Section 165 Income Tax Act 2025: How Is Arm's Length Price Determined?

What does Section 165 provide?

Section 165 requires the arm's length price of an international transaction or specified domestic transaction to be determined by the most appropriate method. It also regulates the determination of a single price or multiple prices and permits the Assessing Officer to reassess pricing in specified circumstances, subject to a show-cause notice.

Section 161 addresses the computation of income having regard to arm's length price; Section 162 defines associated enterprises; Section 163 concerns international transactions; and Section 164 concerns specified domestic transactions.

Which methods are permitted under Section 165(1)?

The statute lists six methods. Their application is governed by the applicable rules and the facts of each transaction.

1. Comparable Uncontrolled Price (CUP) Method

Compares the controlled transaction price with a comparable price charged between independent parties, making appropriate adjustments for material differences.

2. Resale Price Method (RPM)

Starts with the resale price to an independent customer and adjusts for an appropriate gross resale margin and other relevant factors.

3. Cost Plus Method (CPM)

Uses relevant direct and indirect costs plus a comparable arm's length gross profit mark-up, subject to necessary adjustments.

4. Profit Split Method (PSM)

Allocates combined profits between associated enterprises according to their contributions. It may be particularly relevant to integrated activities and unique, valuable contributions.

5. Transactional Net Margin Method (TNMM)

Benchmarks an appropriate net profit indicator against comparable uncontrolled transactions, after necessary adjustments.

6. Other Prescribed Method

Allows another method prescribed by the Board, including an appropriate valuation-based approach where the rules permit it.

How is the most appropriate method selected under Section 165(2)?

Selection depends on the nature or class of transaction, the associated enterprises involved, functions performed and other prescribed factors. A defensible analysis generally examines functions, assets and risks, contractual terms, comparables, data quality and the reliability of adjustments. The chosen method must be applied in the prescribed manner.

How is arm's length price determined under Section 165(3)?

Where only one price is determined: That price is ordinarily the ALP. The actual transaction price may instead be accepted where the difference falls within the percentage notified by the Central Government, subject to the statutory ceiling of 3% of the actual transaction price.

Where more than one price is determined: The ALP is established in the manner prescribed by the applicable rules, including the relevant multiple-comparable computation.

Do not assume an automatic 3% safe margin: The operative percentage depends on the applicable notification, transaction category and tax year. A tolerance provision is not a general standard deduction from an adjustment.

When may the Assessing Officer determine ALP?

Under Section 165(4), the Assessing Officer may independently determine ALP during assessment proceedings where the statutory grounds are satisfied, including:

• The transaction price was not determined under the prescribed framework.
• Required records were not maintained under Section 171(1).
• The pricing data or information is unreliable or incorrect.
• Information or documents requested under Section 171(2) and (3) were not furnished within the specified time.

Show-cause notice under Section 165(5)

Before making such determination, the Assessing Officer must give the assessee an opportunity to explain why ALP should not be determined on the basis of the material in the officer's possession.

Consequences under Sections 165(6) to 165(8)

Following the determination, the Assessing Officer may compute total income having regard to the revised ALP. Section 165(7) restricts specified deductions in respect of income increased by the adjustment. Section 165(8) prevents the corresponding recomputation of another associated enterprise's income merely because ALP was determined in the first enterprise's case, where its stated conditions are met.

Relevant statutory definitions

Practical example of an ALP adjustment

Suppose an Indian company provides services to its overseas associated enterprise for Rs. 90 lakh. A reliable comparability analysis using the most appropriate method determines an ALP of Rs. 100 lakh. Subject to the applicable tolerance and other legal requirements, a transfer pricing adjustment may increase the Indian company's taxable income by Rs. 10 lakh. This is illustrative only; actual benchmarking depends on the applicable method, data and rules.

Transfer pricing compliance checklist

• Identify covered international and specified domestic transactions.
• Confirm associated enterprise relationships and applicable thresholds.
• Prepare a functions-assets-risks analysis and select the most appropriate method.
• Document comparable searches, financial data and adjustments.
• Maintain the records required under Section 171 and check reporting obligations under Section 172.
• Verify applicable rules and tolerance notifications for the relevant tax year.

Frequently asked questions

Is TNMM compulsory for all related-party transactions?

No. Section 165 permits six methods and requires selection of the most appropriate method based on the circumstances.

Does Section 165 allow an automatic 3% adjustment?

No. The statute sets a maximum ceiling for a notified tolerance percentage in the single-price situation. The applicable notified percentage and statutory conditions must be checked.

Can the Assessing Officer reject a taxpayer's transfer pricing analysis?

Yes, on the specified grounds under Section 165(4), but the show-cause procedure under Section 165(5) must be followed.

Which provision of the 1961 Act corresponds to Section 165?

Section 92C of the Income-tax Act, 1961 broadly corresponds to Section 165 of the Income-tax Act, 2025.

Official legislation and further reading

Consult the authoritative statutory text, rules and notifications before relying on a particular pricing computation.