Non-arm’s length transactions under tax law

Non-arm’s length transactions under tax law

Section 78 of the Income Tax Ordinance, 2001 has been instituted to address non-arm’s length transactions. The Federal Board of Revenue (FBR) has provided clarity on this provision, which was updated up to June 30, 2021, through the Finance Act, 2021.

Understanding Section 78: Non-Arm’s Length Transactions

Section 78 of the Income Tax Ordinance, 2001, specifically targets transactions that fall under the category of non-arm’s length transactions. An arm’s length transaction is a transaction between two parties who are independent and not related. In contrast, a non-arm’s length transaction involves parties with a pre-existing relationship, potentially impacting the fairness of the transaction.

The key provisions of Section 78 are as follows:

(a) Consideration Equal to Fair Market Value: In the case of disposing of an asset in a non-arm’s length transaction, the person making the disposal shall be treated as having received consideration equal to the fair market value of the asset. This fair market value is determined at the time the asset is disposed of.

(b) Cost for the Acquirer: Simultaneously, the person acquiring the asset in a non-arm’s length transaction shall be treated as having a cost equal to the fair market value determined under clause (a). This ensures that the cost for the acquirer is based on the fair market value, maintaining a level playing field in the transaction.

This provision aims to prevent potential manipulation of transaction values in situations where parties involved have a close relationship. By treating the consideration for the seller and the cost for the buyer as the fair market value, the ordinance seeks to establish a fair and objective basis for taxation.

Importance of Fair Market Value: Fair market value is a key concept in taxation, representing the price at which a property would change hands between a willing buyer and a willing seller when neither is under compulsion to buy or sell, and both have reasonable knowledge of the relevant facts. Using fair market value in non-arm’s length transactions helps eliminate the possibility of undervaluation or overvaluation based on relationships rather than market realities.

Disclaimer and Implications: It’s important to note that the text provided in Section 78 is for informational purposes, and PkRevenue.com, while making efforts to provide the correct version of the text, is not responsible for any errors or omissions.

This section underscores the commitment of tax authorities to create a tax system that is equitable, transparent, and resilient to potential attempts at manipulating transaction values. By addressing non-arm’s length transactions, the ordinance aims to maintain the integrity of the taxation system and ensure that transactions accurately reflect market values. Businesses and individuals engaged in such transactions should be aware of these provisions to ensure compliance with the Income Tax Ordinance, 2001.