Transfer Pricing 2025

1. Rules Governing Transfer Pricing

1.1 Statutes and Regulations

The Income Tax Act, 1961 ("IT Act") contains a specific chapter, namely Chapter X, which deals with special anti-avoidance rules in the form of transfer pricing regulations as applicable to companies entering into related-party transactions. Sections 92 to 92F of the IT Act, which forms part of "Chapter X – Special provisions relating to avoidance of tax", deals with transfer pricing regulations mandating the determination of arm's length price of related-party transactions entered into by the taxpayer. These regulations are required to be read with Rules 10A to 10THD of the Income Tax Rules, 1962("IT Rules"). These regulations are also governed through the issuance of circulars as well as notifications by the Central Board of Direct Taxes (CBDT) from time to time.

1.2 Current Regime and Recent Changes

Historically, the main intention for the introduction of transfer pricing provisions was to discourage companies from shifting profit to overseas associated enterprises (AE) through under-pricing or over-pricing of cross-border transactions. In India, transfer pricing regulations were introduced for the first time in 2001, following the UN Model Transfer Pricing Regulations, which were, in turn, based on the Organisation for Economic Co-operation and Development's (OECD) Model Transfer Pricing Regulations introduced in 1980. Though India is not a member of the OECD, India is still a key partner country that actively participates in various committees, workshops and working groups of the OECD. The OECD and India have enhanced their co-operation in dealing with issues related to transfer pricing and to promote better tax compliance in order to improve the prevention of cross-border disputes. These transfer pricing regulations were introduced to avoid base erosion of the Indian tax base and discourage shifting of profits out of India by multinational enterprises (MNE). Since then, these regulations have been constantly amended to be in line with the various global and local practices and some of the landmark changes are highlighted below.

• Advance Pricing Agreement programme ("APA programme") – the APA programme was introduced in India vide the Finance Act, 2012 by introducing Section 92CC and Section 92CD to the IT Act. The APA programme sought to provide certainty to the taxpayer by allowing them to opt for a unilateral, bilateral or multilateral APA, for five prospective years along with a roll back option for four previous years. Further, the APA programme does not impose any threshold in terms of the value of the transaction upon a taxpayer.
• Safe harbour provisions – "safe harbour", in a transfer pricing regime, is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a jurisdiction's general transfer pricing rules. It substitutes simpler obligations for those under the general transfer pricing regime. Therefore, for this purpose, CBDT has notified Rules 10TA to 10TG of the IT Rules in relation to "safe harbour rules" for "international transactions", and Rules 10TH to 10THD of the IT Rules in relation to "safe harbour rules" for "specified domestic transactions". The objective for introduction of such rules was to provide an optional dispute avoidance mechanism that prescribes the minimum cost-plus mark-up/transfer price that an eligible taxpayer has to maintain in relation to eligible categories of international transactions for a specified block of financial years (FY).
• Secondary adjustments – these provisions were introduced in India in the year 2017, thereby mandating an adjustment in the books of accounts of both the Indian taxpayer and its AE, to reflect that the actual allocation of profits is based on the arm's length principle. These provisions also require repatriation of excess money in the hands of the taxpayers into India within a prescribed time-limit, failing which the amount not repatriated is treated as deemed advance on which interest would be chargeable. In 2019, amendments were introduced, thereby allowing the taxpayer to repatriate secondary adjustment from any of its AEs and also gives an option to pay an additional tax at 18% (plus applicable surcharge on tax) in case the taxpayer is not able to repatriate the money into India.
• Mutual Agreement Procedure (MAP) – statutory framework for MAP was initially introduced by insertion of Part IX-C under the IT Rules, for the benefit of taxpayers, tax authorities and competent authorities of treaty partners. Thereafter, Circular No.F.No.500/09/2016- APA-I dated 07.08.2020 (as modified by Circular No.F.No.500/09/2016-APA-I dated 10.06.2022) was issued by the CBDT providing guidance on the procedure as well as mechanism to cover aspects of access to and denial of MAP route, technical issues and implementation of MAP outcomes. Among other things, it has been stated in the guidance that India is committed to endeavour to resolve MAP cases within an average timeframe of 24 months.
• Thin Capitalisation – Section 94B was introduced in the IT Act vide the Finance Act, 2017 to limit interest deduction to 30% of Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) with a carry forward period of eight years for balance interest amount. This provision applies for interest payments to the associated enterprises or any lender (to whom the AEs have provided an explicit or implicit guarantee) exceeding INR10 million. In 2020, interest payments on loans taken from an Indian branch of a foreign bank have been excluded from the purview of the provision for limitation of interest deduction.

2. Definition of Control/Related Parties

2.1 Application of Transfer Pricing Rules

In terms of the mandate provided under Section 92(1) of the IT Act, a taxpayer is required to comply with the transfer pricing provisions in a case where he/she has entered into an international transaction or a specified domestic transaction with its associated enterprise. Further, in order to understand the application of the transfer pricing regulations in India, it is pertinent to understand the meaning of following terms.

• Arms' Length Price – Section 92F(ii) of the IT Act defines arm's length price (ALP) to mean a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.
• Associated enterprises – in terms of Section 92A(1) of the IT Act, two enterprises are considered to be AEs when one party (directly or indirectly) participates in the management, control or capital of the other party; or a common person (or persons) participates in the management, control or capital of both enterprises. Further, Section 92A(2) of the IT Act, in the case where two enterprises do not fall into the criteria laid down in Section 92A(1) of the IT Act, but fall into one of the 13 criteria provided under Section 92A(2) of the IT Act, then such enterprises may be deemed to be AEs, and may also be considered as an international transaction for the purposes of Section 92B(2) of the IT Act.
• Transactions – as per Section 92F(v) of the IT Act, the term transaction includes an arrangement, understanding or action in concert, whether or not such arrangement, understanding or action is formal or in writing; or whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding.
• International transactions – in terms of Section 92B of the IT Act, an international transaction is a transaction between two or more AEs, and at least one of the parties in such transaction is a non-resident.
• Specified domestic transactions – these are specific transactions between two domestic AEs which have been enumerated in Section 92BA and exceed INR200 million in value.

In essence, a wide power has been bestowed with the Indian Tax Authorities for assumption of jurisdiction to determine ALP of an international transaction under the provisions of Chapter X of the IT Act.

3. Methods and Method Selection and Application

3.1 Transfer Pricing Methods

The ALP of an international transaction has to be determined by a Transfer Pricing Officer (TPO) in accordance with Section 92C/92CA of the IT Act read with Rule 10B of the IT Rules. Rule 10B of the IT Rules prescribes the following methods for benchmarking the price of an international transaction:

• comparable uncontrolled price (CUP);
• resale price method (RPM);
• cost-plus method (CPM);
• profit split method (PSM);
• transactional net margin method (TNMM); and
• such other method as may be prescribed by the CBDT.

It is relevant to mention that CUP, RPM and CPM are considered as traditional methods and PSM and TNMM are considered as transactional methods.

3.2 Unspecified Methods

The Indian Transfer Pricing Regulations require taxpayers to compute ALP using any of the six methods prescribed under Section 92C of the IT Act (see 3.1 Transfer Pricing Methods). In terms of available judicial precedent, preference is given to traditional methods over transactional methods whilst selecting the most appropriate method.

Section 92C(2) of the IT Act read with Rule 10B of the IT Rules, prescribes the concept of "most appropriate method" for determination of ALP and provides that the comparability of an international transaction or a specified domestic transaction with an uncontrolled transaction shall be judged with reference to the following, namely:

• the specific characteristics of the property transferred or services provided in either transaction;
• the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
• the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; and
• conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.

It is further mandated that an uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if:

• none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or
• reasonably accurate adjustments can be made to eliminate the material effects of such differences.

CBDT has prescribed the "other method" by inserting Rule 10AB to the IT Rules. For determination of ALP in relation to an international transaction, the "other method" shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non- AE, under similar circumstances, considering all the relevant facts.

Generally speaking, the other method acts as "residuary method", which allows taxpayers some flexibility for using data around prices that would have been charged between third parties under a comparable scenario for the arm's length exercise. However, in the authors' experience, the "other method" is subjected to a higher threshold of contemporaneous evidence for being selected as the most appropriate method.

3.3 Hierarchy of Methods

As mentioned, the OECD Transfer Pricing Guidelines outline five transfer pricing methods (refer to 3.1 Transfer Pricing Methods), which are segregated into two general categories: (i) traditional transaction methods (CUP, RPM & CPM) and (ii) transactional profit methods (PSM and TNNM).

Further, the OECD Transfer Pricing Guidelines do not provide any hierarchy per se within the transfer pricing methods enumerated in 3.1 Transfer Pricing Methods. Nonetheless, traditional transaction methods are commonly considered a most direct way of determining ALP, since reliance is placed on comparable data from uncontrolled transactions with conditions such as product, entity and market characteristics, contractual terms, assets employed in the transaction, functions and risks assumed by each party, highly similar to the transaction under review. On the other hand, transactional profit methods focus more on the specific transactions between related parties and rely more on internal data.

Such an approach of the OECD has also been adopted by the Indian Revenue Authorities and, as mentioned, the traditional or the transactional profit methods are preferred over the usage of the residuary method.

3.4 Ranges and Statistical Measures

Until March 2014, to arrive at ALP, the margin of the tested party (company with which the margin is to be compared) was compared with the arithmetic mean of the comparable companies.

To provide flexibility to taxpayers, the CBDT introduced the concept of arm's length range in place of arithmetic mean, applicable in the case of all transfer pricing methods except PSM and "other methods". The aforementioned concept has been applicable from April 2014 onwards. For PSM or other methods, the earlier concept of arithmetic mean has to be adopted for calculating the ALP. Also, the range concept applies only when the data set is of at least six comparable companies.

The arm's length range is defined as 35th percentile and the 65th percentile of the data set of comparable companies arranged in ascending order. If the transaction falls within the aforesaid range, then the transaction is deemed to be at arm's length. Furthermore, in case of less than six comparable companies, the earlier concept of arithmetic mean must be followed. These amended rules provide a certain flexibility in arriving at the ALP by the taxpayers in India.

3.5 Comparability Adjustments

Rule 10B(3) of the IT Rules allows for making reasonably accurate adjustments to an uncontrolled transaction in order to remove material effect of differences which emerges during the course of its comparison with an international transaction or specified domestic transaction. However, since the obligation is on the taxpayer to maintain proper documentation and information under Section 92D of the IT Act, the onus to prove "reasonably accurate comparability adjustment" is also on the taxpayer. Thus, comparability adjustments, if any, cannot be sought as a matter of right and must be substantiated/ backed by contemporaneous data.

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Originally published by Chambers and Partners, May 2025

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.