Chapter X - Special Provisions Relating to Avoidance of Tax
Section 165
Section 165: how the arm's length price is determined
Section 165 sets out the mechanics for arm's length pricing under Chapter X - which method to use, how the price is fixed when the chosen method throws up one price or several, when the Assessing Officer can step in and redetermine the price, and what happens to the assessee's income once that redetermination is made.
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This article is for general information. Refer to the Income-tax Act, 2025 as amended by the Finance Act, 2026 and the Taxation and Other Laws (Amendment) Act, 2026 for the official provisions. If you need professional advice for your situation, contact Bizeneed.
Statutory text
Bare law
(1) The arm’s length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following methods, being the most appropriate method— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board.
(2) The most appropriate method referred to in sub-section (1) shall be,— (a) selected having regard to the nature of transaction or class of transaction or class of associated enterprise or functions performed by such enterprises or such other relevant factors as the Board may prescribe; (b) applied for determination of arm’s length price in such manner as may be prescribed.
(3) The arm’s length price shall be— (a) in case, only one price is determined by the most appropriate method,— (i) the price determined by that method; or (ii) the price at which the international transaction or specified domestic transaction has actually been undertaken, if the variation between the arm’s length price so determined and price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed such percentage not exceeding 3% of the latter, notified by the Central Government in this behalf; or (b) in case, more than one price is determined by the most appropriate method, the price determined in such manner as may be prescribed.
(4) The Assessing Officer, during the course of any proceeding for the assessment of income, may proceed to determine the arm’s length price in relation to an international transaction or specified domestic transaction as per sub-sections (1), (2) and (3) if, on the basis of material or information or document in his possession, he is of the opinion that— (a) the price charged or paid in an international transaction or specified domestic transaction has not been determined as per sub-sections (1), (2) and (3); or (b) any information and document relating to an international transaction or specified domestic transaction has not been kept and maintained by the assessee as per section 171(1); or (c) the information or data used in determination of the arm’s length price by the assessee is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under section 171(2) and (3).
(5) The Assessing Officer, before determining the arm’s length price under sub-section (4), shall issue a notice calling upon the assessee to show cause, on the date and time to be specified in the notice, why the arm’s length price should not be determined on the basis of material or information or document in the possession of the Assessing Officer.
(6) The Assessing Officer, on determination of arm’s length price under sub-section (4), may compute the total income of the assessee having regard to the arm’s length price so determined.
(7) No deduction shall be allowed under Chapter VIII in respect of income by which the total income of the assessee is enhanced after computation of income under sub-section (6).
(8) When the total income of an associated enterprise is computed under sub-section (6) on determination of the arm’s length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XIX-B, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the first mentioned enterprise.
Introduction
Section 165 lists accepted arm's-length pricing methods and requires the most appropriate method for the transaction. The law also covers single versus multiple comparable prices, specified variation tolerance, Assessing Officer review and resulting income computation.
Key takeaways
Arm's-length methods
The most appropriate prescribed method determines arm's length price: comparable uncontrolled price, resale price, cost plus, profit split, transactional net margin or another prescribed method.
Method selection
Selection depends on the transaction, functions and other prescribed factors; the Assessing Officer may redetermine price where the taxpayer's method or supporting information fails the section's tests.
The prescribed methods
The arm's length price for an international transaction or specified domestic transaction is determined by whichever of the following is the most appropriate method:
- Comparable uncontrolled price method
- Resale price method
- Cost plus method
- Profit split method
- Transactional net margin method
- Such other method as may be prescribed by the Board
Choosing and applying the most appropriate method
The most appropriate method is selected having regard to the nature of the transaction (or class of transaction), the class of associated enterprise, the functions performed by the enterprises, or such other relevant factors as the Board may prescribe, and is applied for determining the arm's length price in the manner prescribed.
Fixing the price - single vs. multiple results
Where the most appropriate method throws up only one price, the arm's length price is that price - or, if the variation between that price and the price at which the transaction was actually undertaken does not exceed a percentage (up to 3%) notified by the Central Government, the arm's length price can instead be taken as the actual transaction price.
Where the method throws up more than one price, the arm's length price is determined in the manner prescribed.
When the Assessing Officer can redetermine the price
During assessment proceedings, the Assessing Officer may proceed to determine the arm's length price under sub-sections (1) to (3) if, based on material, information or a document in their possession, they are of the opinion that:
- The price charged or paid in the transaction has not been determined per sub-sections (1) to (3); or
- The assessee has not kept and maintained information/documents as required under section 171(1); or
- The information or data used by the assessee to determine the arm's length price is not reliable or correct; or
- The assessee failed to furnish, within the specified time, information or a document required by a notice under section 171(2) and (3).
Procedure and consequences of redetermination
Before determining the arm's length price under sub-section (4), the Assessing Officer must issue a show-cause notice to the assessee specifying a date and time, asking why the price should not be determined based on the material in the Officer's possession.
Once the arm's length price is determined under sub-section (4), the Assessing Officer may compute the assessee's total income having regard to that price.
No deduction is allowed under Chapter VIII in respect of income by which the total income is enhanced after this recomputation.
Where an associated enterprise's total income is recomputed under sub-section (6) on determination of the arm's length price paid to another associated enterprise (from which tax has been deducted or was deductible under Chapter XIX-B), the other associated enterprise's income is not recomputed by reason of that determination.
Step-by-step flow for applying Section 165
- 1
Select the most appropriate method
Choose from the comparable uncontrolled price, resale price, cost plus, profit split or transactional net margin method, or any other method prescribed by the Board, having regard to the nature or class of transaction, the class of associated enterprise, the functions performed and any other factors the Board prescribes.
- 2
Apply the method in the prescribed manner
Section 165(2)(b) leaves the manner of application to the rules.
- 3
Does the method produce only one price?
- More than one price: The arm's length price is determined in the manner prescribed (Section 165(3)(b)).
- Only one price: Go to the next step.
- 4
Is the variation from the actual price within the notified percentage?
The Central Government notifies the percentage, which cannot exceed 3% of the actual transaction price.
- Yes: The actual transaction price is taken as the arm's length price.
- No: The price determined by the method is the arm's length price.
- 5
Can the Assessing Officer redetermine the price?
Only where one of the Section 165(4) grounds exists, and after a show-cause notice under Section 165(5). Income may then be computed under Section 165(6); no Chapter VIII deduction is allowed on the enhancement (Section 165(7)).
Practical checklist
Do
- Document functions, assets, risks and comparability when selecting the most appropriate method.
- Keep data sources, adjustments and calculation workpapers for the chosen method and any prescribed range or tolerance.
Avoid
- Do not assume the maximum 3% figure is an automatic tolerance for every tax year or transaction.
- Do not use a method solely because it produces the most favourable outcome without appropriateness analysis.
Illustrative example
Worked example: the tolerance band for a single arm's length price
Hypothetical facts (illustration only, not a real taxpayer): An Indian company sells goods to its associated enterprise for ₹98,00,000. The most appropriate method gives a single arm's length price of ₹1,00,00,000. For illustration only, assume the notified percentage is 3% (the Act sets 3% as the ceiling; the actual notified figure must be checked).
Variation
₹1,00,00,000 - ₹98,00,000 = ₹2,00,000.
Compare with the actual price
The percentage is measured on the actual price ("the latter"): ₹2,00,000 / ₹98,00,000 = about 2.04%, within the assumed 3%.
Result
Under Section 165(3)(a)(ii), the actual price of ₹98,00,000 is taken as the arm's length price, so no adjustment arises.
Contrast
If the method gave ₹1,02,00,000, the variation of ₹4,00,000 would be about 4.08% of ₹98,00,000, above the assumed 3%. The arm's length price would be ₹1,02,00,000. If a Section 165(4) ground exists, income could be enhanced by ₹4,00,000, and no Chapter VIII deduction would be allowed on that ₹4,00,000.
Outcome
- Whether the tolerance band applies depends on the percentage actually notified for the year.
- Keep the method selection reasoning and comparables data, because unreliable data is itself a ground for redetermination under Section 165(4)(c).
Glossary
- Most appropriate method
- The statutory transfer-pricing method selected for the transaction's facts and functions.
- Comparable uncontrolled price
- A method using a comparable independent-party transaction as a pricing benchmark.
Frequently asked questions
What methods can be used to determine the arm's length price?
The comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method, or any other method prescribed by the Board - whichever is the most appropriate for the transaction.
Is there a tolerance band between the computed price and the actual transaction price?
Yes - where only one price results from the most appropriate method, and the variation between that price and the actual transaction price does not exceed a percentage (up to 3%) notified by the Central Government, the actual transaction price can be treated as the arm's length price.
Can the Assessing Officer override the assessee's own arm's length price determination?
Yes, in specified circumstances - such as where the price was not determined per the prescribed method, required documentation was not maintained, the data used is unreliable, or the assessee failed to respond to a notice - but only after issuing a show-cause notice to the assessee.
What happens to Chapter VIII deductions when income is enhanced by a transfer pricing adjustment?
No deduction is allowed under Chapter VIII on the portion of income by which total income is enhanced as a result of the arm's length price recomputation.
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Talk to our team about arm's length price determinationLast updated 10 October 2026