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In the contemporary context of global business expansion, multinational enterprises (MNEs) are increasingly dependent on offshore subsidiaries located in India to leverage its extensive talent pool, cost efficiencies, and expanding market potential.Nevertheless, this strategic approach engenders intricate tax-related complexities, particularly concerning transfer pricing (TP) methodologies.For offshore subsidiaries which are generally defined as Indian entities under foreign parent corporations, adhering to TP regulatory frameworks constitutes not merely a legal requirement but also a protective measure against rigorous tax audits, significant financial penalties, and reputational liabilities.As of October 20251, with the enactment of the Income-Tax Act 2025 (which will take effect on April 1, 2026) and the recent modifications to safe harbour provisions, the regulatory environment is undergoing significant transformation.This article delves into the fundamental aspects of TP compliance and documentation, providing pragmatic insights for compliance officers, tax consultants, and corporate legal advisors navigating these complex terrains2.
Foundations of Transfer Pricing in India
Transfer pricing pertains to the pricing of commodities, services, intangible assets, and financial dealings between affiliated entities within a multinational enterprise group.In the Indian context, the principal objective is to avert the shifting of profits and the erosion of the tax base, thereby ensuring that transactions adhere to arm's length principles i.e. prices that independent parties would negotiate under comparable conditions.The foundational regulatory framework is encapsulated in Chapter X of the Income Tax Act of 1961 (anticipated to be superseded by the 2025 Act), specifically within Sections 92 to 92F.These provisions stipulate that income derived from international transactions or specified domestic transactions exceeding INR 200 million must be evaluated at arm's length price.International transactions encompass dealings between associated enterprises (AEs) wherein at least one party is a non-resident, involving activities such as sales, loans, royalties, and even informal agreements that influence profitability.Associated enterprises are broadly characterized as entities with direct or indirect involvement in management, control, or capital, or those that satisfy criteria such as possessing 26% voting power or supplying 90% of raw materials.
India's regulatory framework is influenced by the guidelines established by the OECD and the UN, while simultaneously integrating distinctive components such as an examination of expenditures associated with advertising, marketing, and promotional activities (AMP) aimed at cultivating intangible assets related to branding.For subsidiaries operating abroad, this necessitates a thorough analysis of intra-group financial transactions such as the provision of software development services to the parent entity or the importation of raw materials through a perspective that is distinctly Indian in nature.Failure to comply with these regulations may result in various repercussions, including adjustments to taxable income, secondary adjustments which classify excess remittances as loans subject to imputed interest, and adherence to thin capitalization regulations that limit interest deductions to 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA).
Determining Arm's Length Price: Methods And Selection
The selection of the most suitable methodology for benchmarking the arm's length principle is of paramount importance, as it constitutes the foundation of any transfer pricing defence. Section 92C and rule 10B outline six methodologies which do not adhere to a strict hierarchical framework but rather exhibit a preference for conventional over transactional approaches, as evidenced by judicial precedents. The Comparable Uncontrolled Price (CUP) method entails a comparison of prices in identical uncontrolled transactions, which is ideally suited for commodities yet rare for services. The Resale Price Method (RPM) involves the deduction of a gross margin from resale prices, making it particularly appropriate for distributers, such as numerous offshore manufacturing entities. The CPM incorporates a markup to costs, a technique that is prevalent among standard contract manufacturers. In the context of intricate scenarios that encompass intangibles such as pharmaceutical research and development or information technology intangibles, the profit split method allocates aggregated profits in accordance with the contributions made by each party, whereas the Transactional Net Margin Method (TNMM) benchmarks net margins against comparable entities frequently employing operating expenses as the reference point for Indian IT and ITES subsidiaries.
The "other method" outlined in Rule 10AB functions as a comprehensive framework, encompassing any verifiable uncontrolled pricing mechanisms. The assessment of comparability is contingent upon a thorough analysis of functions, assets, and risks, as well as contractual stipulations and prevailing economic circumstances. Any necessary adjustments for discrepancies, including variations in working capital or risk profiles, must be contemporaneous and adequately substantiated. Since 2014, an interquartile range is applicable for datasets comprising six or more comparable entities, in absence of which, the arithmetic mean prevails. Taxpayers possess the capacity to proactively modify their returns through the submission of Form 3CEB, but the burden of proof remains theirs.
Intangible assets present distinct challenges for offshore subsidiaries engaged in intellectual property licensing or performing DEMPE activities. Hard-to-value intangibles, including emerging technology patents are characterised by a lack of comparable benchmarks, necessitating dependence on ex-ante forecasts that are subsequently examined ex-post by regulatory authorities.
Compliance Obligations: a Three Tiered Approach
Compliance is mandated for all international transactions, irrespective of any threshold, and for specified domestic transactions exceeding INR 200 million. Offshore subsidiaries are required to maintain comprehensive documentation in accordance with section 92D, which should be prepared by the due date for income tax returns for most companies.
The three-tiered structure, aligned with BEPS Action 13, includes:
Local file: a detailed transfer pricing analysis that encompasses entity profiles, industry assessments, a breakdown of functions, assets and risks, justification of the chosen method, economic benchmarking and transaction specifics. This documentation is critical for substantiating the ALP during audits.
Master file: applicable to groups with consolidated revenues exceeding INR 5 billion and qualifying transactions, this must be submitted via form 3CEAA. It outlines the global strategic approach, intangible assets, inter-company financing arrangements, and R&D providing a holistic group view.
Country-by-country reporting: ultimate parent entities (UPEs) of multinational enterprises with revenues surpassing EUR 70 million are required to fill via form 3CEAD by March 31. Additionally, Indian subsidiaries must notify via form 3CEAC if the UPE is located abroad, with submissions due by January 31.
The compliance calendar for the fiscal year 2024-25 highlights the urgency associated with transfer pricing audits which must be completed by October 31 2025, documentation must be contemporaneous with transactions and the master file is required by November 30. Exemptions are provided for low-value transactions that fall below INR 10 million, thereby alleviating the compliance burden on smaller offshore entities.
Safe Harbours, APAs, and Dispute Resolution
To alleviate disputes in India's tax system, Safe Harbour Rules (SHRs) and Advance Pricing Agreements (APAs) provide predictability.SHRs under Section 92CB specify margins for standard transactions, recently updated by CBDT Notification 21/2025.Notable changes include extended applicability to FY 2025-26, increased service transaction threshold to INR 3 billion, and recognition of lithium-ion batteries as "core auto components" at a 12% margin.For IT/ITES sectors, margins are set at 17-18% of operating expenses, while contract R&D reaches 24%.Submission of Form 3CEFA by November 30 ensures protection from adjustments if criteria are satisfied.APAs, whether unilateral or bilateral, secure methodological pre-approval.In FY 2023-24, India executed 86 unilateral and 39 bilateral APAs, cumulatively reaching 641, predominantly in IT and pharmaceuticals.The number of pending applications exceeds 800, indicating strong engagement.The Mutual Agreement Procedure (MAP) within treaties addresses double taxation, currently managing 524 cases.
Penalties, Risks, and Mitigation Strategies
Non-compliance incurs significant penalties, including 2% of transaction value for documentation lapses, 50-200% for under-reported tax, and daily fines for CbCR failures, while secondary adjustments introduce additional tax or interest. Best practices for offshore subsidiaries include conducting timely TP studies, utilizing databases for comparable, integrating FAR into contracts, training on DEMPE, and seeking APAs, with local advisors providing necessary insights. For offshore subsidiaries, TP compliance is essential in India's evolving tax landscape, where proactive measures and tools can prevent penalties and support growth.As the 2025 Act progresses, remaining informed on CBDT notifications is crucial for MNEs, which will benefit from adaptability in the global tax environment.
Footnotes
1 India Tax Administration amends the transfer pricing safe harbour rules. (n.d.).
2 Transfer Pricing 2025 - India | Global Practice Guides | Chambers and Partners. (n.d.).
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.
