SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAXCentral

Section 161 of Income Tax Act 2025

Computation of income from international transaction and specified domestic transaction having regard to arm’s length price

CHAPTER X

SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX

(1)Any income arising from an international transaction or a specified domestic transaction shall be determined having regard to the arm's length price.
(2)Any allowance for any expense or interest arising from an international transaction or a specified domestic transaction shall also be determined having regard to the arm's length price.
(3)If in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for—
1. (a)allocation or apportionment of any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises; or
2. (b)any contribution to any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises,

the cost or expense allocated or apportioned to, or, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility.

(4)The provisions of this section shall not apply if the determination under sub-section (1) or (2) or (3) has the effect of reducing the income chargeable to tax or increasing the loss, computed on the basis of entries made in the books of account in respect of the tax year in which the international transaction or specified domestic transaction was entered.

Summary

Income from international transactions or specified domestic transactions must be calculated based on the arm's length price (the price that would be charged between unrelated parties in uncontrolled conditions).
Any business expense or interest arising from these transactions must also be calculated using the arm's length price.
When associated enterprises share or allocate costs for services, benefits, or facilities, those cost allocations must reflect the arm's length price of the service.
These rules will not be applied if they result in reducing the total taxable income or increasing the tax loss of the business in India compared to its actual books of accounts.

Practical examples

1TechIndia, an Indian software development company, provides coding services to its parent company, TechUS, based in the United States. If TechIndia charges TechUS 400,000 rupees for a project that would normally be priced at 1,000,000 rupees in the open market, the Indian tax authority will recalculate TechIndia's taxable income using the arm's length price of 1,000,000 rupees to prevent tax avoidance.

2AutoCorp India buys raw steel from its foreign associated enterprise, SteelGlobal, for 5,000,000 rupees in November 2026. The market price of similar steel between independent parties is only 3,500,000 rupees. Under Section 161, AutoCorp's allowable expense for tax purposes will be reduced to the arm's length price of 3,500,000 rupees, which increases its taxable income in India.

FAQ

1. What is the primary purpose of using the arm's length price under this section?

The primary purpose is to ensure that income, expenses, and interest arising from transactions between associated businesses are calculated as if the businesses were independent, preventing artificial profit shifting.

2. Do these rules apply to mutual cost-sharing agreements for services or facilities?

Yes, if associated enterprises have an agreement to share or contribute to the costs of any benefit, service, or facility, the shared costs must be determined based on the arm's length price of those benefits.

3. What happens if calculating the arm's length price actually reduces the tax liability in India?

The arm's length price rules will not apply if their application would decrease the taxable income or increase the tax loss of the taxpayer compared to what is shown in their books of accounts.

4. Are both income and expenses covered under Section 161?

Yes, any income arising from, and any allowance for expenses or interest arising from, an international or specified domestic transaction must be determined using the arm's length price.

Test yourself

1.When will the arm's length price provisions of Section 161 NOT be applied?

2.Besides income, what else must be determined having regard to the arm's length price under Section 161?

3.Under Section 161, cost allocation or contribution between associated enterprises for sharing a service must be based on what?

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