Meaning of the term “Arm’s Length Principle” :

The Arm‟s Length Price of a transaction between two associated enterprises is the price that would be paid if the transaction had taken place between two comparable independent and unrelated parties, where the consideration is only commercial.

The Arm‟s Length Principle (ALP), in the context of taxation, is explained in the OECD Model Tax Convention as under:

“Where conditions are made or imposed between two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”

The OECD transfer pricing guidelines provides guidance on the application of the arm’s length principle in order to arrive at the proper transfer pricing range between associated enterprises. Market forces determine business relations between independent parties. The Arm‟s length principle seeks to adjust the profits between two associated enterprises by comparing the same as if the transaction is carried out between two independent enterprises. It treats each enterprise as a separate independent entity rather than as inseparable parts of a single unified business.