In the fast-evolving world of international taxation, every small tweak in regulation can have far-reaching effects. On November 6, 2025, the Central Board of Direct Taxes (CBDT) issued Notification No. 157/2025, a concise yet impactful update that defines the tolerance range for Arm’s Length Price (ALP) determination for Assessment Year (AY) 2025–26.

While the announcement might seem technical at first glance, its implications ripple across multinational enterprises (MNEs), tax authorities, and the larger business community. The notification cements the tolerance range of 1% for wholesale trading and 3% for all other cases, reaffirming the government’s consistent approach toward pragmatic flexibility in transfer pricing (TP) compliance.

But what does this really mean for businesses operating across borders? Why is this small percentage range such a crucial part of India’s tax framework? And what does it reveal about the government’s evolving stance on transfer pricing certainty?

Let’s dive deeper.

Setting the Context: Why Tolerance Limits Matter in Transfer Pricing

To understand the gravity of this announcement, we must first understand the concept of Arm’s Length Price (ALP) in the transfer pricing ecosystem.

Under Section 92C of the Income-tax Act, 1961, the ALP is the price that would have been charged between unrelated parties in comparable transactions. Essentially, it’s the benchmark for fairness in cross-border transactions between related entities — ensuring profits aren’t artificially shifted to low-tax jurisdictions.

However, in practice, determining the exact ALP is a complex exercise. It involves intricate benchmarking studies, data limitations, and subjective judgments. No two comparables are ever perfectly identical, and hence, minor variations are inevitable.

Recognizing this inherent difficulty, the law allows a tolerance range — a margin within which the actual transaction price may deviate from the computed ALP without triggering an adjustment. This range provides administrative relief to taxpayers and reduces unnecessary litigation, a persistent challenge in Indian transfer pricing.

In simple terms, if your transaction price falls within the notified tolerance band (say ±3%), it is deemed to be at arm’s length, sparing you from transfer pricing adjustments.

The Notification in Focus: What CBDT Has Announced

As per the CBDT Notification S.O. 5053(E) dated November 6, 2025, issued under the third proviso to Section 92C(2) of the Income-tax Act and the proviso to Rule 10CA(7) of the Income-tax Rules, 1962:

“Where the variation between the arm’s length price determined under section 92C and the price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed, (i) one per cent of the latter in respect of wholesale trading; and (ii) three per cent of the latter in all other cases — the price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm’s length price for the assessment year 2025–2026.”The Central Board of Direct Tax…

This means the same tolerance levels that applied in the preceding years are continued for AY 2025–26 — ensuring stability and predictability for taxpayers.

The notification also defines “wholesale trading” clearly:

• The purchase cost of finished goods must be 80% or more of the total cost of trading activities.

• The average monthly closing inventory should not exceed 10% of sales related to those trading activities.

This distinction is crucial because wholesale trading often operates on thin margins and rapid inventory turnover, warranting a narrower tolerance band (1%) compared to other sectors.

Why Maintaining the Same Tolerance Range Matters

At first glance, one might wonder — what’s so significant about maintaining a 1% or 3% range?

The answer lies in consistency, compliance ease, and predictability.

India’s transfer pricing regime has matured over two decades, evolving from rigid enforcement to a more balanced approach emphasizing dispute prevention. The tolerance limit, though small in numerical value, represents a bridge between policy intent and commercial practicality.

By retaining the 1% and 3% limits, CBDT signals several key messages:

1. Stability for Taxpayers: Businesses can continue their TP documentation and compliance processes without recalibrating models for AY 2025–26.

2. Administrative Continuity: It avoids unnecessary confusion or transitional challenges for tax authorities and taxpayers alike.

3. Alignment with Global Practice: Most countries allow a range of reasonable variations in determining ALP, recognizing market imperfections and data constraints.

4. Litigation Control: A stable tolerance range helps in reducing avoidable disputes over marginal differences — a long-standing concern in India’s TP regime.

This approach reinforces India’s broader tax policy shift toward certainty and trust-based compliance, complementing initiatives like Advance Pricing Agreements (APAs) and Safe Harbour Rules.

Tracing the Evolution: A Brief Historical Perspective

The idea of tolerance limits in transfer pricing isn’t new. The Income-tax Act incorporated this concept through Section 92C(2) and its provisos, and the limits have been notified annually by CBDT.

Historically, the tolerance band has remained steady at 1% for wholesale trading and 3% for other sectors for several years. This consistency aligns with India’s goal of maintaining a stable transfer pricing environment while adapting to international best practices under the OECD’s Base Erosion and Profit Shifting (BEPS) framework.

Over the past decade, India has significantly modernized its transfer pricing landscape — introducing country-by-country reporting (CbCR), Master File requirements, and APAs — all designed to ensure transparency while reducing tax controversy.

The tolerance range complements these initiatives by acting as a pragmatic buffer zone that acknowledges that pricing cannot be mathematically precise in every instance.

The Real-World Implications for Businesses

Now, let’s translate this policy into real-world impact.

Imagine a multinational engaged in importing goods from its parent entity. Based on benchmarking, the ALP for a particular transaction is determined at ₹100. However, the actual transaction occurs at ₹102.

If the tolerance range is 3%, the difference (₹2) falls within that range. Hence, the price of ₹102 will be deemed to be at arm’s length, and no TP adjustment will be made.

This seems straightforward, but in practice, the benefits extend far beyond this example.

1. Reduced Litigation and Compliance Burden

Transfer pricing continues to be one of the most litigated areas in Indian tax law. By providing a reasonable tolerance margin, CBDT effectively minimizes disputes arising from marginal pricing differences.

2. Certainty in Financial Planning

Businesses thrive on predictability. Knowing the tolerance levels in advance allows CFOs and tax teams to plan intercompany pricing policies confidently and assess potential exposure.

3. Encouraging Efficient Supply Chains

For wholesale traders, a 1% tolerance reflects the thin margins they operate within. This narrower range ensures fairness without penalizing genuine business efficiencies.

4. Alignment with Global Tax Reforms

With BEPS Action Plan 13 and OECD guidelines emphasizing transparency, India’s consistent approach builds confidence among global investors, signaling regulatory maturity.

5. Retroactive Clarification without Adverse Impact

Interestingly, the notification explicitly mentions that it is retrospective in effect but certified not to adversely affect any taxpayer. This ensures that no taxpayer faces negative implications from the date of its enforcement.

Linking It with Broader Transfer Pricing Reforms

This notification doesn’t exist in isolation — it’s part of India’s broader strategy to create a more predictable, globally aligned, and less adversarial tax environment.

The APA programme and Safe Harbour Rules have already been instrumental in achieving certainty for taxpayers. The tolerance limit complements these by providing a built-in margin of flexibility for those outside the APA or Safe Harbour frameworks.

Moreover, with the increasing digitalization of business models and emerging complexities in intangibles and intercompany services, transfer pricing analysis has become more nuanced. Retaining familiar tolerance levels offers comfort amid such evolving dynamics.

It also reinforces the idea that India is moving from aggressive enforcement to cooperative compliance, reflecting the “Ease of Doing Business” agenda of the government.

Comparative Perspective: How India Stands Globally

Globally, tax jurisdictions handle tolerance or range concepts differently. For instance:

• OECD Guidelines do not prescribe a specific percentage but allow for an “arm’s length range” based on statistical interquartile analysis.

• United States relies more on the “best method rule” without a fixed tolerance percentage.

• India, however, provides clear numeric thresholds, offering certainty and simplicity — especially beneficial in a developing economy with diverse industry structures.

This clarity makes India’s framework more transparent, even if numerically rigid. While developed economies lean toward sophisticated statistical models, India’s approach ensures ease of implementation and reduced subjectivity in determining ALP compliance.

Challenges and the Way Forward

While the notification offers much-needed stability, it’s not without its challenges and debate points.

1. Uniform Tolerance vs. Industry-Specific Flexibility: Some experts argue that different industries have varying volatility in margins, and a uniform 3% range might not suit all. Sectors like ITES, pharmaceuticals, or financial services often face benchmarking variations exceeding this threshold.

2. Dynamic Global Pricing: In volatile global markets, especially with fluctuating forex rates or inflationary pressures, even a 3% tolerance may sometimes seem narrow.

3. Dependence on Quality of Comparables: The tolerance range is only as good as the benchmarking study behind it. Poor-quality comparables can still lead to disputes despite the margin.

Nevertheless, maintaining this narrow band underscores the government’s belief that data quality and APA mechanisms can manage outliers, while the tolerance range remains a safety net for genuine minor differences.

Case in Point: The Practical Impact of Consistent Tolerance Policy

Consider a real-world case where a manufacturing MNE’s ALP is computed at ₹500 crore based on comparables, while the actual transaction value stands at ₹514 crore. The difference of ₹14 crore translates to 2.8% — within the 3% band.

Without this tolerance limit, such a company might have faced a TP adjustment of ₹14 crore, leading to higher tax, interest, and possible penalties. With the tolerance, the transaction is deemed compliant, avoiding unnecessary litigation and cost.

This example underscores why these small percentages are not just numbers but pillars of administrative efficiency and business confidence.

The Broader Message: Stability Breeds Trust

Tax certainty is a cornerstone of a healthy investment climate. Over the years, India has been striving to balance revenue protection with investor confidence.

By maintaining the tolerance limits, CBDT communicates that:

• It recognizes the practical challenges businesses face in determining ALP.

• It intends to avoid penalizing marginal deviations that arise from genuine commercial circumstances.

• It remains committed to a stable, predictable tax environment that attracts global investments.

This continuity, though modest in form, carries significant weight in substance. It reinforces India’s shift toward a tax administration built on trust rather than tension.

Conclusion: Small Margins, Big Impact

The CBDT’s notification on maintaining the 1% and 3% tolerance range for AY 2025–26 might appear as a routine annual update — but in essence, it’s a reaffirmation of India’s maturing transfer pricing framework.

It symbolizes consistency, clarity, and confidence in the country’s tax governance. For multinational companies, it provides a predictable environment to plan, price, and operate without the fear of minor pricing deviations leading to large-scale disputes.

At a time when global supply chains are being reshaped and tax transparency is under sharper scrutiny, such regulatory stability sends a strong message: India values certainty and reasonableness in its tax system.

The road ahead may bring more sophisticated transfer pricing mechanisms, perhaps even AI-assisted benchmarking or dynamic tolerance models. But for now, this notification reinforces a crucial truth — sometimes, stability is the boldest form of progress.