Arm's length price: meaning, range and a worked example

Section 92F(ii) of the Income-tax Act, 1961 defines the arm's length price as the price applied, or proposed to be applied, in a transaction between persons other than associated enterprises, in uncontrolled conditions. In plain words: what would two independent businesses have charged each other for the same thing, on the same terms?

Section 92(1) requires income from an international transaction to be computed having regard to the arm's length price. The same test applies to specified domestic transactions above ₹20 crore. It only applies between an associated enterprise and you, so the first question is always whether the other party is associated at all.

The rule works in one direction. Section 92(3) says transfer pricing cannot be used to reduce your income or increase your loss. If your group price is better for the Indian tax base than arm's length, the officer leaves it alone.

1. Identify the transaction. Goods, services, royalty, loan, guarantee, reimbursement or share transfer, with its contract terms.
2. Analyse functions, assets and risks. Who does the work, who owns the assets, who bears market, credit and inventory risk.
3. Choose the most appropriate method from the six allowed by section 92C and Rule 10B. Our guide to transfer pricing methods covers each one.
4. Find comparables. Uncontrolled transactions or independent companies, usually from the Prowess or Capitaline databases.
5. Adjust for differences in working capital, risk, volume or accounting that would change the price.
6. Compute the range or the mean and test your actual price against it.

Rule 10B(2) lists what makes a comparable comparable: the characteristics of the goods or services, the functions performed and risks assumed, the contractual terms, and the market conditions, including geography, market size, competition and the level of the market.

Rule 10CA brought in the range concept. It applies when the most appropriate method is CUP, resale price, cost plus or TNMM and there are at least six comparables. The comparables' results are arranged in ascending order and the range runs from the 35th to the 65th percentile.

• The 35th percentile is the lowest value in the data set such that at least 35% of the values are equal to or below it. If exactly 35% of the values are at or below it, the 35th percentile is the average of that value and the next one up.
• The 65th percentile and the median (the 50th percentile) are worked out the same way.
• If your price is inside the range, it is accepted as arm's length. No adjustment.
• If it is outside, the arm's length price is the median, not the nearer end of the range. That is why missing the range by a little can cost a lot.

From tax year 2026-27 the same rule is Rule 81 of the Income-tax Rules, 2026, read with section 165 of the Income-tax Act, 2025. It keeps the 35th to 65th percentile range for six or more entries, the median rule and the same percentile definitions.

An Indian subsidiary develops software for its US parent. Its operating cost for the year is ₹40 crore and it bills cost plus 12%. The tested party is the Indian company, the method is TNMM and the profit level indicator is operating profit on operating cost (OP/OC). The search finds eight comparable companies with these margins, in ascending order:

• 35th percentile: 35% of 8 values is 2.8, so the lowest value with at least 2.8 values at or below it is the 3rd: 13.2%.
• 65th percentile: 65% of 8 is 5.2, so it is the 6th value: 17.4%.
• Median: 50% of 8 is exactly 4, so it is the average of the 4th and 5th values: (14.6% + 16.0%) / 2 = 15.3%.

The arm's length range is 13.2% to 17.4%. The company's 12% is below it, so the arm's length margin becomes the median of 15.3%. The adjustment is ₹40 crore × (15.3% − 12%) = ₹1.32 crore, added to taxable income.

Because the adjustment is above ₹1 crore, section 92CE also applies. Unless ₹1.32 crore is brought back from the parent within 90 days, it is treated as an advance and interest is imputed on it every year until it is repaid. A price of 13.5% would have avoided all of this.

With fewer than six comparables, or when the method is profit split or the other method, the arm's length price is the arithmetic mean of the comparables. The third proviso to section 92C(2) then gives a tolerance band. If the difference between the arm's length price and your actual price is within a notified percentage of your actual price, no adjustment is made.

CBDT notifies the band each year, and Rule 81(7) of the 2026 Rules caps it at 3%. It has been 1% for wholesale trading and 3% for all other cases in recent notifications, most recently for AY 2025-26. Wholesale trading here means the purchase cost of finished goods is at least 80% of the total trading cost and average monthly closing inventory is not more than 10% of sales.

Example: the mean of the comparable prices is ₹100 and you charged ₹98. The difference of ₹2 is 2.04% of ₹98, inside 3%, so ₹98 stands.

When comparables are selected on current-year data, their data for the two preceding years can also be used, and the margin is the weighted average across the years. If a comparable's current-year results are not available when the TP study is prepared, the preceding years' data can be used at that stage. Using three years smooths one-off swings in a comparable's results, which usually helps a stable captive service provider.

From tax year 2026-27 the arm's length principle continues under the Income-tax Act, 2025. The forms are renumbered: the accountant's report is Form 48 instead of Form 3CEB. A new Form 46 lets a taxpayer exercise the option for determination of the arm's length price under section 166(9), the block-period option announced in Budget 2025 for applying one year's arm's length price to later years with the same transactions.

• Test your margin at the half year against last year's comparables, not after 31 March.
• Put a true-up clause in the intercompany agreement, so a year-end price correction has a contractual basis.
• Keep segmental accounts that separate associated enterprise business from third-party business.
• Document working capital and risk adjustments with the calculation, not just the conclusion.
• Avoid unexplained year-end credit notes that pull the margin into the range. They are a classic reason for a TPO reference.

If you need the range worked out for your own transactions, our transfer pricing services include the benchmarking search and database cost.