Affiliated companies must conduct business at arm’s length, with no special discounts or price reductions beyond those offered to any customer. This ensures fair market value and prevents tax issues. Some countries have laws on intercompany pricing.
In today’s global business environment, it is not unusual for subsidiaries of larger companies to transact business with each other as if they were not part of the same corporate family. When two companies are affiliated by a connection through a parent company, the type of business they conduct is often referred to as an independent transaction. The unit price that is quoted for items bought and sold is known as the arm’s length price. Here is some background on how the market price concept works and why it is considered important.
The basic premise behind the market price extension is to ensure that even though both buying and selling companies are affiliated through a parent company, the extended rates or prices will still reflect fair market value. This means that while the subsidiary can enjoy the same volume discounts that can be extended to any customer with a similar pattern of volume purchases, there will be no special internal discounts extended. In effect, the arm’s length price is another way of stating that the sister company cannot expect any discounts or price reductions beyond those that would be extended to any customer.
Extending the price an arm’s length essentially accomplishes two things. First, this form of pricing structure is good for the seller. Pressure to supply goods at a sister company’s cost would easily reduce profits and could put the company in a precarious financial position. Second, spreading the price over distance helps prevent things like taxes from becoming a problem.
Because there is no special pricing for the affiliated business, there is no need to conduct any government investigation into possible activities that were undertaken to intentionally reduce taxes owed by one or more of the affiliated businesses. Both reasons also contribute to a third reason. With the extension of the market price, there is no doubt about the conflict of interest. The structure of trading products for income is completely transparent, with no ulterior motives to read into the transaction.
Several countries have laws establishing guidelines for determining intercompany or arm’s length pricing structures. When dealing with a supplier that is affiliated with the buyer through a third party, it’s always a good idea to make sure that the extended price is within the legal limits that apply to both the buyer’s and seller’s locations.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
