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Arm’s Length Price Transfer Pricing.

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June 4, 2021 |

9 mins read

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
  • Applied or proposed to be applied in a transaction (existing or future);
  • Transaction between persons other than Associated Enterprises;
  • Transaction is entered in uncontrolled conditions
Methods of calculating ALP (Section 92C, Income Tax Act, 1961)
  • Traditional Transaction Method;
    • Comparable Uncontrolled Price Method
    • Resale Price Method
    • Cost Plus Method
  • Transactional Profit Method;
    • Profit Split Method;
    • Transactional Net Margin Method
  • Any other method prescribed by the Central Board of Direct Taxes (Rule 10AB)

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.

International Taxation Services

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 –

ANY OTHER METHOD PRESCRIBED BY THE CENTRAL BOARD OF DIRECT TAXES – Rule 10AB

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.

For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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