The Arm’s Length Price (or “ALP”) represents the price that should have been paid between related parties had those parties not been linked to each other, as opposed to business transactions between related parties, which are done at an open market price. According to Section 92F of the Act, a “arm’s-length price” is a price that is imposed or intended to be applied to transactions between parties other than AEs under unregulated circumstances.
In simple words, it relies on the concept that “when two close people meet each other, there is a tendency to hug each other, and the law requires them to only give a formal handshake.”.
Section 92A of the Income Tax Act defines the relationship of related enterprises (AEs) as any direct or indirect involvement of another enterprise in the management, control, or capital of an enterprise. It also applies in cases where the same person (directly or indirectly) participates in the capital, management, or control of both businesses.
Section 92C of the Income Tax Act specifies the following procedures for determining arm’s-length price:
The best technique for a certain transaction would need to be chosen while taking into account the nature of the transaction, the class of transaction, any involved parties, and the roles played by those parties.
Comparable uncontrolled price (CUP) method.
CUP method is used when price is charged for a product or service. First, the price that must be charged for the good or service that is transferred in a “comparable uncontrolled transaction” must be established.
The price is then modified to reflect the practical distinction between the global transaction and the corresponding uncontrolled transaction, which has the potential to significantly impact the open market price.The ALP is the finalised adjusted price.
Resale price method (RPM). Cost plus method (CPM)
RPM is relevant when goods or services are obtained from associated enterprises and then sold to unrelated enterprises. It is determined by the price at which the enterprise resells or provides the good or service it acquired from an associated enterprise to an unrelated enterprise. If there is no comparable uncontrolled transaction, consider the gross profit of an unrelated person from the purchase and resale of comparable goods. This reduces the resale price by the normal gross profit margin accruing to the enterprise from the purchase and resale of similar goods. The enterprise’s expenses associated with the purchase of the property are also deducted from the price.
Cost plus method (CPM)
This approach can be used in cases where related parties sell semi-finished goods to one another or in scenarios that are comparable, or it can be used with joint facility agreements, long-term buy and supply arrangements, or service provider agreements.
Steps include determination of the direct and indirect production expenses in relation to the goods or services transferred to the related business. Identify the typical uncontrolled gross profit. For the functional and other variances seen in the foreign transaction, adjust the typical gross profit. ALP will be costs plus an adjusted gross profit markup.
In Hero Moto Corp Vs DCIT, the Delhi Bench of Income Tax Tribunal has held that the cost plus method was the most appropriate method for determining the arm’s length price, involving the procurement of raw material.
Profit split method (PSM)
This approach is mostly appropriate for foreign transactions involving the transfer of special intangibles or for numerous international transactions that are too intertwined to be assessed independently.
The first stage in this methodology is to determine the total net profit that the related enterprise will get from the overseas transaction.Analyse the contributions made by each party taking into account the roles they played, their responsibilities, the resources they used, and outside market information. Divide the total net profit by the contribution ratio that was previously established and Take the gain to reach to ALP.
Transactional net margin method (TNMM)
A broad functional level of comparability must be established for the TNMM. It necessitates a comparison between the net margins obtained from the operations of the uncontrolled parties and the net margins obtained from comparable operations by an associated enterprise
Prior to calculating the net profit margin from the similar uncontrolled transaction, the net profit margin from the international transaction with an affiliated firm must be determined. To arrive at ALP, subtract the difference between the transactions from the net profit of uncontrolled transactions and take the resulting net profit margin.
Such other methods as may be prescribed
The Central Board of Direct Taxes [CBDT] has issued a notification stating that the “other method” for determining the arm’s-length price in relation to an international transaction shall be any method that takes into account the price that 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, taking into account all the relevant facts.
The Mumbai bench of the Income Tax Appellate Tribunal (ITAT) held that the “Other method” as per Rule 10AB shall be the most appropriate method for determining the arm’s length price of royalty transactions in M/s. ASB International vs Additional income tax officer
The regulations state that the arm’s-length price of the international transaction or certain domestic transactions should be the arithmetic mean (average) of such prices if more than one arm’s-length price is determined by employing the most applicable transfer pricing method.
Taxpayers have been given some flexibility, though, by being permitted a range benefit that would be announced by the government and would not be greater than 3%. As a result, the price at which the transaction has actually been completed shall be deemed to be the arm’s-length price if the difference between the arm’s-length price and the price at which the transaction has actually been performed does not exceed the stated range of the latter.
In PCIT v. Aegis Limited, the Bombay High Court has held that the Transfer Pricing Officer (TPO) has authority to consider the external comparable in determining the arm’s length price.
Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates
