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

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

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.

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.

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

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.

33.8 Benchmarking step by step

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.

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.

33.10 Transfer pricing audit process

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

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).

© 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.