Reframing Arm's Length Pricing in India's Evolving Transfer Pricing Regime : Clause 165 of the Income Tax Bill, 2025 Vs. Section 92C of the Income-tax Act, 1961

Clause 165 Determination of arm's length price.

Income Tax Bill, 2025

Introduction

Clause 165 of the Income Tax Bill, 2025, represents a pivotal statutory provision governing the determination of the arm's length price (ALP) for international transactions and specified domestic transactions between associated enterprises. This clause is integral to India's transfer pricing regime, which seeks to prevent profit shifting and tax avoidance by ensuring that transactions between related parties are conducted at prices that would have prevailed in transactions between unrelated parties under open market conditions. The provision mirrors and seeks to update the existing framework established under section 92C of the Income-tax Act, 1961, and the detailed methodologies prescribed in Rule 10B of the Income-tax Rules, 1962.

This commentary provides a comprehensive analysis of Clause 165, exploring its objectives, mechanisms, and implications, and situates its provisions within the broader context of existing law and regulatory practice. A comparative analysis with Section 92C and Rule 10B is also undertaken, highlighting both continuity and change in the legislative approach to transfer pricing in India.

Objective and Purpose

The legislative intent behind Clause 165 is to codify and refine the process of determining the arm's length price in order to curb tax avoidance through transfer pricing manipulation. The provision aims to align Indian transfer pricing regulations with international standards, notably those set by the OECD, while incorporating lessons from over two decades of Indian transfer pricing administration. The clause seeks to provide clarity, procedural fairness, and administrative efficiency in the determination of ALP, thereby fostering greater compliance and certainty for taxpayers and tax authorities alike.

Historically, transfer pricing rules were introduced in India in 2001, following global trends and the increasing volume of cross-border transactions involving multinational enterprises. The legislative evolution has been marked by a continuous effort to address practical challenges, close loopholes, and harmonize domestic law with international best practices. Clause 165 is the latest step in this evolutionary process, reflecting both the maturing of India's transfer pricing jurisprudence and the need to adapt to changing economic realities and tax planning strategies.

Detailed Analysis of Clause 165 of the Income Tax Bill, 2025

1. Methods for Determination of Arm's Length Price

Clause 165(1) enumerates six methods for determining the arm's length price:

• Comparable Uncontrolled Price (CUP) Method
• Resale Price Method (RPM)
• Cost Plus Method (CPM)
• Profit Split Method (PSM)
• Transactional Net Margin Method (TNMM)
• Any other method as prescribed by the Board

This mirrors the methods prescribed u/s 92C(1) and Rule 10B. The explicit enumeration of methods ensures that taxpayers and tax authorities have a clear set of tools for ALP determination, with flexibility to adopt new methods as prescribed by the Central Board of Direct Taxes (CBDT) in response to evolving business models and transaction types.

The inclusion of a residual "such other method as prescribed by the Board" is particularly significant. It allows for the adoption of alternative methods (e.g., the "other method" under rue 10AB, such as the valuation method for intangibles) when traditional methods may not be suitable, thereby enhancing the adaptability of the regime.

2. Selection and Application of the Most Appropriate Method 

Clause 165(2) stipulates that the most appropriate method must be selected with regard to:

• The nature of the transaction or class of transaction
• The class of associated enterprise
• The functions performed by such enterprises
• Other relevant factors as may be prescribed

The method must then be applied in the manner prescribed. This approach is consistent with Section 92C(1) and is further elaborated in Rule 10B, which prescribes detailed criteria for method selection and application. The emphasis on functional analysis (functions, assets, and risks-FAR analysis) is central to transfer pricing, ensuring that the chosen method reflects the economic substance of the transaction.

The provision also delegates significant procedural detail to subordinate legislation, allowing the CBDT to prescribe the manner of application. This ensures flexibility and responsiveness to practical challenges, but also introduces potential uncertainty as detailed rules may change over time.

3. Determination of Arm's Length Price 

Clause 165(3) addresses scenarios where the most appropriate method yields either a single price or multiple prices:

1. If only one price is determined, it shall be the ALP, unless the actual transaction price is within a prescribed tolerance band (not exceeding 3%), in which case the actual price will be deemed the ALP.
2. If more than one price is determined, the ALP is to be determined in a prescribed manner.

This closely tracks the approach in Section 92C(2), which previously relied on the arithmetical mean of multiple prices and provided for a tolerance range. The 2025 Bill's reference to a "prescribed manner" for cases with multiple prices indicates a move towards more detailed rule-making, potentially allowing for methods such as interquartile ranges, as seen in OECD guidelines and in recent Indian administrative practice.

The provision for a tolerance band (not exceeding 3%) aligns with current law and serves to reduce disputes over minor pricing differences, acknowledging the inherent imprecision in transfer pricing analysis.

4. Role of the Assessing Officer 

Clause 165(4) empowers the Assessing Officer (AO) to determine the ALP if, during assessment proceedings, he is of the opinion that:

• The price charged or paid was not determined in accordance with the prescribed methods
• Required documentation was not maintained
• The information or data used is not reliable or correct
• The assessee failed to furnish information or documents as required

This is substantially similar to Section 92C(3), which outlines the circumstances under which the AO may intervene in ALP determination. The provision ensures that the burden of proof lies initially on the taxpayer, but the AO retains the authority to make adjustments where compliance is lacking or information is inadequate.

Clause 165(5) introduces a procedural safeguard, requiring the AO to issue a show-cause notice before determining the ALP on the basis of material in his possession. This is a critical element of natural justice, ensuring that the taxpayer has an opportunity to respond before an adverse determination is made.

Clause 165(6) authorizes the AO, upon determination of the ALP, to recompute the total income of the assessee accordingly. This is a direct consequence of an ALP adjustment and is consistent with existing law.

5. Restriction on Deductions 

Clause 165(7) provides that no deduction shall be allowed u/s 144 or under Chapter VIII in respect of the income by which the total income is enhanced after an ALP adjustment. This is analogous to the restriction in Section 92C(4), which disallows deductions u/s 10A, 10AA, 10B, or Chapter VI-A for enhanced income following a transfer pricing adjustment.

The rationale is to prevent taxpayers from claiming tax incentives or exemptions on income that has been added back due to non-arm's length pricing, thereby preserving the integrity of the transfer pricing regime.

6. Non-duplication of Income Adjustments 

Clause 165(8) ensures that where the total income of one associated enterprise is enhanced due to an ALP adjustment (and tax has been deducted or was deductible on payments to the other associated enterprise), the income of the other associated enterprise shall not be recomputed by reason of such determination. This anti-double taxation measure is crucial for fairness and is mirrored in the second proviso to Section 92C(4).

This provision prevents the same income from being taxed twice within the group, reflecting a principle of single taxation and aligning with international norms.

Practical Implications

For Taxpayers

Clause 165 imposes significant compliance obligations on taxpayers engaged in international or specified domestic transactions with associated enterprises. Key implications include:

• Requirement to select and apply the most appropriate transfer pricing method based on detailed functional and economic analysis
• Maintenance of robust documentation and data to substantiate the ALP
• Exposure to adjustments and penalties if compliance is lacking or if the AO determines that the ALP has not been properly established
• Potential denial of tax incentives on enhanced income resulting from transfer pricing adjustments

The procedural safeguards, such as the show-cause notice, provide some protection against arbitrary adjustments, but the overall regime remains rigorous and exacting.

For Tax Authorities

The provision empowers tax authorities to scrutinize transfer pricing documentation and challenge the taxpayer's ALP determination where warranted. The AO's authority is balanced by procedural requirements and by the need to act on the basis of material evidence. The ability to prescribe detailed rules and methods allows the CBDT to respond dynamically to new challenges and to align with global best practices.

For the Economy and Policy

A robust transfer pricing regime is essential for protecting the tax base in an era of globalized business and complex supply chains. Clause 165, by codifying and refining the ALP determination process, seeks to deter profit shifting and ensure that India receives its fair share of tax from multinational enterprises. At the same time, the provision aims to provide certainty and predictability for businesses, thereby supporting investment and economic growth.

Comparative Analysis with Section 92C and Rule 10B

1. Methods and Criteria

Both Clause 165 and Section 92C list the same six methods for determining ALP, with Rule 10B providing detailed procedural rules for each method. The explicit reference in Clause 165(2) to "class of associated enterprise" and "functions performed" echoes the FAR analysis in Rule 10B(2), ensuring that the selection of the most appropriate method is grounded in economic substance rather than mere form.

Rule 10B further elaborates on the application of each method, setting out step-by-step procedures and comparability criteria. While Clause 165 does not reproduce these details, it delegates the procedural aspects to prescription by the Board, thus maintaining alignment with the existing rules while allowing for future updates.

2. Determination of ALP and Tolerance Band

Section 92C(2) originally provided for the use of the arithmetical mean when multiple prices are determined, with a tolerance band (initially 5%, later 3%). Clause 165(3) similarly recognizes the possibility of multiple prices but leaves the manner of determination to be prescribed. This could signal a move away from the rigid arithmetical mean approach towards potentially more nuanced statistical or economic methods, subject to future rules.

The 3% cap on the tolerance band in Clause 165 is in line with recent notifications u/s 92C, reflecting a policy shift towards tighter control over transfer pricing adjustments.

3. Documentation and Compliance

Both regimes require taxpayers to maintain contemporaneous documentation and empower the AO to intervene if documentation is lacking, unreliable, or not furnished in time. While Section 92C refers to Section 92D for documentation requirements, Clause 165 refers to section 168(1) (presumably the new documentation provision in the 2025 Bill).

Rule 10B provides detailed guidance on comparability analysis, data selection (including the use of multi-year data), and adjustments for differences. Clause 165 leaves these matters to prescription, ensuring flexibility but also placing a premium on the quality and clarity of future rules.

4. Procedural Safeguards

The requirement for a show cause notice before making an ALP adjustment is found in both Clause 165(5) and the proviso to Section 92C(3). This procedural safeguard is essential to uphold the principles of natural justice and to provide taxpayers with an opportunity to explain or defend their pricing.

5. Restrictions on Deductions and Double Taxation

The restriction on deductions for enhanced income and the safeguard against double adjustment of associated enterprises are common features of both Clause 165 and Section 92C(4). These provisions ensure that the purpose of transfer pricing adjustments-to prevent profit shifting-is not undermined, while also preventing unfair double taxation within the group.

6. Delegated Legislation and Future Flexibility

A notable feature of Clause 165 is the increased reliance on prescription by the Board for procedural and methodological details. While this enhances flexibility and responsiveness, it also introduces a degree of uncertainty, as key aspects of the regime may be subject to frequent change or interpretive disputes unless the rules are clear and stable.

Rule 10B currently provides detailed and stable guidance, but its future under the new regime will depend on the nature and quality of the rules prescribed under Clause 165.

Ambiguities and Potential Issues

While Clause 165 is comprehensive, several areas may give rise to interpretational challenges:

• Prescribed manner for multiple prices: The clause leaves it to the rules to specify how the ALP is to be determined when multiple prices are found. The absence of statutory detail could lead to uncertainty until rules are notified.
• Scope of "such other method": The flexibility to prescribe other methods is valuable, but could lead to disputes over the appropriateness of new methods, especially in novel or complex transactions.
• Interaction with other provisions: The restriction on deductions refers to section 144 and Chapter VIII in the Bill, which may differ from the sections referenced in the Income-tax Act, 1961. The precise scope of these restrictions will depend on the final structure of the new Act.
• Documentation and compliance burden: The requirement to maintain extensive documentation and respond to AO inquiries can be onerous, especially for small and medium-sized enterprises.

Practical Compliance and Procedural Impacts

From a compliance perspective, Clause 165 reinforces the need for meticulous documentation, robust benchmarking studies, and proactive engagement with transfer pricing rules. Taxpayers must ensure that their transfer pricing policies are defensible, supported by appropriate data, and periodically reviewed in light of evolving rules and guidance.

Procedurally, the show-cause requirement and the reliance on prescribed rules provide important checks and balances. However, the effectiveness of these safeguards will depend on the clarity and fairness of the rules ultimately issued by the CBDT.

Conclusion

Clause 165 of the Income Tax Bill, 2025, represents a logical and necessary evolution of India's transfer pricing law. It consolidates and refines the statutory framework for ALP determination, aligning with both domestic experience and international standards. The provision balances the need for administrative flexibility with the imperative of legal certainty, and seeks to protect the tax base while providing procedural fairness to taxpayers.

The ultimate effectiveness of the new regime will depend on the quality of subordinate legislation and the capacity of both taxpayers and tax authorities to implement and administer the rules in a fair and efficient manner. Potential areas for further reform include greater use of advance pricing agreements, enhanced dispute resolution mechanisms, and further alignment with global transfer pricing trends.

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Full Text:

Clause 165 Determination of arm's length price.

 

Dated: 24-4-2025