What is transfer pricing?

Transfer pricing is the set of rules governing how related entities price transactions between themselves — a parent company selling goods to its Indian subsidiary, an Indian captive charging its overseas group for software services, or a domestic manufacturer paying royalty to a related brand owner. Tax authorities worldwide, including India's, require that these related-party ("associated enterprise") transactions be priced as if the parties were unrelated and dealing at "arm's length." The goal is simple: prevent profits from being artificially shifted out of (or into) a jurisdiction through non-market pricing.

India's transfer pricing regime is set out in Sections 92 to 92F of the Income-tax Act, 1961, supplemented by Rules 10A to 10THD of the Income-tax Rules. The regime applies to two broad categories of transactions:

  • International transactions (Section 92B) — cross-border dealings between two or more associated enterprises.
  • Specified Domestic Transactions (Section 92BA) — certain related-party domestic transactions, such as payments to entities claiming profit-linked tax deductions, above a ₹20 crore aggregate threshold.

Two enterprises are treated as "associated" where one participates directly or indirectly in the management, control or capital of the other, or where common persons participate in both — tested against a list of specific shareholding, board-control and financial-dependency criteria under Section 92A.

The six prescribed methods

Indian law prescribes six methods for determining the arm's length price, and requires taxpayers to select the "most appropriate method" based on the nature of the transaction, availability of comparable data, and degree of comparability achievable:

  • Comparable Uncontrolled Price (CUP) — compares the price charged in a controlled transaction with the price in a comparable uncontrolled transaction.
  • Resale Price Method (RPM) — works back from the resale price to an unrelated party, typically used for distributors.
  • Cost Plus Method (CPM) — adds an arm's length mark-up to costs, typically used for contract manufacturers and service providers.
  • Profit Split Method (PSM) — splits combined profit between associated enterprises based on relative contribution, used for highly integrated or unique transactions.
  • Transactional Net Margin Method (TNMM) — compares net profit margins realised from a controlled transaction with margins earned in comparable uncontrolled transactions; the most widely applied method in India.
  • Other Method — a residual method used where none of the above can be reasonably applied, such as valuation-based approaches for intangibles.
In practice, over 70% of Indian transfer pricing assessments involve the TNMM, given the availability of reliable comparable company data through Indian and global databases.

Documentation & Form 3CEB

Taxpayers with international or specified domestic transactions must maintain contemporaneous documentation under Rule 10D — covering ownership structure, business description, functional and economic analysis, and the pricing method applied — and must obtain and file an Accountant's Report in Form 3CEB, certified by a Chartered Accountant, along with the income tax return.

Key thresholds to know

  • TP documentation applicability: aggregate international/specified domestic transactions exceeding ₹1 crore in a financial year.
  • Specified Domestic Transactions: aggregate value exceeding ₹20 crore.
  • Master File (Form 3CEAA): generally applies where consolidated group revenue exceeds ₹500 crore and the entity's own international transactions exceed prescribed limits.
  • Country-by-Country Report: applies to Indian constituent entities of groups with consolidated revenue above roughly ₹6,400 crore (≈ €750 million).

Routes to certainty: APA & Safe Harbour

Given the judgment involved in benchmarking, India offers two formal routes to reduce dispute risk: Advance Pricing Agreements, which lock in a pricing methodology with the tax authority (and, for bilateral/multilateral APAs, a treaty partner) for up to nine years, and Safe Harbour Rules, which offer pre-agreed margins for specific sectors like IT/ITES, KPO and contract R&D in exchange for accepting a minimum reported margin.

Penalties for non-compliance

Non-compliance carries meaningful cost: a penalty of 2% of the transaction value for failure to maintain documentation or report a transaction, up to 2% for failure to furnish Form 3CEB or Master File, and penalties for CbCR non-filing that can run into lakhs of rupees per day of default, in addition to the tax and interest arising from any TP adjustment itself.