Section 165 of the Income-tax Act, 2025 — Determination of Arm's Length Price (Transfer Pricing)

In plain language

What Section 165 says in plain English

Section 165 of the Income-tax Act, 2025 lays down how the arm's length price (ALP) of an international transaction or a specified domestic transaction must be worked out. The idea is simple: when two associated enterprises (say an Indian company and its foreign parent, or two group companies) deal with each other, they must price that dealing the same way unrelated parties bargaining freely would have priced it. Section 165 is the operating manual for calculating that "fair" price, and it is the successor to the old Section 92C of the Income-tax Act, 1961. It sits inside the transfer-pricing chapter of the 2025 Act (broadly sections 161 to 173, which re-map the old sections 92 to 92F).

The six methods to compute ALP

Section 165 requires you to compute the ALP using the "most appropriate method" chosen from a fixed list. The recognised methods are:

• Comparable Uncontrolled Price (CUP) method — compare the price to a genuinely independent transaction.
• Resale Price Method (RPM) — start from the resale price to an unrelated buyer and work back through a normal gross margin.
• Cost Plus Method (CPM) — take the cost of goods/services and add an arm's length mark-up.
• Profit Split Method (PSM) — split the combined profit of the group parties based on their relative contribution.
• Transactional Net Margin Method (TNMM) — compare net operating margins with comparable independent companies.
• Any other method notified/prescribed by the Board (CBDT).

How to pick the "most appropriate method"

You do not get to freely choose. The method must be selected having regard to the nature of the transaction, the class of transaction, the class of associated enterprises, the functions performed, assets employed and risks assumed (the FAR analysis), and other relevant factors that the Board may prescribe. This is why every transfer-pricing study runs a detailed FAR analysis before settling on a method and a set of comparables.

The tolerance band — small variations are ignored

A crucial relief: where applying the most appropriate method gives a single price, and the price actually charged is within a notified tolerance (a percentage the Central Government notifies, capped at 3%) of that ALP, the actual transaction price is accepted and no adjustment is made. Where the method throws up more than one price (a data set of comparables), the ALP is determined using the prescribed range / arithmetic-mean rules (the successor to the old Rule 10CA machinery). The exact percentage is notified each year — historically 1% for wholesale trading and 3% for other cases — so treat the 3% as the statutory ceiling, not a guaranteed figure.

Who it applies to

• Any person entering into an international transaction with an associated enterprise (cross-border group dealings).
• Persons entering into a specified domestic transaction above the prescribed monetary threshold.
• Multinational groups, Indian subsidiaries of foreign companies, captive IT/ITeS units, and Indian parents with overseas arms.

Powers of the Assessing Officer

The AO can step in and re-determine the ALP during assessment only in specified situations — where the price was not computed as per Section 165, the required documentation was not maintained, the information/data used is unreliable, or the assessee failed to furnish information called for. Critically, before recomputing income the AO must first issue a show-cause notice giving the taxpayer an opportunity to be heard. In practice this exercise is usually referred to the Transfer Pricing Officer (TPO) under the successor to old Section 92CA.

Practical implications

• No double benefit: once income is enhanced by a transfer-pricing adjustment, no deduction under the relevant deduction provisions or Chapter VIII is allowed on that enhanced portion.
• Maintain a contemporaneous TP study and file the accountant's report in Form 3CEB before the due date.
• Poor documentation shifts the balance of power to the AO/TPO and invites adjustments plus penalties.