WHAT IS ARM’S LENGTH PRINCIPLE AND WHAT ARE THE METHOD TO DETERMINE ARM’S LENGTH
Arm length transaction is a very hot topic in transfer pricing. This article seeks to explain what it means “ at arm length and what are some of the traditional methods to determine “ arm length”
“ At Arm Length” means that a transaction performed within a company must be priced as if carried out between two UNRELATED parties. The price must be based on how much the transaction would cost if it were made in similar conditions on the open market.
Hence, it is important that a company should have a clear and well-defined transfer pricing policy that demonstrate every possible effort has been made to ensure that prices are determined at arm’s length.
Some of the normal methods to determine “arm length are as follows:
(i) Cost Plus(CP).
CP is often used for the sale of finished goods. The price is determined by adding a suitable mark-up to the costs incurred by the seller for raw materials, labour,etc. The mark up is based on the profit received by the company in comparable transactions with unrelated companies, or on profits received by a similar company in comparable transaction
(ii) Comparable Uncontrollable Price(CUP)
This method is a simple comparison. The price is effectively determined by using the price of a similar or comparable transaction between two unrelated companies
(iii) Resale Price(RP)
This method is often used for resale of finished goods. It is found by subtracting a suitable mark-up from the resale price. This mark-up is determined by examining the price for which the finished good would sell to a third party. This is estimated by comparing similar transactions between unrelated parties.
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October 19, 2009
Tags: Arms length, TRANSFER PRICING
Posted in: Performance Mgmt, TRANSFER PRICING
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