Library / Income-tax Act, 2025: The Professional's Master Guide

33. Transfer Pricing (Sections 161 to 173)

Transfer pricing ensures that transactions between related parties across borders (and some domestic ones) are priced as if they were between unrelated parties. This is the arm's length price (ALP). The principles are unchanged from the 1961 Act; only section numbers and forms have changed.

33.1 Section map

Topic

New

Old

Computation of income having regard to ALP

161

92

Associated enterprise

162

92A

International transaction

163

92B

Specified domestic transaction

164

92BA

Determination of ALP, methods

165

92C

Reference to Transfer Pricing Officer

166

92CA

Safe harbour rules

167

92CB

Advance pricing agreement and its effect

168, 169

92CC, 92CD

Secondary adjustment

170

92CE

Documentation, master file, CbCR

171

92D

Accountant's report (Form 48, old 3CEB)

172

92E

Definitions

173

92F

33.2 Who is covered

  • Associated enterprises (section 162): one enterprise participates in the management, control or capital of the other, directly or indirectly, or common persons participate in both. Deemed tests include holding 26% or more of voting power, loans of 51% or more of total assets, guarantees of 10% or more of borrowings, appointment of more than half the board, and dependence for raw materials or intangibles.
  • International transaction (section 163): a transaction between two or more AEs, at least one of which is a non-resident, including purchase and sale of goods, services, loans, guarantees, cost sharing, intangibles and business restructuring.
  • Specified domestic transaction (section 164): transactions of tax holiday units with related parties, where the aggregate exceeds Rs. 20 crore in the year.

33.3 Methods and range

Method

When commonly used

Comparable Uncontrolled Price (CUP)

Commodities, interest rates, royalties with good external data

Resale Price Method (RPM)

Distributors that resell without much value addition

Cost-plus Method (CPM)

Contract manufacturers, semi-finished goods

Profit Split Method (PSM)

Highly integrated operations, unique intangibles on both sides

Transactional Net Margin Method (TNMM)

Most service providers and distributors; compares net margins

Other method

Any method that gives an arm's length result, e.g. valuation methods

Where six or more comparables are available, the range is the 35th to 65th percentile of their results; if the transaction price is within the range, no adjustment is made; if outside, the median is taken. With fewer than six comparables, the arithmetic mean is used with a tolerance of 3% (1% for wholesale traders). Multiple year data can be used.

Illustration 125: Software services to the US parent

Indus Tech Pvt. Ltd. provides software development services to its US parent. Total cost Rs. 50 crore; it charges cost-plus 10% = Rs. 55 crore. Using TNMM, the operating margins on cost of 12 comparable companies give a range of 13% to 19%, with a median of 16%.

Price charged (cost-plus 10%)

55,00,00,000

Mark-up is below the range (13% to 19%), so the median of 16% applies

Arm's length price (50 crore x 1.16)

58,00,00,000

Transfer pricing adjustment (primary adjustment)

3,00,00,000

The Rs. 3 crore is added to Indus Tech's income. Because the primary adjustment exceeds Rs. 1 crore, a secondary adjustment under section 170 also applies: the excess money of Rs. 3 crore must be brought into India within 90 days, failing which it is treated as an advance to the parent and interest is imputed each year. Alternatively, the company may pay a one-time additional tax of 18% (plus surcharge and cess) on the Rs. 3 crore, which works out to about Rs. 54 lakh before surcharge and cess.

33.4 Safe harbour (section 167) and advance pricing agreements (sections 168, 169)

Safe harbour margins are accepted by the department without scrutiny. From Budget 2026, IT and IT enabled services providers with international transactions up to Rs. 2,000 crore (earlier Rs. 300 crore) can opt for a single safe harbour margin of 15.5% on operating cost, through an automated process.

Illustration 126: Safe harbour check

If Indus Tech had charged cost-plus 15.5% (Rs. 57.75 crore) and opted for safe harbour, the price would have been accepted without benchmarking, avoiding the Rs. 3 crore adjustment and the secondary adjustment.

An APA fixes the method or price for up to five future years, with rollback for four earlier years. Unilateral APAs for IT services are to be concluded within two years. From 1 April 2026, where an APA or a mutual agreement reduces the Indian entity's income, the associated enterprise can file a modified return to claim a refund of tax withheld or paid.

33.5 Documentation and reporting

Requirement

Threshold

Form and due date

Transfer pricing documentation (functional analysis, benchmarking)

Aggregate international transactions above Rs. 1 crore

Kept on file; produced on request

Accountant's report

Any international transaction or SDT

Form 48 (old 3CEB), by 31 October

Master file

Group revenue above Rs. 500 crore and international transactions above Rs. 50 crore (or intangibles above Rs. 10 crore)

Form 56 (old 3CEAA)

Country-by-country report

Group consolidated revenue of Rs. 6,400 crore or more

Form 59 (old 3CEAD), within 12 months of year-end

Key point

Failure to maintain documentation or report transactions attracts penalties of 2% of the transaction value in the old law; the Finance Act 2026 converted delays in filing the accountant's report into a graded fee. Keep contemporaneous documentation: it is the first line of defence in a TP audit.

33.6 Block assessment option for transfer pricing

The Finance Act 2025 introduced an option where the ALP determined for a transaction in one year can, at the taxpayer's request, be applied to the same transaction in the next two years, reducing repeated audits of recurring transactions.

33.7 Functional analysis: the heart of transfer pricing

Every transfer pricing study starts with a FAR analysis: the functions performed, assets used and risks assumed by each party. It decides which party is the "tested party" (usually the less complex one), which method fits, and what kind of comparables are needed.

Aspect

Contract service provider (typical Indian captive)

Entrepreneur (typical foreign parent)

Functions

Performs development work as directed

Strategy, client acquisition, product decisions

Assets

Workforce, office, IT equipment

Intangibles, brand, customer relationships

Risks

Limited: service risk only; paid cost-plus

Market, credit, product and foreign exchange risk

Expected return

Stable, routine mark up on cost

Residual profit or loss

33.8 Benchmarking step by step

Step

Description

1

Understand the industry and the business of the taxpayer and the group

2

Identify international transactions and characterise the entity (FAR)

3

Select the most appropriate method and the tested party

4

Search databases (Prowess, Capitaline and similar) for comparable companies using filters: industry, turnover, related party transactions below 25%, persistent losses, different year-end

5

Reject companies with different functions or significant intangibles, and document reasons

6

Compute the profit level indicator (for example, operating profit on operating cost) for each comparable, using current year and up to two prior years' data as allowed

7

Apply the range (35th to 65th percentile) or arithmetic mean with tolerance

8

Make adjustments for differences (working capital, risk) where reliable

Illustration 127: Computing the range

Eight comparables have weighted average margins on cost of: 9%, 11%, 12%, 14%, 15%, 17%, 18%, 22%. Sorted, n = 8.

35th percentile: 8 x 35% = 2.8, not a whole number, so take the next higher, the 3rd value = 12%. 65th percentile: 8 x 65% = 5.2, so the 6th value = 17%. Median: 8 x 50% = 4, a whole number, so the average of the 4th and 5th values = (14% + 15%) / 2 = 14.5%.

If the taxpayer's margin is 13%, it is within 12% to 17%: no adjustment. If it is 10%, the ALP is at the median of 14.5%.

33.9 Common types of transactions

Intra-group services and management fees

Payments by an Indian entity to its parent for management, IT support or brand services are closely examined. The taxpayer must show (a) the services were actually rendered, (b) they gave a real benefit, (c) they were not duplicative or shareholder activities, and (d) the charge is at arm's length. Keep emails, reports, timesheets and cost allocation workings.

Loans and guarantees

Interest on loans to or from AEs is benchmarked against market rates in the currency of the loan (often SOFR or a similar reference rate plus a credit spread based on the borrower's credit rating). Corporate guarantees given by the Indian parent for loans to its foreign subsidiaries are international transactions; tribunals have often accepted guarantee fees of 0.5% to 1% of the guaranteed amount, depending on facts.

Illustration 128: Outbound loan

An Indian company lends USD 10 million to its US subsidiary at 2% interest. The subsidiary's credit rating implies a market rate of SOFR plus 3%, about 7.5% when SOFR is 4.5%. The Indian company charged 5.5% less than arm's length, so an adjustment of about USD 550,000 a year is likely. Converting at Rs. 84, the adjustment is about Rs. 4.6 crore, with a secondary adjustment obligation since it exceeds Rs. 1 crore.

Marketing intangibles and AMP expenses

Indian distributors of foreign brands that incur high advertising, marketing and promotion (AMP) expenses have faced claims that they are building the foreign brand owner's intangible and should be compensated. Courts have held that AMP is not automatically a separate international transaction; the revenue must show an arrangement. Distributors should document that AMP benefits their own sales and that their margins already reflect the functions performed.

Judicial view: Advertising, marketing and promotion expenses

Sony Ericsson Mobile Communications India (P) Ltd. v. CIT (Delhi High Court, 2015): rejected the "bright line test" for AMP and held that, where the distributor's overall margins are at arm's length under TNMM, a separate adjustment for AMP is generally not warranted.

Maruti Suzuki India Ltd. v. CIT (Delhi High Court, 2015): AMP spending is not an international transaction unless the revenue shows, with evidence, an arrangement with the foreign AE for such spending.

33.10 Transfer pricing audit process

Stage

What happens

Time frame (broad)

Selection

Case selected for scrutiny; the Assessing Officer refers TP matters to the TPO

After the return is filed

TPO proceedings

Notices, submissions, show cause on proposed adjustment

TPO order due at least 60 days before the assessment time limit

Draft order (eligible assessees)

Assessing Officer issues draft order incorporating TP adjustment

After TPO order

DRP

Taxpayer objects within 30 days; DRP issues binding directions

Within 9 months from the end of the month of the draft order

Final order and appeal

Order passed per DRP directions; appeal lies to the Tribunal

Within 1 month of DRP directions

MAP

Taxpayer can seek relief through the competent authorities under the treaty, in parallel

Usually within 3 years of the first notification

33.11 Documentation contents

  • Ownership structure, group profile, business description of the taxpayer and AEs.
  • Nature and terms of international transactions, with contracts and invoices.
  • Functional analysis (FAR) and the economic analysis (method selection, comparables search, rejections, final set).
  • Forecasts, budgets and assumptions affecting pricing.
  • Records of adjustments made, and any reasons for deviation from the ALP.
  • Master file (Form 56) and CbCR (Form 59) where thresholds are met; local file in the form of the above documentation.

33.12 Secondary adjustment in detail

Where a primary TP adjustment exceeds Rs. 1 crore (made suo motu, by the TPO and accepted, under an APA, safe harbour or MAP), the excess money lying with the AE must be repatriated within 90 days. If not, it is treated as an advance, and interest is computed each year at a rate linked to SBI rates (for rupee loans) or a benchmark plus spread (for foreign currency). Alternatively, the taxpayer may pay a one-time additional tax of 18% (plus 12% surcharge and cess) on the excess money, after which no further interest is imputed.

33.13 Advance pricing agreements: the process

Stage

What happens

Pre-filing consultation

Optional meeting, possibly anonymous, to discuss feasibility

Application

Filed before the first year of the proposed APA term, with fee based on transaction value

Processing

Examination of functions, assets, risks, data; site visits; for bilateral APAs, negotiation with the other country's competent authority

Agreement

Term of up to 5 years; rollback to up to 4 earlier years on request

Compliance

Annual compliance report; the APA can be cancelled for non-compliance or misrepresentation

Unilateral APAs are between the taxpayer and India only; bilateral and multilateral APAs involve the treaty partners and eliminate double taxation. Budget 2026 targets completion of unilateral APAs for IT services within two years.

33.14 Mutual agreement procedure

Where a TP adjustment in India causes double taxation (the same income taxed in India and in the country of the AE), the taxpayer can request the competent authorities to resolve it under the treaty. MAP runs parallel to domestic remedies; the taxpayer must choose between the MAP resolution and the domestic appeal outcome. India has resolved many cases with the US, UK and Japan through MAP and bilateral APAs.

33.15 Common TP issues in Indian audits

  • Rejection of comparables with extraordinary events or different functions, and inclusion of high margin companies by the TPO.
  • Characterisation of captive service providers (low-risk vs entrepreneurial), especially where Indian teams do high-value work.
  • Payments for intra-group services and royalties without evidence of benefit.
  • Interest on outstanding receivables from AEs beyond normal credit periods.
  • Guarantee fees for guarantees given to foreign subsidiaries.
  • Share valuation in issue of shares to non-resident AEs (generally not an income transaction, as held by the Bombay High Court in Vodafone India Services Pvt. Ltd., 2014).

Judicial view: Issue of shares to a foreign parent

Vodafone India Services Pvt. Ltd. v. Union of India (Bombay High Court, 2014): the issue of shares by an Indian subsidiary to its foreign parent at a price allegedly below FMV did not give rise to income, as there was no income arising from the capital account transaction. Transfer pricing provisions apply only where income arises from an international transaction. The department accepted the decision.

Chapter summary

• Transactions with AEs must be at arm's length, benchmarked using prescribed methods.

• Range of 35th to 65th percentile with six or more comparables; median if outside.

• Safe harbour for IT services up to Rs. 2,000 crore at 15.5%; APAs give certainty.

• Secondary adjustment above Rs. 1 crore: repatriate in 90 days or face imputed interest or one-time tax.

• Documentation and Form 48 by 31 October.

© Vipin Nair. This guide is for reading online only. Copying, downloading, printing and redistribution are not permitted. For study and general reference; not legal, tax or investment advice.