Calculation of Arm’s Length Price Under Income Tax Act, 1961

Abstract

A separate code on transfer pricing under Sections 92 to 92F of the Indian Income Tax Act, 1961 (the Act) covers intra-group cross-border transactions which is applicable from 1 April 2001 and specified domestic transactions which is applicable from 1 April 2012. Since the introduction of the code, transfer pricing has become the most important international tax issue affecting multinational enterprises operating in India. The regulations are broadly based on the Organization for Economic Co-operation and Development (OECD) Guidelines and describe the various transfer pricing methods, impose extensive annual transfer pricing documentation requirements, and contain harsh penal provisions for noncompliance. The concept of Arm’s length derives its meaning from the independent relation shared between independent parties. Unlike business transactions between related parties, the transactions between unrelated parties are done at an open market price and accordingly, Arm’s Length Price (‘ALP’) demonstrates the price that should have been charged between related parties had those parties were not related to each other This concept along with the Indian legal provisions have been discussed in brief under this topic. Under Indian Transfer Pricing regulations, the entire transfer Pricing Mechanism is based on computation of income arising out of cross-border transactions having regard to the arm’s length price. The definition of ALP as defined under Organization for Economic Co-operation and Development (‘OECD’) Transfer Pricing Guidelines means a price, at which transactions between persons other than associated enterprises are carried out in uncontrolled circumstances. Articles also covers this. In general, the Indian Transfer Pricing Regulations provide exhaustive definitions of terms Associated Enterprise (‘AE’) and International Transactions on which the transfer pricing procedure is based. In other words, for the purpose of computing Arm’s length price, it is pertinent to understand the concept of AE and International transactions. He same is elaborated in the article. The term Associated Enterprises has been defined under the Income Tax Act, 1961 under section 92A (1). The concept of Deemed Associated Enterprises has been defined under section 92A (2) of the Act. Further, certain parties are defined as AE under Indian Domestic Transfer Pricing provisions. All the Income Tax Act provisions have been discussed. Finally, Associated enterprises entering in international transactions need to ensure that the transactions take place at an arm's length price as if the transactions were taking place between unrelated parties in an uncontrolled manner. If such arm's length price is not ensured and documents are not maintained in respect thereof, adjustments and penalties may be attracted.