Definitions;
A
transaction in which the buyers and sellers of a product act independently and
have no relationship to each other. The concept of an arm’s length transaction
is to ensure that both parties in the deal are acting in their own self
interest and are not subject to any pressure or duress from the other party.
Under Companies Act, 2013 define Arm’s Length Transactions for
the purpose of Section 188(1), the expression Arm’s Length Transaction means a
transaction between two related parties that is conducted as if they were
unrelated, so that there is no conflict of interest.
Under Income Tax Act, 1961 Section 92F define Arm’s Length
Price is the price applied (or proposed to be applied) when two unrelated
persons enter into a transaction in uncontrolled conditions.
Unrelated Persons; Section 92A, the persons said to be unrelated if they are
not associated or deemed to be associated enterprise.
Uncontrolled Conditions; are that conditions which are not controlled or suppressed
or moulded for achievement of a predetermined results.
Main ingredients of Arm’s Length Price;
1. The price should be applied or
proposed to be applied in a transaction.
2. A transaction will be between two
unrelated or persons; and
3. The transaction should be in
uncontrolled conditions.
If
an international transaction includes only outgoings such as expenses,
interest, allowances or other then these are also decided or valued on the
basis of Arm’s Length Price [Section 92(1)]. Income includes losses and it will
be net of expenses as decide in case of UOI v. A Sanyasi Rao (1996) 219 ITR
330(SC).
Note: Section 92 is not applicable to a Non-resident whose
income is not taxable as per provisions sections 5 and 9 of the Income Tax Act,
1961.
Section
9 provides for income which is deemed to accrue or arise in India.
Section
5 provides “ that non residents is liable to tax in respect of income which is
received or deemed to be received in India by him or on his behalf or which
accrue or arises or deemed to accrue or arises in India during previous year.
Note: if certain policies of government restrict free play
and free movement of transactions in the market then the Arm’s Length Price
will be computed after considering these conditions and restrictions.
METHODS OF COMPUTATION OF ARM’S LENGTH PRICE SECTION 92C
Arm’s
Length Price can be computed by the following methods;
1. Comparable Uncontrolled Price
Method;
2. Resale Price Method;
3. Cost Plus Method;
4. Profit Split Method;
5. Transaction Net Margin Method;
6. Such other methods as may be
prescribed by the board.
Note: Where an assessee has entered into various types of
international transactions basis with associated enterprises, arm’s length
price should be determined on a transaction by transaction basis not on an
aggregate basis- Development Consultants (P.) Ltd. V. CIT.
1. COMPARABLE UNCONTROLLED PRICE METHOD(CUP);
Under
this method;
i)
Determined the price charged or paid for the property transferred or services
provided in a comparable uncontrolled transaction.
ii)
Such price is adjusted to account for differences, if any, between the
International transaction and comparable uncontrolled controlled transactions
or between the parties entering into such transactions, which could materially
affect the price in the open market.
iii)
The adjusted price arrived at under ii) is taken to be Arm’s Length Price in
respect of the property transferred or services provided in international
transaction.
Note: CUP is applied when price is charged for a product or
service. This is a comparison of prices charged for the property transferred or
service provided in a controlled transaction to a price charged for property or
services transferred in a comparable uncontrolled transaction.
2. RESALE PRICE METHOD;
Under
this method,
i)
The price at which property purchased or services obtained by the enterprise
from an associated enterprise are resold or are provided to an unrelated
enterprise, is identified.
ii)
Such resale price is reduced by the amount of normal gross profit margin
accruing to the enterprise or to an unrelated enterprise from the purchase and
resale of the same or similar property or from obtaining and providing the same
or similar services in a comparable uncontrolled transaction, or a number of
such transactions;
iii)
The price so arrived at is further reduced by the expenses incurred by the
enterprise in connection with the purchase of the property or obtaining the
services.
iv)
The price so arrived at is adjusted to take into account the functional and
other differences including differences in accounting practices , if any ,
between the international transaction and the comparable uncontrolled
transactions, or between the enterprises entering into such transactions, which
could materially affect the amount of gross profit margin in the open market;
v)
The adjusted price arrived at iv) is taken to be arm’s length price in respect
of the purchase of property or obtaining of the services by the enterprise from
the associated enterprise.
Note: This is applicable when property is purchased or
services are obtained from associated enterprises and the same are sold to
unrelated enterprises. This is based on the price of a property or service
purchased or obtained from an associated enterprise and further resale of the
same to unrelated enterprise.
3. COST PLUS METHOD;
Rule
10B prescribes the manner in which CPM can be applied. The text reads as
follows:
(i)
the direct and indirect costs of production incurred by the enterprise in
respect of property transferred or services provided to an associated
enterprise, are determined;
(ii)
the amount of a normal gross profit mark-up to such costs (computed according
to the same accounting norms) arising from the transfer or provision of the
same or similar property or services by the enterprise, or by an unrelated
enterprise, in a comparable uncontrolled transaction, or a number of such
transactions, is determined;
(iii)
the normal gross profit mark-up referred to in sub clause (ii) is adjusted to
take into account the functional and other differences, if any, between the
international transaction or the specified domestic transaction and the
comparable uncontrolled transactions, or between the enterprises entering into
such transactions, which could materially affect such profit mark-up in the
open market;
(iv)
the costs referred to in sub-clause (i) are increased by the adjusted profit
mark-up arrived at under sub-clause (iii);
(v)
the sum so arrived at is taken to be an Arm’s Length Price in relation to the supply
of the property or provision of services by the enterprise;”
Note: This method is applicable where some semi finished
goods are sold between related parties or similar situations or in respect of
joint facility agreements, long term buy and supply arrangements of provisions
of services.
4. PROFIT SPLIT METHOD;
Under
this method;
i)
The combined net profit of the associated enterprises arising from the
international transaction in which they are engaged, are determined;
ii)
The relative contribution made by each of the associated enterprises to the
earning of such combined net profit, is then evaluated on the basis of the
functions performed, assets employed or to be employed and risks assumed by
each enterprise and on the basis of reliable external market data which
indicates how such contribution would be evaluated by unrelated enterprises
performing comparable functions in similar circumstances.
iii)
The combined net profit is then split among the enterprises in proportion to
their relative contributions, as evaluated under ii);
iv)
The profit thus apportioned to the assessee is taken into account to arrive at
arm’s length price in relation to the international transaction.
Note: This method is applicable mainly in international
transactions involving transfer of unique intangibles or in multiple
international transactions which are so interrelated that they cannot evaluated
separately for the purpose of determining the arm’s length price of any one
transaction.
5. TRANSACTIONAL NET MARGIN METHOD (TNMM)
Under
this method;
i)
The net profit margin realised by the enterprise from an international
transaction entered into with an associate enterprise is computed in relation
to costs incurred or sales effected or assets employed or to be employed by the
enterprise or having regard to any other relevant base;
ii)
The net profit margin realised by the enterprise or by an unrelated enterprise
from a comparable uncontrolled transaction or a number of such transactions is
computed having regard to the same basis;
iii)
The net profit margin referred to in ii) arising in comparable uncontrolled
transactions is adjusted to take into account the differences , if any between
the international transaction and the comparable , uncontrolled transactions,
or between the enterprises entering into such transactions , which could
materially affect the amount of net profit margin in the open market;
iv)
The net profit margin realised by the enterprise and referred in i) is
established to be the same as the net profit margin referred in iii);
v)
The net profit margin thus established is then taken into account to arrive at
an arm’s length price in relation to the international transaction.
Note: The TNMM requires establishing comparability level at
a broad functional level. It requires comparison between net margin derived
from operation of the uncontrolled parties and net margin derived by an
associated enterprise on similar operation.
Under this method, the net profit margin realised by an
associated enterprise from an international transaction is computed in relation
to a particular factor such as costs incurred, sales, assets utilized, etc. The
net profit margin earned by an associate enterprise is compared with net profit
margin of uncontrolled transactions to arrive at arm’s length price.
The
Arm’s Length Price will be determined u/s. 92C (1) by using most appropriate
method. The Most Appropriate Method is best suited method to the facts and
circumstances of each particular transaction. If an enterprise entered into
various transactions with different associated enterprises, then same method
will not be applicable to all transactions. The Most Appropriate Method will be
selected considering the facts and circumstances of each and every transaction
to find out appropriate Arms’ Length Price.
As
held in case of Serdia Pharmaceuticals (India) (P.) Ltd. V. CIT [2011]
44 SOT 391(Mum), there is no particular order or priority of methods which the
assessee must follow. No method can invariably be considered to be more
reliable than others.
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