Compensating adjustment

Tax Glossary Definition

Compensating adjustment

Compensating Adjustment – This refers to a modification made to align the taxable income of related entities with the arm’s length standard in transfer pricing. Such an adjustment reconciles disparities in the profits reported by associated companies operating in different tax jurisdictions, ensuring that income is distributed fairly and consistently.

Example: When a subsidiary’s reported profits fall below the level justified by arm’s length pricing, a compensating adjustment may be applied to increase its taxable earnings accordingly.

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