Arm's Length Principle (ALP): Definition and How It Works
The arm's length principle defined: the rule that related-party prices must match independent prices, its OECD and Indian statement, and how it is tested in practice.
Definition
The arm’s length principle (ALP) is the rule that transactions between related parties must be priced as if the parties were independent dealings with each other on the same terms. It is the foundation of transfer pricing law worldwide: where a controlled price deviates from what independents would have agreed, the tax authority may adjust the price — and the resulting income — to the arm’s length result.
Its statements: OECD Model Tax Convention Article 9 (associated enterprises must be taxed as if independent); Indian law, section 92(1) of the Income-tax Act (income computed with reference to an arm’s length price for international transactions).
How it is tested
The principle is a standard, not a price. Testing it in practice means:
- Identifying the controlled transaction and the parties’ functional analysis (functions, assets, risks).
- Selecting a method (CUP, TNMM, cost plus, and the rest) that compares the controlled result against independent evidence.
- Computing the arm’s length range and placing the tested party’s result in it.
The full rule, in OECD and Indian terms, is covered in the arm’s length principle guide.
Example
An Indian manufacturer sells components to its US subsidiary at a price 12% below what unrelated buyers pay for the identical component on identical terms. The ALP says the subsidiary’s purchase price — and the Indian manufacturer’s revenue — should reflect the independent price; the difference is the exposure.
See also
- Related Party — who the rule applies to
- Controlled Transaction — what the rule applies to
- The arm’s length principle guide
FAQ
Is the arm’s length price a specific number? No — it is a result derived from comparable evidence, usually expressed as a range. The price is “arm’s length” if it falls within that range.
Does the ALP apply to domestic related-party transactions in India? Section 92(1) covers international transactions; specified domestic transactions (notably certain related-party loans and the section’s other listed cases) are also in scope. The international case is the core.
Run the screens as a study, not a spreadsheet
Quartyl applies the method, PLI and screening steps above as a pipeline — and keeps a documented reason for every exclusion.
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