Arms length transaction

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Pradip Srinivasan

Pradip Srinivasan (Querist)
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05 December 2009 What does Arms length transaction mean?

Sunil

Sunil (Expert)
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05 December 2009 In International Transactions usually when related parties transact, eg. a foreign parent and Indian subsidiary, chances are that Indian subsidiary may sell to the foreign arm at a rate that is lower than what the foreign arm will pay elsewhere to buy the similar product. In this case the Indian Government would assume that income has been transferred out of India as arms length price is not charged to the foreign company. Similar holds good in reverse. Foreign Parent can force an Indian subsidiary to purchase raw material from a particular vendor at a higher price than what is the fair market price because of its relation with the vendor. The Indian Government would expect the transaction to be at arms length, i.e in comparison to other vendors supplying similar products.

In both cases, to be at arms length, the deviation should not be more than 5% as per the lowest calculated price for purchase transaction and not less than 5% as per the highest calculated prices in case of sales transactions. Department has prescribed various methods of calculating the prices and you have to apply all before determining the percentage of variance. This is applicable only for transactions between RELATED parties in international transactions.