Clarification for Transfer Pricing: New Income Tax Bill Brings Crystal-Clear ALP Tolerance Rules

Introduction

Transfer pricing, the pricing of transactions between associated enterprises, is a cornerstone of international taxation. For years, taxpayers and tax authorities in India have grappled with interpretational ambiguities around the application of tolerance ranges in determining the Arm’s Length Price (ALP). The Finance Bill 2025, introducing a New Income Tax Act, has now addressed one of the long-standing uncertainties—whether the +/-3% tolerance range applies when the ALP is a single price.

This legislative clarification is both timely and significant. It enhances transparency, reduces litigation, and brings India’s transfer pricing regime closer to international best practices.

Background: ALP and Tolerance Range Under Section 92C(2)

Under the Indian Income Tax Act, Section 92C lays down the framework for determining the ALP for international transactions between related parties. The ALP is the price that would have been charged between unrelated parties under comparable circumstances.

Subsection (2) of Section 92C allowed for a tolerance range (or margin) of +/-3% (or +/-1% for wholesale traders) of the transaction value, provided the price at which the international transaction was undertaken did not exceed this range from the ALP.

The Core Ambiguity

The language of the existing law, however, was unclear on one crucial point:

Does the tolerance range apply only when a range of ALPs is determined, or also when a single most appropriate ALP is selected?

This led to varied interpretations:

Some tribunals and courts held that the tolerance band is not applicable where only a single price is adopted as ALP.
Others allowed the 3% variation even with a single-point ALP, treating it as a standard compliance relief.

This lack of uniformity created compliance challenges and gave rise to frequent litigation.

The Reform: New IT Bill Clarification

The New Income Tax Bill 2025 has stepped in to decisively settle this issue.

Key Clarification:

The Bill explicitly states that the +/-3% tolerance range is applicable even where a single price is determined as the ALP.

This means:

Taxpayers will not be penalized or subject to adjustment if their transaction value deviates from the determined ALP by no more than 3%.
The provision now acts as a de facto safe harbor, reducing scrutiny where deviations are within this acceptable margin.

Implications of the Clarification

1. Reduction in Litigation

This change directly addresses a frequent area of dispute between taxpayers and the Income Tax Department. By providing legislative clarity, it minimizes subjectivity and aligns tax administration with commercial realities.

2. Improved Tax Certainty

Businesses can now structure inter-company transactions with better predictability and avoid last-minute adjustments solely for fear of minor ALP deviations.

3. Boost to Ease of Doing Business

By offering a clearer and more rational transfer pricing framework, the reform contributes to India’s image as a business-friendly jurisdiction—particularly for multinationals operating shared service centers, R&D hubs, or regional headquarters in India.

4. Compliance Simplification

Tax professionals now have a codified reference point that simplifies the preparation of transfer pricing documentation, reducing reliance on contradictory judicial precedents.

Illustrative Example

Scenario Before the Clarification

A company in India sells software to its associated enterprise in Germany.
It uses the Comparable Uncontrolled Price (CUP) method and determines the ALP as ?1,000 per unit.
The actual transaction was made at ?970 per unit.
There is a deviation of 3% from the ALP.

Previous Ambiguity:
Some tax officers might have argued that because a single price (?1,000) was determined as ALP, the +/-3% tolerance did not apply, and hence ?970 was not at arm’s length. A transfer pricing adjustment could be imposed.

Scenario After the Clarification

Under the new provision, the tolerance band does apply, even to a single ALP.
The price of ?970 is within the allowed 3% deviation (?1,000 ± ?30).
No adjustment is required.

This clarification thus prevents unnecessary scrutiny and aligns with practical pricing realities.

Comparison With Global Practices

Many countries (e.g., the UK, US, Australia) permit a reasonable range or margin of tolerance, especially in recognition of minor differences that don’t significantly distort pricing. India’s move toward accepting the tolerance range even for a single ALP enhances compatibility with OECD transfer pricing guidelines, which emphasize substance over form and accept limited deviations where warranted.

Open Questions: Multi-Price or Range Scenarios

While the Bill addresses the single-price scenario, practitioners await further clarity or guidance on:

How the tolerance range is applied when a range of ALPs is derived through multiple comparable prices.
Interaction with the concept of interquartile range (IQR), which is often applied to eliminate outliers and determine the acceptable pricing corridor.

These may be addressed through future CBDT circulars, notifications, or transfer pricing guidelines.

Conclusion

The New IT Bill 2025’s clarification on the +/-3% tolerance range is a progressive step forward. By removing ambiguity, it resolves a thorny interpretational issue, provides administrative relief to taxpayers, and improves the transfer pricing ecosystem in India.

As India continues to refine its tax regime in response to globalization and digital economy challenges, such reforms will help create a stable, fair, and investment-conducive environment.

Key Takeaways

The +/-3% tolerance under Section 92C(2) will now explicitly apply even where a single price is determined as ALP.
This reform reduces disputes and compliance burdens.
Taxpayers gain greater predictability in cross-border transaction pricing.
Further clarifications may still be needed for multi-price and interquartile range scenarios.

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Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including Newspapers, Journals, Bare Acts, Case Materials , Charted Secretary, Research Papers etc.

Mayank Garg (LegalMantra Team)