The Arm’s Length Price (ALP) ensures that transactions between related parties are priced in the same manner as they would be between independent, unrelated entities. This principle promotes fairness and transparency in international trade and taxation.
In the Union Budget 2025, a proposal was introduced to implement a scheme for determining the arm’s length price for international transactions over a three-year block period. This initiative aims to streamline the transfer pricing process, reduce the burden of annual assessments, and enhance certainty for taxpayers. By aligning with global best practices, the move is expected to simplify compliance and improve efficiency in cross-border tax administration.
Under Section 92C of the Income Tax Act, several methods are prescribed for computing the arm’s length price in international transactions.
This article explores the proposed ALP scheme in detail, highlighting its key features, implications for taxpayers, and alignment with international norms
What is the Arm’s Length Price (ALP)?
The Arm’s Length Price (ALP) refers to the price at which transactions between related parties (such as subsidiaries, affiliates, or associated enterprises) are conducted as if they were unrelated, dealing independently in an open and competitive market. This ensures that the terms and pricing of such transactions reflect fair market value, free from undue influence or manipulation.
The purpose of ALP is to prevent profit shifting and tax avoidance through artificially inflated or deflated prices in cross-border transactions. By applying the arm’s length principle, profits and expenses are allocated fairly, in line with industry benchmarks and regulatory expectations.
Legal Definition – Section 92F of the Income-tax Act, 1961:
“Arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.
This principle is a cornerstone of transfer pricing regulations and is crucial for ensuring transparency, tax compliance, and equitable treatment across jurisdictions
Importance of Arm’s Length Price in Transactions
The Arm’s Length Price (ALP) plays a vital role in maintaining fairness, transparency, and regulatory compliance in cross-border and intercompany transactions. For multinational corporations and large business groups, adhering to the arm’s length principle ensures that transactions with related entities are conducted at fair market value, just as they would be with independent third parties.
This pricing standard is essential to:
Ensure accurate tax reporting across jurisdictions, preventing the manipulation of profits to low-tax countries.
Reduce legal and regulatory risks by aligning with transfer pricing rules and international tax norms.
Promote transparency and integrity in financial reporting and corporate governance.
Avoid disputes and penalties from tax authorities by demonstrating compliance with established guidelines.
Protect public interest by ensuring a fair allocation of taxable income, thereby supporting domestic revenue generation.
In essence, the arm’s length principle fosters equitable business practices, strengthens global tax compliance, and supports the smooth functioning of international trade and investment
What is the Arm’s Length Price Scheme?
The Union Budget 2025 proposes the introduction of a new Arm’s Length Price (ALP) Scheme aimed at simplifying the determination of fair market value for international transactions between related parties.
Under this scheme, businesses will have the option to determine the ALP for a three-year block period, rather than undergoing annual transfer pricing assessments. Once the price is validated for the base year, it will apply consistently for the next two years for similar transactions, provided the underlying conditions remain unchanged.
This initiative seeks to:
Streamline compliance by reducing repetitive documentation and assessments,
Provide pricing certainty for multi-year intercompany transactions,
Align India’s tax framework with international best practices,
And enhance administrative efficiency for both taxpayers and authorities.
By offering greater predictability and reducing the compliance burden, the scheme represents a significant step forward in modernizing India’s transfer pricing regime
How is the Arm’s Length Price Scheme Beneficial for Businesses?
Under the current framework, businesses are required to undergo annual assessments of their Arm’s Length Price (ALP), often resulting in repetitive audits, documentation efforts, and potential disputes with tax authorities. This process can be time-consuming and administratively burdensome, particularly for companies engaged in recurring cross-border transactions.
The Finance Bill 2025 introduces a three-year ALP determination scheme, allowing eligible businesses to opt for a multi-year pricing review. Once the ALP is finalized and approved by the Transfer Pricing Officer (TPO) for the base year, the same pricing can be applied for the following two consecutive years, assuming the nature and conditions of the transactions remain consistent.
Key Benefits:
Reduces administrative burden and compliance costs
Minimizes disputes and litigation through pricing certainty
Simplifies documentation requirements over the block period
Modernizes India’s transfer pricing regime
Aligns with international best practices, enhancing global investor confidence
Overall, the proposed scheme promotes efficiency, consistency, and predictability, offering substantial relief to businesses engaged in similar intercompany transactions over multiple years
Section 92C of the Income Tax Act – Methods for Computing the Arm’s Length Price (ALP)
Section 92C of the Income Tax Act, 1961 prescribes various methods for determining the Arm’s Length Price (ALP) in international and specified domestic transactions between associated enterprises. These methods are designed to ensure that the pricing of such transactions reflects fair market value, as would be the case between unrelated parties in open market conditions.
Below are the six prescribed methods:
1. Comparable Uncontrolled Price (CUP) Method
This method compares the price charged in a controlled transaction with the price charged in a comparable uncontrolled transaction under similar circumstances. Adjustments are made to account for differences in terms, conditions, or other factors affecting the price.
Best used when: Identical or highly comparable products/services are involved.
2. Resale Price Method (RPM)
Used when a product purchased from an associated enterprise is resold to an independent party. The resale price is reduced by an appropriate gross profit margin (representing resale costs and a reasonable profit), arriving at the ALP.
Best used when: The reseller adds little value to the product before resale.
3. Cost Plus Method (CPM)
This method determines the ALP by adding a reasonable markup to the direct and indirect costs incurred by the supplier in a controlled transaction. It is useful when related entities engage in contract manufacturing, provision of services, or long-term supply arrangements.
Best used when: Semi-finished goods or services are transferred between group entities.
4. Profit Split Method (PSM)
PSM is applied in complex transactions where the involved parties contribute unique intangibles or are highly integrated operationally. The combined net profit is split between the entities based on their relative functions, assets, and risks.
Best used when: No reliable comparable data is available due to unique contributions from both entities.
5. Transactional Net Margin Method (TNMM)
This method compares the net profit margin earned by an associated enterprise from a controlled transaction with that of unrelated entities engaged in comparable activities. Adjustments are made for functional differences.
Best used when: Comparable transactions or margins are easier to identify at the net profit level than at the gross level.
6. Other Method
Recognized by Rule 10AB, the “Other Method” may be used when it provides a more reliable measure of the arm’s length price. This includes methods based on valuation techniques or market data, often used in royalty payments, guarantees, and intangible asset transactions.
Authority: Accepted by the Central Board of Direct Taxes (CBDT) and affirmed by the Income Tax Appellate Tribunal (ITAT) in various rulings
Arm’s Length Principle in Transfer Pricing
The Arm’s Length Principle is a fundamental concept in transfer pricing, requiring that transactions between related parties—such as parent companies and subsidiaries—are conducted under the same terms and conditions as they would be between independent, unrelated entities in a free and open market.
This principle is designed to:
Prevent profit shifting to low-tax jurisdictions,
Ensure accurate allocation of income and expenses, and
Promote fairness and transparency in cross-border transactions.
By mandating that the pricing of goods, services, or intellectual property exchanged between associated enterprises reflects fair market value, the arm’s length approach helps ensure that tax liabilities are correctly assessed in each jurisdiction involved.
In essence, the Arm’s Length Principle serves as a safeguard against tax avoidance, strengthens global compliance, and maintains the integrity of international trade and financial reporting
About the Author
Rohan
Rohan is a seasoned content writer with expertise in business registration, tax laws, trademark regulations, and corporate compliance. Known for his clarity and precision, Dinesh crafts insightful articles that provide practical, easy-to-understand guidance, helping businesses confidently navigate complex legal and regulatory landscapes
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