Methods to Determine Arm’s Length Price – Detailed Explanation

Methods to Determine Arm’s Length Price, We recently studied about Arm’s Length Price. Now let us study the various methods used to calculate ALP. For details you can refer Transfer Pricingand the problems faced in handling Arm’s Length Transactions Practical Difficulties In Application of Arm’s Length Price. Now you can scroll down below n check more details for “Methods to Determine Arm’s Length Price”

Methods to Determine Arm’s Length Price

Now let us do a detailed study about how can Arm’s Length Price be calculated. Here, we are providing you with a detailed explanation of the five methods of calculation of Arm’s Length Price.

1. Comparable Uncontrolled Price Method:

• Under this method the price charged or paid for any item under any comparable uncontrolled transaction or transactions should be
• Adjustment to the account for differences between the international transaction and comparable uncontrolled transactions which could materially affect the price in the open markets are done.
• The adjusted price as worked out as above will be considered as an arm’s length price for the item.

2. Resale Price Method:

• Under this method, the price at which the item purchased by the enterprise from an associated enterprise and is resold to an unrelated enterprise should be identifiable.
• The following adjustments can be made to such resale price.
  • For normal gross profit margin
  • For expenses incurred in connection with the purchase of the item.
  • For functional and other differences, including differences in accounting practices which could affect the gross profit margin in the open market.
• The adjusted price as stated above will be considered as the arm’s length price for the item.

3. Cost Plus Method:

• Under this method, the direct and indirect costs of production incurred by the enterprise for the item are to be d
• The amount of a normal gross profit mark-up to such costs arising from the same or similar item or by an unrelated enterprise in comparable uncontrolled transactions should be done.
• The above normal gross profit mark-up can be adjusted to be taken into account the functional and other differences which could materially affect such profit mark-up in the open
• Costs referred above should be increased by the adjusted profit mark-up and the price so arrived at will be considered as an arm’s length price of the item.

Must Read –

• Practical Difficulties In Application of Arm’s Length Price
• Profitability Index (PI) Detailed Analysis
• Weighted Average Cost of Capital

4. Profit Split Method:

• This is a method which may be applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter – related that they cannot be evaluated separately for the purpose of determining the arm’s length price of one transaction.
• Under this method, combined net profit of the associated enterprises arising from the international transactions in which they are engaged is first calculated.
• The combined net profit is then split amongst the enterprises in proportion to their relative contributions. The profit thus apportioned to the assessee is taken into consideration to arrive at the arm’s length price in relation to the international transaction.

5. Transactional Net Margin Method

• In this method, the net profit margin realized by the enterprise from an international transaction with an associated enterprise is computed having regard to the costs incurred or sales affected or assets employed or having regard to any other relevant base.
• The net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction by applying the same base as above is computed. This profit margin is adjusted to take into account the differences which could materially affect the net profit margin in the open market having regard to international transaction and comparable uncontrolled transactions or having regard to the enterprise entering into such transactions.
• If the net profit margin realized by the enterprise is established to be the same as the net profit margin, then the same is taken into consideration to arrive at an arm’s length price in relation to the international transaction.

In this way, The Arm’s Length Price is calculated under various methods.