On October 18, 2024, the Ministry of Finance issued an important notification that will impact how businesses determine the arm’s length price for international and specified domestic transactions for the assessment year 2024-2025. This new guideline is especially relevant for companies engaged in wholesale trading and other forms of commercial activity
What is Arm’s Length Pricing?
Arm’s length pricing is a principle used in tax law to ensure that transactions between related parties are conducted as if they were between unrelated parties. This principle helps prevent profit shifting and ensures that transactions are priced fairly for tax purposes. The Income-tax Act, 1961, mandates that businesses comply with this pricing mechanism to maintain tax integrity.
Key Highlights of the Notification
1. Variation Thresholds
The new notification specifies the variation thresholds that businesses can consider when determining arm’s length pricing. Here’s how it breaks down:
- For Wholesale Trading: If the variation between the arm’s length price and the actual transaction price is within 1%, the actual transaction price will be accepted as the arm’s length price.
- For All Other Cases: A variation of up to 3% is permissible. If the actual transaction price falls within this range, it will also be deemed as the arm’s length price.
2. Definition of Wholesale Trading
To qualify for the more lenient threshold of 1%, the transaction must meet specific criteria defining wholesale trading:
- Purchase Cost: The cost of finished goods must constitute 80% or more of the total costs associated with the trading activities.
- Inventory Levels: The average monthly closing inventory of these goods should be 10% or less of the total sales for those trading activities.
These conditions are designed to ensure that the trading activities genuinely reflect wholesale operations and do not inadvertently benefit from the relaxed pricing rules.
Implications for Businesses
Simplified Compliance
The new thresholds for arm’s length pricing provide significant relief for businesses, particularly those in wholesale trading. By allowing a greater margin of variation, companies can more easily align their transaction pricing with arm’s length standards without facing the complexities of rigorous adjustments.
Enhanced Clarity
The clear definitions provided in the notification help businesses better understand what qualifies as wholesale trading. This clarity reduces ambiguity in compliance and provides a framework for companies to evaluate their transactions against the outlined criteria.
