India transfer pricing involves setting prices for goods, services, and intellectual property between related entities within a multinational company. Governed by the Income Tax Act, Section 92 to 92F, businesses in India must comply with Indian transfer pricing regulations to avoid penalties and tax adjustments by the income tax department.

This blog will provide you with all the key information you need to understand the Indian transfer pricing laws, including the arm’s length principle, documentation requirements, and the potential consequences of non-compliance.

Overview of Transfer Pricing in India

Transfer pricing in India ensures that transactions between related companies, such as the exchange of goods, services, and intellectual property, are priced at fair market value. These regulations are designed to prevent tax avoidance, including profit shifting, and are governed by Indian tax law as well as Organization for Economic Co-operation and Development (OECD) guidelines.

The arm’s length principle is fundamental in India’s transfer pricing rules, meaning that transactions between related parties must reflect the same terms that independent businesses would agree upon in similar circumstances.

Companies are required to maintain detailed transfer pricing documentation that justifies their pricing methods and supports compliance with the arm’s length principle. Non-compliance with these rules can result in significant penalties, audits, and tax adjustments by the Indian tax authorities.

Transfer Pricing Rules and Regulations in India

India’s transfer pricing rules and regulations are designed to align with global standards while addressing the specific needs of the Indian tax system. Let’s take a look at the details related to the transfer pricing rules and regulations in India.

Key Laws and Regulations

In India, transfer pricing is primarily governed by Sections 92 to 92F of the Income Tax Act, 1961 and the Income Tax Rules, 1962. These provisions require transactions between related entities to adhere to the arm’s length principle, ensuring that prices are set as if the parties were unrelated. The income tax department enforces these rules, and businesses must maintain detailed documentation to justify their intercompany pricing and avoid tax adjustments. Non-compliance may result in penalties and audits.

Organization for Economic Co-operation and Development (OECD) Guidelines and India’s Alignment

India follows the OECD Transfer Pricing Guidelines to a large extent, particularly in areas such as comparability analysis, pricing methods, and documentation standards. Indian businesses engaging in cross-border transactions must ensure compliance with both domestic regulations and OECD guidelines in other jurisdictions to minimize the risk of double taxation and disputes.

Commenda can simplify the India transfer pricing documentation for your business by offering automated compliance solutions and ensuring that businesses meet all requirements.

For India transfer pricing, determining whether entities are associated enterprises is crucial for applying transfer pricing rules.

Definition of Associated Enterprises in India

Under India’s transfer pricing rules, entities are considered associated enterprises when they have common ownership or control, influencing how transactions between them are priced. The Income Tax Act 1961 defines associated enterprises as entities with direct or indirect control over each other or under common control by a third party.

Key Conditions for Associated Enterprises:

  • Ownership Control: One entity holds at least 26% of the voting power or shareholding in another entity.
  • Common Management or Control: Entities share overlapping directors, executives, or other key decision-makers influencing operations or pricing.
  • Intercompany Transactions: Significant business transactions, such as goods, services, royalties, or financing, are subject to the arm’s length principle under Indian regulations.

Example:

If an Indian parent company owns 60% of a subsidiary in the UK and provides it with software licenses, the Indian income tax department requires the pricing to adhere to the arm’s length principle to ensure fair taxation.

Once entities are classified as associated enterprises, the next step is to ensure that their intercompany transactions comply with the arm’s length principle. The Income Tax Act prescribes specific methods to assess and ensure fair pricing in such transactions.

Methods for Determining Arm’s Length Price in India

India’s transfer pricing rules recognize several methods for determining whether intercompany transactions comply with the arm’s length principle. Let’s examine the approved methods for determining this principle:

  • Comparable Uncontrolled Price (CUP) Method: Compares the price charged in a controlled transaction with the price charged in a comparable uncontrolled transaction under similar conditions.
  • Resale Price Method (RPM): Determines the arm’s length price by reducing the resale price of a product by an appropriate gross margin.
  • Cost Plus Method (CPM): Adds an appropriate markup to the production cost of goods or services in a controlled transaction.
  • Transactional Net Margin Method (TNMM): Compares the net profit margin from a controlled transaction to that of comparable independent entities.
  • Profit Split Method (PSM): Allocates profits between associated enterprises based on how independent parties would divide them in a similar transaction.

The Income Tax Act mandates that companies use the most reliable method rule, selecting the method that provides the most accurate measure of an arm’s length price for Indian transactions.

Commenda can help streamline the transfer pricing rules and compliance in India for your business by automating arm’s length price determination. Read more on Transfer Pricing.

Transfer Pricing Documentation Requirements in India

Under the India transfer pricing rules, businesses must maintain proper documentation to justify intercompany pricing and comply with the Income Tax Act, 1961. India follows a documentation framework aligned with the OECD Transfer Pricing Guidelines but has specific requirements under the Income Tax Rules, 1962.

Master File

The Master File provides an overview of the multinational group’s global operations, transfer pricing policies, and business structure. While not mandatory for all businesses, large Indian multinationals often prepare it to ensure compliance with global transfer pricing regulations.

Local File

The Local File contains detailed documentation on intercompany transactions involving Indian entities. It includes a functional analysis, an economic analysis, and a justification of the transfer pricing methods used. This documentation is required for income tax department audits and must be readily available upon request.

Country-by-Country Reporting (CbCR)

India requires Country-by-Country Reporting (CbCR) for multinational groups with consolidated revenue of INR 6,400 crore (approximately $850 million) or more in the previous financial year. The CbCR Report must be filed with the Indian tax authorities as part of the annual tax return. This filing includes the group’s global allocation of income, taxes, and business activities.

Form 3CEB

Required for Indian taxpayers who engage in international transactions or specified domestic transactions. This form must be signed by a Chartered Accountant and submitted with the annual tax return. A transfer pricing certificate is also often required along with Form 3CEB to confirm that the intercompany transactions comply with the arm’s length principle.

Transfer Pricing Declaration

In the tax return, businesses must disclose their compliance with transfer pricing provisions, including reporting intercompany transactions and confirming arm’s length pricing.

Note: Non-compliance can result in tax adjustments, penalties up to 200% of the underpaid tax, and increased scrutiny during audits.

In addition to maintaining documentation, Indian businesses must stay compliant with transfer pricing rules to avoid penalties and minimize audit risks from the income tax department.

Risk Factors and Common Challenges in India

Businesses operating under India’s transfer pricing rules and compliance face several risks, including income tax department audits, tax adjustments, and penalties for improper intercompany pricing.

Income Tax Audits and Enforcement Trends

The income tax department actively audits multinational companies, focusing on high-value transactions, intangible assets, and cost-sharing arrangements. With increased scrutiny of transfer pricing practices in recent years, especially concerning complex international transactions, “multinational tax planning and transfer pricing in India” has become a critical focus area. The Indian tax authorities carefully scrutinize transfer pricing documentation to ensure that businesses are adhering to the arm’s length principle, thereby minimizing the risk of tax avoidance through manipulation or mispricing.

Compliance Challenges

The arm’s length principle under India’s transfer pricing regulations requires detailed benchmarking studies, which can be complex and costly. Businesses must ensure that they adhere to both Indian transfer pricing regulations and OECD guidelines, which adds to the compliance burden.

Double Taxation and Dispute Risks

Disputes over intercompany pricing between the income tax department and foreign tax authorities can lead to double taxation. In such cases, taxpayers may need to seek resolution through Advance Pricing Agreements (APAs) or Mutual Agreement Procedures (MAPs) to avoid or resolve double taxation issues and minimize risks of prolonged disputes.

Commenda helps businesses reduce income tax department audit risks by automating India’s transfer pricing documentation and ensuring compliance with OECD transfer pricing guidelines in other countries. Learn more about Compliance, Risks, and Best Practices for Transfer Pricing.

Advance Pricing Agreements (APAs) and Safe Harbor Rules in India

To minimize income tax department disputes and compliance risks, businesses in India can use APAs and certain safe harbor provisions to secure tax certainty.

APAs 

APAs allow businesses to pre-negotiate transfer pricing methods with the income tax department, reducing the risk of audits and disputes. The Indian tax authorities offer:

  • Unilateral APAs (agreement with Indian tax authorities only).
  • Bilateral/Multilateral APAs (agreements involving Indian tax authorities and foreign tax authorities).

Example: An Indian pharmaceutical company with a subsidiary in the UK can secure a bilateral APA to avoid double taxation on intercompany royalty payments.

Safe Harbor Rules

India offers safe harbor provisions that simplify compliance for certain low-risk transactions. Under the Safe Harbor Rules introduced in Section 92CB of the Income Tax Act, businesses can apply simplified transfer pricing methods for certain transactions, such as intra-group services or low-value-added transactions, without the need for detailed documentation.

Example: A company can provide intercompany loan services to its subsidiaries. The business can apply a fixed interest rate based on a prescribed rate by the Indian tax authorities (typically close to the benchmark interest rates set by the Reserve Bank of India).

Although APAs and safe harbor provisions can help businesses secure tax certainty, failure to comply with India’s transfer pricing rules still exposes companies to significant audit risks, tax adjustments, and enforcement challenges from the income tax department.

Industry-Specific Transfer Pricing Considerations in India

Certain industries in India face stricter transfer pricing regulations due to the complexity of their transactions and the increased risk of profit shifting. The income tax department closely monitors these industries to ensure compliance with India’s transfer pricing rules.

Technology 

Companies involved in intellectual property (IP), patents, and software face stringent transfer pricing scrutiny in India.

Cost-sharing arrangements (CSAs) and royalty payments must be aligned with India’s transfer pricing regulations to avoid challenges from the income tax department. These industries are subject to frequent audits to ensure that prices for intangibles and IP are consistent with the arm’s length principle.

Financial Services

Intercompany financing, guarantees, and capital allocation must adhere to the arm’s length pricing principle in India. The income tax department enforces rules to prevent thin capitalization and mispriced interest rates in related-party loans, ensuring that financial transactions are priced based on market conditions.

Business Restructuring and Transfer Pricing in India

Companies undergoing business restructuring must document changes in functions, risks, and asset ownership. The income tax department assesses whether restructured entities receive appropriate compensation based on their economic contributions, ensuring compliance with India’s transfer pricing rules.

As industries adapt to India’s transfer pricing regulations, the rise of the digital economy introduces new complexities, particularly in valuing intangibles, data-driven transactions, and cross-border e-commerce.

Impact of Digital Economy on Transfer Pricing in India

The rise of digital business models complicates the India transfer pricing rules, especially in valuing intangibles, data, and online transactions. The income tax department closely monitors IP, software, and royalty payments to prevent profit shifting. E-commerce and digital services face stricter rules, with economic substance tests to ensure proper income allocation. While India hasn’t adopted OECD’s Pillar One and Pillar Two, global tax discussions influence enforcement policies.

As digital transactions increase, disputes over intangibles and profit allocation are more common, requiring companies to use APAs or MAPs to resolve them.

Dispute Resolution Mechanisms in India

Transfer pricing disputes in India are typically resolved through income tax department administrative procedures, MAP, or litigation.

Mutual Agreement Procedure (MAP)

  • Governed by India’s tax treaties with other countries.
  • Helps resolve double taxation disputes between India and foreign tax authorities.
  • Taxpayers can request MAP assistance when income tax department adjustments conflict with another country’s tax rules.
  • If an agreement is reached, both tax authorities work together to eliminate double taxation.

Advance Pricing Agreements (APAs)

Businesses can pursue APAs to secure future transfer pricing compliance and avoid potential disputes.

Administrative Appeals

Businesses can negotiate transfer pricing adjustments with the Irish Revenue Commissioners through administrative appeals.

Litigation

  • If administrative remedies are exhausted, companies can escalate the case to the Income Tax Appellate Tribunal (ITAT), High Court, or Supreme Court.
  • Litigation is a last resort due to its complexity and cost.

Note: To avoid disputes, businesses must maintain strong transfer pricing documentation and comply with India’s transfer pricing regulations under Section 92 of the Income Tax Act, 1961.

Commenda helps businesses prevent transfer pricing disputes by automating documentation, compliance analysis, and dispute resolution support, ensuring alignment with Income Tax regulations and OECD guidelines to minimize risks.

Penalties for Non-Compliance in India

Businesses in India that fail to comply with transfer pricing regulations face tax adjustments, financial penalties, and increased scrutiny from the income tax department.

  • Tax Adjustments: The income tax department can reallocate income, increasing taxable income and tax liability.
  • Penalties for Mispricing: If a transfer price deviates by more than 20% from the arm’s length principle, penalties of up to 200% of the tax underpayment may apply. Larger deviations (over 50%) could lead to higher penalties.
  • Failure to Maintain Documentation: Businesses must maintain transfer pricing documentation and provide it upon request. Inadequate or insufficient records can lead to audits and penalties, resulting in higher tax assessments.
  • Interest on Underpayments: The income tax department imposes interest on tax deficiencies resulting from improper transfer pricing.

To avoid transfer pricing audits and penalties in India, businesses must adhere to Income Tax Act regulations, maintain proper documentation, and ensure arm’s length pricing for all intercompany transactions.

Conclusion

In conclusion, India’s transfer pricing regulations are designed to ensure that intercompany transactions are priced fairly and in line with the arm’s length principle. With rigorous documentation requirements, businesses must be diligent in maintaining proper records and selecting the right pricing methods. To mitigate risks, companies should stay updated on regulatory changes, consider entering APAs, and adopt strategies that align with both local and international standards.

Commenda simplifies transfer pricing compliance by automating documentation, risk assessments, and dispute resolution support, ensuring businesses meet arm’s length pricing standards while minimizing audit risks. Ready to simplify transfer pricing? Schedule a free demo today.

Frequently Asked Questions (FAQs) on Transfer Pricing in India

Q. What is India transfer pricing, and why is it important?

Transfer pricing in India refers to the pricing of transactions between related parties, ensuring they follow the arm’s length principle, which means the prices should be similar to those charged between unrelated entities.

Q. What are the transfer pricing methods recognized in India?

India recognizes several methods, including the Comparable Uncontrolled Price (CUP), Cost Plus Method, Resale Price Method, Transactional Net Margin Method (TNMM), and Profit Split Method.

Q. What documentation is required for transfer pricing compliance in India?

Companies must maintain a transfer pricing study that includes financial statements, details of intercompany transactions, comparability analysis, and the selected transfer pricing method.

Q. What are the penalties for non-compliance with transfer pricing rules in India?

Penalties for incorrect transfer pricing reporting can range from 2% to 100% of the tax under-reported due to non-compliance.

Q. How does India handle transfer pricing for digital businesses or intangibles?

India recognizes the complexities of digital business models and intangibles, requiring companies to apply appropriate transfer pricing methods that align with the arm’s length principle, especially for cross-border transactions involving intellectual property.

Q. Can businesses in India enter into an Advance Pricing Agreement (APA)?

Yes, businesses can enter into an APA with the Indian tax authorities to agree on the transfer pricing methodology for a set period, typically 5 years, to avoid future disputes.