The OECD Transfer Pricing Guidelines describe the arm's length principle as the international standard for determining transfer prices for tax purposes, and base it on Article 9 of the OECD Model Tax Convention. The principle treats the members of a group as separate entities and compares their transactions with comparable transactions between unrelated parties.
The price that results from the comparison is called the arm's length price. Article 66-4 of Japan's Act on Special Measures Concerning Taxation defines it as the amount of consideration calculated by the most appropriate method, taking into account the content of the transaction and the functions performed by the parties, for a transaction carried out on ordinary terms between independent businesses.
Consider a hypothetical example in which, for a swap with a notional amount of 10 billion yen, unrelated parties would charge a fee of 5 million yen, while two group companies set a fee of 3 million yen. Under the arm's length principle, the difference from 5 million yen is the issue, and whether the Japanese rule applies depends on whether that difference raises or lowers the income of the Japanese company.