ARM LENGTH PRICE (ALP), Advance Pricing Agreement (APA), Safe Harbor

 

ARM LENGTH PRICE (ALP) PRINCIPLE:  

• ARM LENGTH PRICE (ALP) is the price at which two independent unrelated business entities execute business/economic transaction in natural/uncontrolled conditions usually corresponding to fair market price. 
• Fair Price means if the transaction is taking place as if sub.A was having transaction at same rate as if it was having with any another MNC Let it be MNC-Y. 
• The price at which such transaction takes place  is ALP.

              

In the image, sub.A and sub.B are subsidiaries of MNC X. If there is any economic transactions between sub.A and sub.B at fair price or market price ,then it is ARM LENGTH PRICE.

Advance Pricing Agreement (APA):

• Advance Pricing Agreement (APA) is an agreement between the government authorities and the MNC which determines in advance the most appropriate Transfer Pricing (TP) methodology or the arm's length price (ALP) for any  inter-subsidiary international transactions for a future period of time. 
• In case of India, this time period is five years as per the Indian Advance Pricing Agreement  regulations. 
• The main objective of the Advance Pricing Agreement (APA) is to provide tax certainty by determining an advance set of criteria applied to transfer pricing 
• Advance Pricing Agreement (APA) reduce disputes and enhances the tax revenue.

Safe Harbor wrt Income Tax: 

• Safe Harbour provide for methodologies adopted by companies in which a certain category of taxpayers can follow a simple set of rules under which transfer prices when applicable are automatically accepted by the revenue authorities.
•  A 'safe harbour', in a Transfer Pricing regime, relieves eligible taxpayers from certain complicated obligations which are otherwise imposed by a jurisdiction's general Transfer Pricing rules.

SAFE HARBOR Provisions wrt Information Technology  Act  : 

• The safe harbour provision has been given under Section 79 of the IT Act 2000. 
• It states that "an intermediary shall not be liable for any third-party information, data, or communication link made available or hosted by him". 
• Ex. Facebook will not be liable for any legal charges if any individual post any illegal comment on it .

Traditional vs Socialist vs Capitalist vs Anarcho Capitalism vs Mixed Economy, Formal vs Informal Economy

 

Traditional Economy: 

• A traditional economy is an original and primitive economic system. 
• The traditions, customs, and belief system of the economy define the nature of   the goods and the services to be produced in an economy, as well as the rules and manner of their distribution. 
• Example: Tribal Communities.

CAPITALIST ECONOMY:

• The purchasing power /desire /demand /wants rather than the basic needs of the people decides what goods are to be  produced and  distributed among people .
• As the control is in the hands of industrialist ,then methods of production will always be selected in the manner in which it is more and more profitable to the businessmen. 
• The produced goods and services are distributed as per the demand /purchasing power of the people.
• Most of the countries in today’s world are moving towards Capitalist mode of Economies.
• Ex. Cheaper housing  for the poor is the basic need of the masses but this demand don’t create demand in the market sense because the poor do not have the purchasing power to support the demand. 

SOCIALIST ECONOMY:

• In a socialist society , the government which decides what goods are to be produced. 
• The decision is  in accordance with the needs rather than the demands  of the society. 
• It is assumed that the government knows what is good for the people of the country and so it takes care of the needs of the people and the desires of individual consumers are not given much importance.
• Ideally, a socialist society has no private property since everything is owned by the state. 
• The methods used for production are labour intensive creating more and more of the jobs.
• In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. 
• Example: The then USSR and China of 1990,s and Cuba.

MIXED ECONOMY:

• In the mixed Economy, both the government and the market together answer the three questions of what to produce, how to produce and how to distribute what is produced.
•  In a mixed economy, the market will provide whatever goods and services it can produce well and it is concerned about the demand /desires/purchasing power  of the society. 
• On the other hand, the government will provide essential goods and services which the market fails to do. 
• India is the classic case of mixed Economy.

Anarcho Capitalism : 

• A radical concept of Political state which advocates for demolition of state and talks of police and legal services to be provided by  the private sector .
• Javier Milei ,the rpesident of Argentina is of this ideology and considered to be the ultra right.

INFORMAL ECONOMY: 

• The informal sector, informal economy, or grey economy is the part of an economy that is not part of the formal system ie it is neither taxed, nor accounted in government records. 
• Unlike the formal economy, activities of the informal economy are not included in Gross Domestic Product (GDP).
• Ex. any nearby shop from which you make purchases without any bill.

FORMAL ECONOMY:

• All the activities of an economy which pay taxes to the government and are accounted in the government records. 
• This economy constitutes a part of Gross Domestic Product (GDP). 
• Example: All the purchases from any mall in which you receive the bill.

Output vs Outcome, OUTCOME BASED BUDGETING

Output vs Outcome:

Outputs are tangible results of an activity which are short term, immediate and quantifiable

while

Outcomes are long term results having a long-lasting impact, qualitative and more focussed on qualitative aspect rather of merely quantitative aspect.

To understand:

01.Total sanitation campaign came into force in 1999 and on records there were toilets constructed in rural areas throughout the country but still people defecated in open.

Construction of toilets in numbers is Output while habit of using toilet is outcome.

Conclusively in case of TSC, output was there but outcome was not there.

02.Sarve Shiksha Abhiyan (SSA) is operational since 2002 and target was to educate all children between 6-14 age by 2010.

But ASER report-2023 published by NGO PRATHAM observed that over 50 % of the children in the age group of 14-18 years are not able to do elementary calculations.

So, bringing children to school is output but learning abilities is outcome, and ASER report clearly highlights that aspect.

Outcome Based Budgeting (OBB):

In view of such examples, outcome budgeting becomes of significance. In terms of Outcome Budgeting, Outcomes refer to the ultimate products and results of various government initiatives and interventions, These are represented in terms of qualitative targets and achievements, enhancing the comprehensiveness of the technique.

• outcome-based budgeting is one of the prominent budgeting methods currently practiced in India.
• OBB involves outlining and estimating the results of each program or scheme that has been developed.
• In OBB, program outcomes are evaluated not merely in monetary terms but also through physical achievements expressed in actual figures, such as learning abilities of students.
• Additionally, outcomes are conveyed in terms of qualitative targets and accomplishments to enhance the overall technique's comprehensiveness.
• This method assesses the developmental outcomes of all government programs and determines whether funds have been utilized for their intended purposes, including the effectiveness of financial expenditure.
• The outcome budget contributes to improved service delivery, informed decision-making, program performance evaluation, communication of program objectives, enhanced program effectiveness, cost-effective budgeting, accountability establishment, and better management of schemes.
• Outcome budgeting shifts the focus of government programs from being oriented around expenditures to being focused on results.
• In India, the Performance Budget was integrated with the Outcome Budget in 2007-08, resulting in a single document known as the Outcome Budget.

As on date in India, All ministries are required to prepare outcome budgets and presents it to Finance Ministry to ensure that budgeting is directed towards achieving specific targets.

Sterlisation, Market Stabilization Scheme

 

STERLISATION: 

• Monetary action in which a central bank limits the effect of inflows and outflows of  foreign capital on the money supply.
•  It involves open market operations undertaken by RBI to neutralize the impact of  associated  foreign exchange operations.

DYNAMICS OF STERLISATION:

BOP should be zero in the accounts of RBI. 

When FDI and FPI increases 

                        ↓

 BOP becomes positive.

                        ↓

 + BOP should be neutralized 

                        ↓

RBI purchased extra Dollar 

                        ↓

Injection of Rupee in the economy 

                        ↓

Inflation in the economy and depreciation of Rupee.

                        ↓

RBI sell G-Sec to absorb liquidity 

                        ↓ 

Economy gets stabilized 

This whole process that starts with influx of foreign currency to the stabilization of Rupee is referred to as sterilization.

Market Stabilization Scheme (MSS): 

• Monetary management tool used by the Reserve Bank of India to suck out sudden excess liquidity from the market through issue of securities like Treasury Bills, Dated Securities etc. on behalf of the government.
• Surplus liquidity arising from sudden large capital inflows is absorbed through sale of temporary short-dated government securities and treasury bills. The money raised under MSS is kept in a separate account called MSS Account and not used by the government and hence it does not have any impact on Budget deficit.
• The interest cost is shown separately in the Budget and interest payment liability against this scheme is called carrying cost.
• MSS was used in 2004 for the first time in the wake of inflow of dollar in India. It was also invoked during the times of demonetization.

 

Gradation of different rates :

 SDF<Reverse Repo< Repo < MSF (Bank Rate)

Liquidity Adjustment Facility: REPO vs Reverse REPO vs Variable Rate Reverse Repo, Marginal Standing facility vs Standing Deposit Facility

 

Liquidity Adjustment Facility:

Monetary policy tool, primarily used by the RBI, to manage liquidity and provide economic stability by using REPO and Reverse REPO as tool. RBI adopted in 1998 on recommendation of Narasimham committee.

Repo Rate: 

The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

REPO Rate is inversely proportional to the liquidity with the banks. All other rates except REPO rate are decided by RBI governor.

DYNAMICS OF REPO:

If REPO Rate increases ----------------funds will be costlier to consumers ---------------borrowing by people will be less resulting into-------- less Liquidity in the economy 

If REPO Rate decreases --------------- funds will be cheaper to consumers --------------- borrowing by people will be more resulting into ------more Liquidity in the economy

Repo Rate History :

• Since the inception of the Liquidity Adjustment Facility on June 5, 2000, the REPO rate is currently quite low. 
• Repo rate was around 9 % during June 2000 and reached the peak during Aug. 2000 to 16 % in the wake of  rising oil prices making  oil imports more expensive and import inflation in the country.
• As of Nov 2024, it is in the range of 6.5 %.

Marginal Standing Facility (MSF): 

• Monetary arrangement announced by the RBI in the year 2011-12, MSF is a penal rate at which banks can borrow money from the RBI over and above their  borrowing capacity  from the RBI under the LAF window. 
• MSF is always fixed at a higher rate than the Repo rate. 
• Banks can borrow funds under MSF by pledging government securities within the limits of the statutory liquidity ratio (banks cant pledge SLR securities while borrowing under REPO window).
• MSF has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system .
• MSF (marginal standing facility) is available on all days of the week, throughout the year.

Reverse Repo Rate:

The interest rate at which the RBI borrows money from banks for the short term often overnight  is defined as Reverse Repo Rate. It is done against the collateral of eligible government securities under the LAF. It is basically done to absorb the liquidity from the market. It is of two types ie 

• Reverse Repo and 
• Variable Reverse Repo.

If Reverse REPO Rate increases----------- the bank will park money with RBI --------- Liquidity with banks will decrease ---------- loans will be costlier to the customers -----------less liquidity in the economy.

If Reverse REPO Rate decreases------------the bank will withdraw money from RBI--------Liquidity with banks will increase --------------- cheaper loans to the customers --------- more liquidity in the economy.

Variable Rate Reverse Repo (VRRR) Auction:

• If the Economy is flush with liquidity, then RBI Since January 2021, had been absorbing money from the banking system via VRRR auctions. 
• RBI ask banks to keep their deposit money with RBI and RBI will pay interest above reverse repo rate (and below repo rate) BUT the rate will be decided through auction. 
• For example, RBI wants to absorb Rs. 50,000 crore liquidity then RBI will select those banks which quotes (asks for) minimum interest rate above reverse repo rate. This VRRR auction can be for overnight or for longer period. At present, VRRR auctions have tenors of 7, 14 and 28 days.

STANDING DEPOSIT FACILITY :

• The idea of an SDF was first mooted in the Urjit Patel Monetary Policy Committee report in 2014 but it could finally be implemented in April 2022.It is an additional tool of Monetary policy for absorbing liquidity without any RBI collateral. 
• When there is huge liquidity in the system and the central bank has to absorb that huge  amount of money from the banking system through the reverse repo window, it becomes difficult for it to provide the required volume of government securities in return. 
• As the SDF is a collateral-free arrangement, RBI need not to give collateral for liquidity absorption .
• SDF rate is higher than Reverse Repo rate, it provides  banks a greater incentive to use the SDF window to park their excess money.  
• Though SDF is for overnight deposits but it retain the flexibility to absorb liquidity of longer tenors. 

VRRR vs SDF :

• VRRR transactions sought for G-Sec as collaterals while there is no such requirement in case of SDF.
• SDF is active throughout the year while VRRR is discretionary of RBI and it is invoked as and when RBI thinks so because of liquidity in the market.
• The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

Corridor: 

• The Corridor in the monetary policy of the RBI refers to the area between MSF  which is the emergency lending rate and SDF which is the liquidity absorption rate. 
• Marginal Standing Facility is the upper ceiling of the Corridor, whereas the Standing Deposit Facility constitutes the lower floor.  
•  The repo rate is usually placed in the middle of the corridor.