Section 165 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Section 165 says how the arm's length price of an international transaction or a specified domestic transaction is determined: by the most appropriate of five named methods, or another method the Board prescribes. It also gives the Assessing Officer the power to determine the price in four situations, after a show-cause notice, and bars certain Chapter VIII deductions on the enhanced income. This article reads it as per the Income-tax Act, 2025 (30 of 2025) as amended by the Finance Act, 2026.
The arm's length price is determined by the most appropriate method among the comparable uncontrolled price, resale price, cost plus, profit split and transactional net margin methods, or another method prescribed by the Board. Where one price results, the assessee's actual price stands if the variation does not exceed a percentage, not exceeding 3%, notified by the Central Government. The Assessing Officer may determine the price in four listed cases after a show-cause notice.
Scope and the amendment by the Finance Act, 2026
Section 165 is in Chapter X. It was amended by section 52 of the Finance Act, 2026: the words "under section 144 or" were omitted from sub-section (7), with effect from 1 April 2026. The Act came into force on the 1st April, 2026 (section 1(3)). Later amendments, rules and notifications should be checked.
The transactions to which the price applies are defined in sections 163 and 164, and the relationship that brings them within Chapter X is in section 162. For the overview, see section 161 on transfer pricing. If you need the methods applied to your own transactions, our tax planning advisory team can help.
Section 165(1): the methods
The arm's length price in relation to an international transaction or specified domestic transaction is determined by any of the following methods, "being the most appropriate method":
- comparable uncontrolled price method;
- resale price method;
- cost plus method;
- profit split method;
- transactional net margin method; and
- such other method as may be prescribed by the Board.
Section 165(2): choosing and applying the method
The most appropriate method is (a) selected having regard to the nature of the transaction, the class of transaction, the class of associated enterprise, the functions performed by such enterprises or such other relevant factors as the Board may prescribe; and (b) applied for determination of the price in such manner as may be prescribed. The factors the Board may prescribe and the manner of application are left to the Income-tax Rules, 2026; see our rule-wise guides for them.
Section 165(3): the price itself
| Case | The arm's length price is |
|---|---|
| (a) only one price is determined by the most appropriate method | (i) the price determined by that method; or (ii) the price at which the transaction has actually been undertaken, if the variation between the price so determined and the actual price does not exceed such percentage, not exceeding 3% of the latter, notified by the Central Government in this behalf |
| (b) more than one price is determined by the most appropriate method | the price determined in such manner as may be prescribed |
Two observations. First, the 3% is a ceiling on the percentage the Central Government may notify, not a percentage fixed by the Act itself. What has been notified is not in the text consulted, so this article states no notified percentage. Second, the percentage is measured against "the latter", which is the price actually undertaken.
Section 165(4): when the Assessing Officer may determine the price
The Assessing Officer, during 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, information or document in his possession, he is of the opinion that:
- (a) the price charged or paid has not been determined as per sub-sections (1), (2) and (3); or
- (b) any information and document relating to the 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 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).
Section 165(5): show-cause first
Before determining the price under sub-section (4), the Assessing Officer shall issue a notice calling upon the assessee to show cause, on the date and time specified in the notice, why the price should not be determined on the basis of material, information or document in his possession. The notice is a condition; sub-section (4) does not allow the determination without it.
Section 165(6) and (7): computing income and the deduction bar
On determination of the price under sub-section (4), the Assessing Officer may compute the total income of the assessee having regard to the price so determined (sub-section (6)). Under sub-section (7), no deduction is allowed under Chapter VIII in respect of the income by which the total income of the assessee is enhanced after computation under sub-section (6). The words "under section 144 or" in sub-section (7) were omitted by the Finance Act, 2026, with effect from 1 April 2026.
Section 165(8): the other associated enterprise
When the total income of an associated enterprise is computed under sub-section (6) on determination of the 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 is not recomputed by reason of that determination in the case of the first enterprise. In words: the adjustment on the payer's side does not by itself reopen the payee's income.
Reference to the Transfer Pricing Officer
Section 165(4) says the Assessing Officer "may proceed to determine" the price. Section 166 allows him, in appropriate cases, to refer the matter to the Transfer Pricing Officer; see our article on section 166.
A worked example
Names and amounts are invented; the 3% ceiling is as printed, and the notified percentage is assumed to be at that ceiling for the illustration only.
Lotus Engineering Private Limited sells a machine part to its non-resident associated enterprise at Rs. 1,020 per unit. Using the most appropriate method, only one price results: Rs. 1,000 per unit.
- Variation = Rs. 1,020 - Rs. 1,000 = Rs. 20.
- Taken against "the latter" (the actual price of Rs. 1,020): Rs. 20 / Rs. 1,020 is about 1.96%.
- If the notified percentage were the 3% ceiling, 3% of Rs. 1,020 = Rs. 30.60, and the variation of Rs. 20 does not exceed it. Under sub-section (3)(a)(ii), the price at which the transaction was actually undertaken (Rs. 1,020) is treated as the arm's length price.
- If the notified percentage were lower than 1.96%, the price determined by the method (Rs. 1,000) would stand under sub-section (3)(a)(i).
Where the Assessing Officer proceeds under sub-section (4), the show-cause notice must come first, and any enhancement of income under sub-section (6) is excluded from Chapter VIII deductions under sub-section (7).
Need help with arm's length pricing?
Choosing the most appropriate method, keeping the documents section 171 requires and answering a show-cause notice all affect the outcome. Our tax planning advisory service can help you prepare for each stage.
Key takeaways
- The arm's length price is determined by the most appropriate method among five named methods or another prescribed method.
- Where one price results, the actual price stands if the variation is within the notified percentage, which cannot exceed 3% of the actual price.
- The Assessing Officer may determine the price in four listed situations, and must first issue a show-cause notice.
- Chapter VIII deductions are barred on income enhanced under sub-section (6).
- Section 165(7) was amended by the Finance Act, 2026, with effect from 1 April 2026.
Read next
- Sections 163 and 164: international transaction and specified domestic transaction
- Section 166: reference to the Transfer Pricing Officer
- Section 161: transfer pricing
- Chapter X of the Income-tax Act, 2025
Disclaimer: Based on the Income-tax Act, 2025 (30 of 2025) as amended by the Finance Act, 2026, as consulted on 2 October 2026. It explains the words of the Act only; the Income-tax Rules, 2026, notifications, circulars, later amendments and the way the tax authorities and courts apply these provisions should be checked. This article is general information, not legal advice; check the official text before acting.