Transfer pricing under the Income Tax Act, 2025.
Our international tax practice.
1. The TP framework.
Transfer pricing under Indian tax law requires that international transactions and specified domestic transactions between associated enterprises (AEs) be priced at arm's length. The framework, originally introduced through sections 92 to 92F of the 1961 Act and carried into the Income Tax Act, 2025 with continuity and updates, requires the taxpayer to (a) compute and apply arm's length pricing to covered transactions, (b) maintain prescribed documentation, (c) file a TP report (Form 3CEB equivalent under the new code) with a Chartered Accountant's certificate, and (d) defend the pricing on assessment.
2. Scope: who is covered.
The TP provisions apply to:
- International transactions between two or more associated enterprises, where at least one is a non-resident. The definition of "international transaction" is broad: purchase or sale of tangible or intangible property, provision of services, lending or borrowing, business restructuring, cost-contribution arrangements.
- Specified domestic transactions above a turnover threshold, between domestic associated enterprises. The threshold has been amended over time; the current threshold and the specific transactions covered should be confirmed with reference to the Act and rules.
Associated enterprise is defined in the Act and the test is met by reference to direct or indirect shareholding (typically 26% or more), common control, or by reference to specified relationship criteria (one entity supplying 90% or more of the raw material to another, etc.).
3. The five methods.
The Act prescribes five methods for determining the arm's length price. The most appropriate method (MAM) is selected based on the facts of the transaction:
- CUP (Comparable Uncontrolled Price). Compares the price charged in a controlled transaction with the price charged in a comparable uncontrolled transaction. Most direct; rarely available because true comparables are rare.
- Resale Price Method (RPM). Starts with the resale price to an unrelated party and works back to an arm's-length purchase price by applying an appropriate gross margin. Used for distribution and resale.
- Cost Plus Method (CPM). Adds an appropriate mark-up to the cost incurred by the supplier. Used for manufacturing and services where the supplier adds value through processing.
- Profit Split Method (PSM). Splits the combined profit of related parties based on their relative contributions. Used for highly integrated transactions or where both parties contribute unique intangibles.
- Transactional Net Margin Method (TNMM). Compares the net profit margin of the controlled transaction with the margins earned by independent comparable companies. The most commonly applied method in Indian practice because of comparables availability.
A sixth method - "any other method" prescribed by the CBDT - allows a residual category. Selection of the MAM and the supporting reasoning are central to the TP study.
4. The TP study.
A TP study is the analytical document that supports the pricing position. A complete study contains:
- Description of the controlled transaction(s).
- Industry and economic analysis (industry trends, competitive dynamics).
- Functional analysis: functions performed, assets used, risks assumed by each AE.
- Selection of the tested party (typically the less complex AE).
- Selection of the most appropriate method, with reasoning.
- Selection of the profit-level indicator (operating margin, gross margin, cost-plus, etc.).
- Comparables search and screening: database search, qualitative screening, application of filters (turnover, profitability, comparability adjustments).
- Computation of the arm's length range / margin.
- Comparison with the tested party's margin and conclusion.
5. Three-tier documentation.
For larger multinational groups, the TP documentation has three levels following the OECD's BEPS Action 13:
- Master File. Maintained by the multinational group. Contains group-level information: organisational structure, business description, intangibles, financial activities, financial and tax positions. Filed in India by the constituent entity if specified thresholds are met.
- Local File. Maintained by the Indian entity. Contains the detailed TP analysis for the Indian entity's controlled transactions - the TP study described above.
- Country-by-Country Report (CbCR). Filed by the ultimate parent (or designated entity) of a multinational group with consolidated revenue above the prescribed threshold. CbCR contains country-level financial and tax data.
Penalties for non-maintenance or non-filing of the prescribed documentation are substantial and are separate from the pricing-related additions.
6. Safe harbour rules.
Safe harbour rules provide pre-defined margins for specified categories of transactions; a taxpayer who applies the safe-harbour margin is not subject to TP scrutiny for that transaction.
Categories typically covered include:
- Software development services (operating margin floor).
- IT-enabled services (operating margin floor).
- Knowledge process outsourcing (operating margin floor).
- Contract R&D services in IT and pharma sectors.
- Manufacture and export of certain auto components.
- Receipt of loans from AEs (interest rate floors).
- Provision of guarantees to AEs (commission rate floors).
Safe harbour is a one-way option for the taxpayer; the tax department cannot use the safe-harbour margin as a basis to reduce a higher-claimed margin. Eligibility, thresholds and margins are revised periodically; the current safe-harbour rules should be confirmed before relying on them.
7. Advance Pricing Agreements.
An Advance Pricing Agreement is a binding ruling between a taxpayer and the CBDT (and, in a bilateral or multilateral APA, with the competent authorities of one or more treaty partners) on the appropriate transfer-pricing methodology and the application of that methodology to covered transactions for a specified period (typically 5 years, with rollback options).
APAs are particularly useful for:
- High-value, repetitive transactions where TP scrutiny is recurring.
- Complex transactions with novel pricing questions (intangibles, intra-group financing, cost-contribution arrangements).
- Groups with a history of TP litigation seeking certainty.
The APA process is structured: pre-filing consultation, application, evaluation, negotiation, and agreement. Timelines have improved meaningfully, with many bilateral APAs now concluding in 24 to 36 months from filing.
8. The TP audit and assessment.
TP cases that exceed prescribed thresholds are referred by the assessing officer to a Transfer Pricing Officer (TPO). The TPO determines the arm's length price and reports it back to the assessing officer, who then frames the order.
The assessment can result in:
- Acceptance of the taxpayer's TP position. No addition.
- Adjustment to the TP position. The TPO finds the taxpayer's pricing outside the arm's-length range and proposes an adjustment, which the assessing officer adds to income.
Appellate routes include the Dispute Resolution Panel (DRP), CIT(A), and the ITAT. The Mutual Agreement Procedure (MAP) under treaties is available where TP adjustments lead to double taxation.
9. Practical issues we see.
- Stale comparables. A TP study used unchanged across years uses comparables that have changed. Refresh the comparables search every year, even if the conclusion does not change.
- Functional changes not reflected. The Indian entity takes on new functions or risks but the TP characterisation does not update. The pricing then becomes inconsistent with the functional profile.
- Cost base inflation. Cost-plus mark-up applied to a cost base inflated by allocations that would not survive a functional analysis. The TPO will challenge the cost base.
- Intra-group services without documentation. Management fees, IT services, regional support fees - charged but not supported by a detailed service description and a benefit demonstration. Frequent ground for TP adjustments.
- Royalty and FTS fragmentation. Splitting a single composite payment into royalty, FTS, and reimbursement to optimise tax outcomes can attract recharacterisation by the TPO.
Frequently asked
What is an associated enterprise?
An associated enterprise is defined under the IT Act (carried forward into the 2025 code) by reference to direct or indirect participation in management, control or capital (typically 26% or more shareholding), or by reference to specified relationships (one entity supplying 90%+ raw material, mutual interest of relatives etc.). A full enterprise-by-enterprise analysis is required where the relationship is not obvious.
What is the most commonly applied TP method in India?
TNMM (Transactional Net Margin Method) is the most commonly used method, primarily because of database availability and the practical difficulty of finding direct CUP or RPM/CPM comparables for many Indian transactions. CUP and Profit Split are applied where the transaction supports them.
Are safe harbour rules a final settlement of the transaction?
Yes, for the transaction and the period covered. A taxpayer who validly opts into safe harbour and applies the safe-harbour margin is not subject to TP scrutiny for that transaction for the period. The election is binding for the period.
What is the difference between unilateral, bilateral and multilateral APA?
Unilateral APA: between the taxpayer and the CBDT only. Bilateral APA: also involves the competent authority of one treaty partner. Multilateral APA: involves the competent authorities of two or more treaty partners. Bilateral and multilateral APAs reduce the risk of double taxation more effectively because the treaty partner has agreed to the same methodology.
What is the secondary adjustment under TP?
Where a primary TP adjustment results in funds remaining with the foreign AE that should have come to India, the IT Act treats the unrepatriated amount as a deemed loan attracting notional interest, until the amount is repatriated. The mechanism aligns Indian TP law with the international BEPS framework on secondary adjustments.
How long should TP documentation be retained?
Eight years from the end of the relevant assessment year, in line with the general retention requirements under the IT Act. The retention applies to all components - local file, master file, contemporaneous documentation, comparables search, board approvals.
Can a TP adjustment be appealed?
Yes, through the standard appellate hierarchy: Dispute Resolution Panel (DRP) at the assessment stage, CIT(A), ITAT, High Court and Supreme Court on substantial questions of law. The Mutual Agreement Procedure (MAP) under DTAA can be invoked in parallel where double taxation arises.
