principle, the price at which the transaction occurs is preferred for tax purposes, as it is a fair reflection of the value of the goods or services.
[2] However, when the parties that negotiate a transaction are related, they may set an artificially lower price with the intention to minimise their taxes.
[5] Such capital flight from the developing world is estimated at ten times the size of aid it receives and twice the debt service it pays.
[11] Another natural and generalizing example of wrong pricing, which lay stress on rational asymmetric development and the fact that the pricing throughout countries incorrectly varies significantly explains Stiglitz : “The average European cow gets a subsidy of $2 a day; more than half of the people in the developing world live on less than that.
It appears that it is better to be a cow in Europe than to be a poor person in a developing country…… Without subsidies, it would not pay for the United States to produce cotton; with them, the United States is, as we have noted, the world's largest cotton exporter” [12] This issue of prices, for which good and services are sold between the connected persons is addressed by the OECD Guidelines in accordance with international agreements to avoid double taxation.
Since in the second half of the 20th century, transfer mispricing had started to become a major problem and therefore, the OECD (Organisation for Economic Co-operation and Development) needed to unify regulatory frameworks to efficiently combat this phenomenon.
"[13] Governments have also devised many measures to avoid the misuse of transfer pricing thanks to these OECD publications, which outline several methods that may be used to assess legitimacy of a given transaction.
[citation needed] Khadija Sharife and John Grobler, writing for the World Policy Journal,[17] exposed $3.5 billion minimum in transfer mispricing of African diamonds from Angola and DRC, through the use of intra-company valuation, shell companies and tax havens, notably Dubai and Switzerland.