Section 165 — Determination of arm's length price. Successor to s.92C of the 1961 Act.
Section 165 is in Chapter X — Special Provisions Relating to Avoidance of Tax, which runs from section 161 to section 177.
Sub-section (1) lists the six methods for determining the arm's length price of an international transaction or specified domestic transaction — comparable uncontrolled price, resale price, cost plus, profit split, transactional net margin, and such other method as the Board may prescribe — and requires the most appropriate of them to be used. Sub-section (2) says how the most appropriate method is selected and applied. Sub-section (3) fixes the result: where the method throws up a single price, that price is the arm's length price, but the actual transaction price stands if the variation from it does not exceed a percentage notified by the Central Government, not exceeding 3%; where more than one price results, the arm's length price is determined in the prescribed manner. Sub-section (4) lets the Assessing Officer determine the arm's length price himself on four grounds — pricing not determined under sub-sections (1) to (3), documentation not kept under section 171(1), unreliable or incorrect information used, or failure to furnish information called for under section 171(2) and (3). Sub-section (5) requires a show cause notice before he does so, sub-section (6) permits him to recompute total income accordingly, sub-section (7) denies any Chapter VIII deduction on the enhancement, and sub-section (8) bars corresponding recomputation in the hands of the other associated enterprise where tax has been deducted or was deductible under Chapter XIX-B.
It supplies the machinery for pricing related-party transactions at arm's length, together with the Assessing Officer's power to substitute his own determination when the taxpayer's is unsupported. Sub-section (7) makes the adjustment bite by denying deductions on the enhanced income, and sub-section (8) stops the same adjustment being unwound on the other side.
| What | Figure | The condition on it | Where |
|---|---|---|---|
| Tolerance band within which the actual transaction price is accepted as the arm's length price | A percentage not exceeding 3% | Of the price at which the transaction was actually undertaken; applies only where a single price is determined by the most appropriate method, and only at the percentage notified by the Central Government | Sub-section (3)(a)(ii) |
Choosing a method is not free: it must be the most appropriate one judged on the factors in sub-section (2)(a), and the manner of applying it is prescribed. The tolerance band is a ceiling, not a rate — the operative figure is whatever the Central Government notifies, which may be less than 3% and can differ by class of transaction. If the Assessing Officer moves under sub-section (4) you are entitled to a show cause notice under sub-section (5) with a stated date and time, but note that documentation failures under section 171 are themselves a ground for him to act, so the record matters as much as the pricing. Any enhancement carries no Chapter VIII deduction.
A company buys components from its associated enterprise abroad for Rs. 100 crore, and the most appropriate method produces a single arm’s length price of Rs. 98 crore — a variation of about 2% of the price actually paid. Whether the Rs. 100 crore survives is not decided by the 3% in the section: sub-section (3)(a)(ii) accepts the actual price only if the variation does not exceed the percentage notified by the Central Government, which the section caps at 3%, so on a notified figure of 1% the actual price falls away and Rs. 98 crore becomes the arm’s length price. That tolerance is unavailable in any event where the method throws up more than one price, since clause (a) covers only the single-price case. Where the Assessing Officer recomputes total income under sub-section (6), sub-section (7) then denies any Chapter VIII deduction on the enhancement.
In transfer pricing proceedings during an assessment — first as the show cause notice sub-section (5) requires before the Assessing Officer determines the arm’s length price himself, then in the recomputation of total income under sub-section (6). You also meet it through section 171: documentation not kept under 171(1), or information not furnished in answer to a notice under 171(2) or (3), is by itself a ground under sub-section (4) for him to act, without his having to show mispricing.
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
See the full 1961 to 2025 concordance.
All of them are in the Rules 2026 index.
See every circular and notification on this section, or the circulars index.
See every circular and notification on this section, or the notifications index.
