Transfer Pricing and Arm's Length Price Under the Income Tax Act 2025: International and Domestic Transactions

Transfer pricing is the rule that income and expenses from a deal between related parties must be computed as if the parties were strangers. Under section 161 of the Income-tax Act, 2025, income and allowable expenses from an international transaction or a specified domestic transaction are fixed by the arm's length price (ALP). It applies when one party is a non-resident associated enterprise, or, for domestic deals, when the specified transactions in a tax year add up to more than Rs 20 crore (section 164).

This guide covers who counts as an associated enterprise, what counts as an international or specified domestic transaction, how the ALP is found under section 165 and rules 79 to 81, and what records must be kept under section 171 and rule 84. Law is as amended by the Finance Act, 2026, effective 1 April 2026. It is general information, not tax advice.

What is transfer pricing under the Income Tax Act 2025?

When two related businesses deal with each other, they can set any price they like. A parent can sell goods to its subsidiary cheaply, or a subsidiary can pay its parent a large fee, and profit shifts from one country to another. Sections 161 to 165 stop that by requiring the price to be tested against what independent parties would have agreed in similar circumstances.

Section 161 has four working rules:

• Income from an international or specified domestic transaction is determined having regard to the ALP (section 161(1)).
• Allowances for any expense or interest from such a transaction are also determined having regard to the ALP (section 161(2)).
• Cost sharing: where associated enterprises agree to allocate or contribute to the cost of a benefit, service or facility, each enterprise's share is set by the ALP of that benefit, service or facility (section 161(3)).
• One-way rule: the section does not apply if using the ALP would reduce the income chargeable to tax, or increase the loss, as computed from the books for the tax year (section 161(4)). The ALP can raise your taxable income. It cannot lower it.

Who is an associated enterprise (section 162)?

An associated enterprise (AE) is a related enterprise, tested by participation in management, control or capital, or by commercial dependence. Section 162(1) lists the tests. Meeting any one is enough.

Test	Threshold in the Act	Clause
Voting power held by one enterprise in the other	26% or more, at any time in the tax year	162(1)(a)(ii)
One person or enterprise holds voting power in both enterprises	26% or more in each	162(1)(a)(iii)
Common participation in management, control or capital	Same persons participate in both	162(1)(a)(i)
Loan advanced by one to the other	Loan is 51% or more of the borrower's total assets (book value)	162(1)(b)
Guarantee of borrowings	10% or more of the other's total borrowings	162(1)(c)
Board control	More than half the directors, or one or more executive directors, appointed by the other enterprise (or by the same person)	162(1)(d), (e)
Dependence on know-how, patents, trademarks, licences	Business wholly dependent on rights owned by the other	162(1)(f)
Raw material supply	90% or more supplied by the other, with prices influenced by it	162(1)(g)
Sales of finished goods	Sold to the other (or its nominees) on terms it influences	162(1)(h)
Common control by an individual or HUF	Controlled by the individual (or a member of the HUF) or a relative	162(1)(i), (j)
Firm, AOP or BOI	The other enterprise holds 10% or more interest in it	162(1)(k)
Other mutual interest	As may be prescribed	162(1)(l)

For a specified domestic transaction, section 162(2) widens the term. It also covers other units, undertakings or businesses of the same assessee, and the other persons referred to in sections 140(13) and 205(4), for the transactions in those sections.

What is an international transaction (section 163)?

An international transaction is a transaction between two or more associated enterprises, at least one of which is a non-resident (section 163(1)). The list of covered dealings is wide:

• purchase, sale, transfer, lease or use of tangible property (machinery, vehicles, buildings, commodities);
• purchase, sale, transfer, lease or use of intangible property (trademarks, patents, know-how, brands, customer lists, licences);
• capital financing: loans, borrowings, guarantees, advances, deferred payments, receivables, and purchase or sale of marketable securities;
• services such as market research, marketing, administration, technical service, design, consultation, scientific research, legal or accounting service;
• business restructuring or reorganisation, whether or not it affects profit at that time;
• cost-sharing or contribution arrangements; and
• any other transaction having a bearing on profits, income, losses or assets.

Deemed international transactions. A deal with an unrelated party can also be treated as an international transaction. Under section 163(2), this happens if there is a prior agreement between that party and an associated enterprise about the deal, or if the terms are in substance set between them, and the enterprise or its AE (or both) is a non-resident. Whether the unrelated party is itself a non-resident does not matter.

Section 163(3) lists what "intangible property" includes: marketing assets such as trademarks and brand names, technology assets, artistic assets, proprietary software and databases, engineering assets, customer relationships, contract rights, trained workforce, location rights, goodwill (including professional practice goodwill), and any item that derives value from its intellectual content.

What is a specified domestic transaction (section 164)?

A specified domestic transaction (SDT) is a transaction that is not an international transaction and is one of these:

• a transaction referred to in section 122 (deductions in computing total income);
• a transfer of goods or services referred to in section 140(9), or business between the assessee and another person referred to in section 140(13) (special provision for specified business);
• a transaction under Chapter VIII to which section 140(9) or (13), or section 80-IA(8) or (10) of the 1961 Act, applies;
• business between the persons referred to in section 205(4); or
• any other transaction as may be prescribed.

The test has one more condition. The total of such transactions in the tax year must exceed Rs 20 crore. The Finance Act, 2026 removed the words "or section 144" from this provision with effect from 1 April 2026.

Quick check: does transfer pricing apply to this deal?

How is the arm's length price determined (section 165)?

Section 165(1) allows the ALP to be found by the most appropriate method out of six. Rule 79 sets out how each works, and rule 80 lists the factors for choosing between them: the nature of the transaction, the functions, assets and risks of the parties, the availability and reliability of data, the degree of comparability, the reliability of adjustments, and the assumptions needed.

Method	What it does (rule 79(1))	Typically suits
Comparable uncontrolled price (CUP)	Takes the price in comparable deals between independent parties and adjusts for differences that affect price	Goods or services with identical or near-identical market comparables
Resale price	Starts from the price at which goods bought from the AE are resold to an unrelated party, then deducts a normal gross margin and direct expenses	Distribution and resale
Cost plus	Takes the direct and indirect cost of production and adds a normal gross mark-up seen in comparable deals	Contract manufacturing, routine services
Profit split	Splits the combined net profit by each party's relative contribution (contribution or residual approach)	Unique intangibles, or deals so interlinked they cannot be tested separately
Transactional net margin (TNMM)	Compares the net profit margin on costs, sales or assets with that of comparable independent transactions	Where gross margins are hard to compare
Other method (rule 78)	Any method that considers the price charged or that would have been charged in the same or similar uncontrolled deal	Cases the five do not fit

The "typically suits" column is a general guide only. The Act and rules do not assign methods to transaction types. Rule 80 asks which method gives the most reliable measure on the facts.

When is a transaction comparable?

Rule 79(2) judges comparability by four factors: the characteristics of the property or service, the functions performed (with assets and risks), the contract terms (formal or not), and market conditions such as geography, size, labour and capital costs, and competition. Under rule 79(3), an uncontrolled transaction is comparable if no differences materially affect price or profit, or if reasonably accurate adjustments can remove them. Rules 79(4) and (5) say which year's data to use. For resale price, cost plus and TNMM, data for the first preceding year may be used if current-year data is not available when the return is filed.

What if the method gives one price, or more than one?

If the method gives a single price, the ALP is that price. But if the assessee's actual price differs from it by no more than a percentage notified by the Central Government (capped at 3% of the actual price), the actual price is accepted (section 165(3)(a)). The notified percentage is not in the Act or the Rules, so check the current notification.

If the method gives several prices, rule 81 applies:

1. Arrange the prices in ascending order to form a dataset (rule 81(2)).
2. If the method is CUP, resale price, cost plus or TNMM and the dataset has six or more entries, build a range from the 35th percentile to the 65th percentile (rule 81(6)).
3. If the actual price is inside the range, it is the ALP. If it is outside, the median of the dataset is the ALP.
4. If the dataset has fewer than six entries, or the method is profit split (which is outside the range rule), the ALP is the arithmetical mean of the dataset, unless the actual price is within the notified tolerance (up to 3%) of it, in which case the actual price stands (rule 81(7)).

Percentile and median have exact definitions in rule 81(8). The 35th percentile is the lowest value such that at least 35% of values are equal to or less than it. The 65th percentile and the median (50%) work the same way. The rule also describes an averaging step when the count lands exactly on a whole number.

How the arm's length range works

Worked example 1: cost plus method with an arm's length range (tax year 2026-27)

Assumptions. An Indian company provides back-office services to its Singapore parent, which holds more than 26% of its voting power, so they are associated enterprises. Cost plus is the most appropriate method. Total direct and indirect cost of the services in 2026-27 is Rs 1,00,00,000. The company charged cost plus 6%. Seven comparable independent enterprises show mark-ups of 8%, 9%, 10%, 11%, 12%, 14% and 16%. This is an illustration, not real data.

Step	Working	Result
1. Count of comparables	7 entries, so the range rule applies (six or more)	7
2. 35th percentile	35% of 7 = 2.45, so we need the lowest value with at least 3 values at or below it (3 of 7 = 42.9%; 2 of 7 = 28.6% is too few)	10%
3. 65th percentile	65% of 7 = 4.55, so we need at least 5 values at or below it (5 of 7 = 71.4%; 4 of 7 = 57.1% is too few)	12%
4. Median	50% of 7 = 3.5, so at least 4 values (4 of 7 = 57.1%)	11%
5. Actual price	Rs 1,00,00,000 + 6% = Rs 1,06,00,000; mark-up 6% is outside 10% to 12%	Outside range
6. ALP	Median applies: Rs 1,00,00,000 + 11% = Rs 1,11,00,000	Rs 1,11,00,000
7. Adjustment	Rs 1,11,00,000 - Rs 1,06,00,000. This raises income, so section 161(4) does not block it	Rs 5,00,000 added to income

Had the company charged 11.5%, the price (Rs 1,11,50,000) would sit inside the 10% to 12% range and be accepted as the ALP with no adjustment (rule 81(6)(a)).

Worked example 2: single price and the tolerance band (tax year 2026-27)

Assumptions. An Indian company buys components from its parent abroad for Rs 1,00,00,000. The comparable uncontrolled price method gives one price. For this example the notified tolerance is taken as the maximum the Act allows, 3% of the actual price. The actual notified percentage is not in the source text, so check it before relying on this.

	Case A: CUP price Rs 96,00,000	Case B: CUP price Rs 98,00,000
Price paid	Rs 1,00,00,000	Rs 1,00,00,000
Variation	Rs 4,00,000	Rs 2,00,000
Variation as % of price paid	4,00,000 / 1,00,00,000 = 4%	2,00,000 / 1,00,00,000 = 2%
Within 3%?	No	Yes
ALP (section 165(3)(a))	Rs 96,00,000	Rs 1,00,00,000 (actual price accepted)
Effect on allowable expense (section 161(2))	Rs 4,00,000 of the purchase cost is not allowed	No adjustment

Real-life example 1: when does a foreign shareholder make a customer an AE?

Meena runs an Indian software company. A UK company holds 30% of her voting shares and also buys her services. Because the UK company holds at least 26% of the voting power (section 162(1)(a)(ii)), the two are associated enterprises. Every service invoice between them is an international transaction under section 163(1)(d), and the price must be supportable as an ALP. If the UK company held only 20% and had no other link (no loan, guarantee, board control or dependence), the test would not be met on shareholding alone.

Real-life example 2: a loan that creates the link

Ravi's manufacturing company in Pune is funded mainly by a loan from a Dubai company that is not a shareholder. At year end the loan is 55% of Ravi's total assets at book value. Section 162(1)(b) treats the lender as an associated enterprise once the loan reaches 51% of the borrower's total assets. The interest Ravi pays is therefore an international transaction (capital financing, section 163(1)(c)). The interest he claims as an expense is determined having regard to the ALP (section 161(2)), so any excess over it can be disallowed.

Real-life example 3: an unrelated buyer, but the terms are agreed with a related one

Anita exports goods to a buyer in Germany that is not related to her. A related company in Dubai, which holds 40% of Anita's voting power, negotiated the price with that buyer. Under section 163(2)(b), the terms of the transaction are determined in substance between the buyer and Anita's associated enterprise, and the associated enterprise is a non-resident. The sale is treated as an international transaction even though the buyer is unrelated.

What records must be kept (section 171 and rule 84)?

Every person who entered into an international transaction or specified domestic transaction must keep prescribed information and documents (section 171(1)(a)). Rule 84(1) lists them. They include:

• ownership structure and the profile of the group, with the legal status and tax residence of each enterprise dealt with;
• a description of the business, industry, functions performed, risks assumed and assets employed by both sides;
• the nature, terms and value of each transaction, and the economic analyses, forecasts and budgets relevant to it;
• the uncontrolled transactions used for comparison and the comparability analysis;
• the methods considered, the method chosen, why it was chosen and how it was applied, with the actual workings, comparable data and adjustments; and
• the adjustments made to align transfer prices with the ALP and the effect on total income.

Point	Rule	Reference
Retention period	Nine years from the end of the relevant tax year	Rule 84(8)
Documents should exist by	The "specified date": one month before the due date for the return under section 263(1)	Rule 84(6); section 173(d)
Contemporaneous	As far as possible, prepared at the time of the transaction	Rule 84(6)
Full documentation not needed	If international transactions recorded in the books total Rs 1 crore or less in the tax year (you must still substantiate that income was computed under section 161)	Rule 84(2), (3)
Multi-year deals	No fresh documentation unless the nature, terms, assumptions or another pricing factor changes significantly	Rule 84(7)
Reply to a notice	Within 10 days of receipt; extension of up to 30 more days on application	Section 171(2), (3)
Supporting evidence	Authentic documents, such as official data and reports from recognised institutions	Rule 84(5)

Section 171(1)(b) and (4) separately cover constituent entities of an international group, who must furnish prescribed information to the authority under section 511(1).

What can the Assessing Officer do?

Under section 165(4), during an assessment the Assessing Officer may determine the ALP if he or she believes, from material on record, that any one of these is true:

1. the price was not determined as per section 165(1) to (3);
2. the information and documents were not kept as required by section 171(1);
3. the data you used is not reliable or correct; or
4. you failed to furnish information or documents within the time given in a notice under section 171(2) and (3).

Before doing so, the officer must issue a show-cause notice giving the date and time for you to explain why the ALP should not be determined from the material the officer holds (section 165(5)). The officer may then compute your total income on the ALP (section 165(6)). No Chapter VIII deduction is allowed on the extra income this creates (section 165(7)).

Relief for the other party. If the adjustment is made on a payment to an associated enterprise from which tax was deducted or was deductible under Chapter XIX-B, the income of that other enterprise is not recomputed because of the adjustment (section 165(8)).

Which accountant's report, Transfer Pricing Officer reference and secondary adjustment apply?

Accountant's report (section 172). Every person who entered into an international transaction or specified domestic transaction in a tax year must obtain a report from an accountant and furnish it by the specified date. Rule 85 prescribes Form No. 48 and says it must be furnished at least one month before the return due date under section 263(1)(c).

Reference to the Transfer Pricing Officer (section 166). If the Assessing Officer considers it necessary or expedient, he or she may refer the ALP determination to the Transfer Pricing Officer, with the previous approval of the Principal Commissioner or Commissioner (section 166(1)). The Transfer Pricing Officer then serves a notice asking you to produce evidence supporting your price (section 166(4)). For multi-year ALP determination, rule 82 uses Form No. 46, accompanied by an accountant's certificate in Form No. 47.

Secondary adjustment (section 170). Where a primary adjustment to the transfer price is Rs 1 crore or more, you must make a secondary adjustment. If the excess money is not repatriated to India within the prescribed time, it is deemed an advance to the associated enterprise, with interest computed as prescribed (section 170(2), (4)). Alternatively, you may opt to pay additional income-tax at 18% on that excess money, and this is treated as final tax (section 170(5), (6)). More detail is in our secondary adjustment guide.

Safe harbour and advance pricing agreements

Rule 89 offers a safe harbour for eligible international transactions: if the assessee has validly opted in and the stated circumstances are met, the declared transfer price is accepted. For example, for provision of information technology services, the operating profit margin to operating expense must be not less than 15.5%, where the aggregate operating revenue of such transactions in the tax year does not exceed Rs 2,000 crore. Rule 97 gives a safe harbour for eligible specified domestic transactions. Only that one rule 89 entry has been read for this guide, so check the full table and the opt-in conditions before relying on it. Advance pricing agreements between the Board and the applicant are covered by section 168 and rules 103 onwards.

Common mistakes

• Counting only shareholding. Associated enterprise status can arise from a 51% loan, a 10% guarantee, 90% raw material dependence, board control or common control, not just the 26% voting test.
• Ignoring domestic deals. Transactions between an assessee and listed related persons or units can be specified domestic transactions once the total passes Rs 20 crore in the year.
• Treating the 35th to 65th range as the median. If the price is inside the range it stands. If it is outside, the median (not the nearest edge of the range) is used.
• Applying the range with fewer than six comparables. The percentile range applies only to CUP, resale price, cost plus and TNMM, and needs six or more entries. Otherwise the mean (with the tolerance rule) applies.
• Preparing documents late. Rule 84(6) expects them to exist by the specified date, one month before the return due date, and to be kept for nine years.
• Assuming a deal with an unrelated party is safe. If the terms are really settled with a related party, section 163(2) can pull it in.

Quick reference

Item	Figure	Where
Voting power test for AE	26% or more	Section 162(1)(a)
Loan test	51% or more of book value of total assets	Section 162(1)(b)
Guarantee test	10% or more of total borrowings	Section 162(1)(c)
Specified domestic transaction limit	Aggregate above Rs 20 crore in a tax year	Section 164
Tolerance band	Notified percentage, not more than 3% of actual price	Section 165(3)(a)(ii)
Arm's length range	35th to 65th percentile, six or more entries	Rule 81(6)
Notice reply time	10 days, plus up to 30 days on application	Section 171(2), (3)
Record retention	Nine years from end of the tax year	Rule 84(8)
Documentation exemption	International transactions of Rs 1 crore or less	Rule 84(2)

How a CA practice can handle this

For a CA firm, the hard part is tracking which clients have foreign shareholders, cross-border loans or related-party deals, and making sure the documentation is ready one month before each return due date. Finexo's practice management software lets you keep a due-date task per client and per transaction type, so the documentation checklist does not get lost in email. It does not compute the ALP or prepare the documentation for you.

Where this is in the Act

• Section 161: income, allowances and cost sharing at arm's length price; one-way rule in sub-section (4).
• Section 162: meaning of associated enterprise (sub-section (2) for specified domestic transactions).
• Section 163: meaning of international transaction and intangible property.
• Section 164: meaning of specified domestic transaction; Rs 20 crore limit.
• Section 165: methods, most appropriate method, tolerance, Assessing Officer's powers, show-cause notice, no recomputation for the other AE.
• Section 166: reference to the Transfer Pricing Officer; section 170: secondary adjustment.
• Section 171: keeping and furnishing information and documents.
• Section 172: accountant's report (rule 85, Form No. 48).
• Section 173: definitions, including "specified date" in clause (d).
• Rules 77 to 81: definitions, other method, methods, most appropriate method, ALP range.
• Rule 84: documents to be kept; rule 89 and rule 97: safe harbour; rule 103 onwards: advance pricing agreements.

Related reading: TDS on rent under the Income-tax Act, 2025.