Arm’s Length Price Transfer Pricing
Related parties i.e. associated enterprises, often, due to being related, agree upon a price that may be below the market price i.e. the price charged in a transaction between two unrelated parties. This plays against international standards and places other entities at a disadvantage. Furthermore it hampers proper tax liability calculation and results in base erosion in economies harbouring such enterprises.
The principle of Arm’s Length Price plays a critical role in ensuring that the transfer price agreed between the associated enterprises is not below the market price.
A brief glance at the principle of Arm’s Length Price:
|Principle of International Taxation||Transfer Pricing|
|Transaction between||International Parties|
|Transfer Price||Price charged between two Associated Enterprises|
|Arm’s Length Price Principle||Price charged between two unrelated parties|
|Governing Provision||Section 92F (ii), Income Tax Act, 1961|
|Conditions for ALP||
|Methods of calculating ALP (Section 92C, Income Tax Act, 1961)||
Arm’s Length Price – Transfer Pricing
Arm’s length Principle – The ARM’s length principle is the fundamental principle within Transfer Pricing. The purpose of this principle is that where there is any transaction between two related parties (AE’s), the price charged/ received in such transaction should be equivalent or comparable to the price that would have been charged/ received, if the transaction was between unrelated parties. The relation between the parties, should not affect the price at which transaction is entered, i.e, there should be no discounts offered/premium charged, or other concessional treatments in the price, merely because the two parties are related.
Steps to compute the Arm’s length Price
- Identify unrelated transaction, which are similar to the transaction between related parties ;
- Make adjustment for difference in nature, quantum and scale for unrelated transaction and related party transaction;
- Arrive at Arm’s length Price
- Compare with the price in related party transaction and make suitable adjustment if the two price are different.
Depending on nature of transaction , different methods may be applied to arrive at the ALP for different transaction.
Arm’s Length Price Meaning [Section 92F]
Section 92F(ii) of the Income Tax Act, 1961 defines arm’s length price to mean a price –
- Which is applied, or proposed to be applied in a transaction
This implies that the arm’s length price can be applied to an existing transaction or may relate to a future transaction;
- Transaction is between person other than AEs
The person should not be either : –
- Associated enterprise
- Deemed Associated enterprises as per Section 92A;
- Transaction is entered in uncontrolled conditions
The conditions under which the transaction has taken place, should not have been designed or suppressed in a manner, so that certain predetermined results are obtained.
Arm’s Length Price (“ALP”) provides a benchmark against which transactions between Associated Enterprise can be compared.
Note : – The provisions relating to application of arm’s length price are not applicable where such application results in reduction of income or increase in losses for tax purpose in India (“Base Erosion Concept”).
Computation of Arm’s Length Price [Section 92C]
There are various methods which are used for determination of the ALP in relation to an international transaction. Each of these method can be applied to a particular set of transaction, based on their nature and facts.
As per Section 92C of the Income Tax Act, 1961, ALP shall be determined by any of the following methods : –
Traditional Transaction Method –
Transactional Profit Methods –
Other Method , can be considered as a method, which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.
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