Two key developments occurred in the twenty-first century: India’s fast expansion in commerce and investment, and the establishment of international supply chains, which facilitated the manufacturing, sale, and redistribution of items to take place in several nations. Due to the fact that the various procedures may be carried out in different regions of the world, this resulted in a growth of intra-group transactions, also referred to as related party transactions, on a global scale. The largest increase was noted in the selling of products and services between holding and subsidiary enterprises. With the liberalization of India’s economy in 1991, the country’s market began to draw FDI as well as engagement from global firms (MNCs). A standing committee focusing on the topic in 1991 judged existing legislation to address tax minimization through transfer pricing unsatisfactory. The Ministry of Finance’s concerns about probable tax avoidance by manipulating prices charged or paid in intra-group transactions grew steadily along with the MNC’s economic activities. A group of experts from the Central Bureau of Direct Taxes (CBDT) made a recommendation in 1999 to revise Section 92 of the Income Tax Act of 1961. As a result of these concerns, the Indian government enacted the Transfer Pricing Regulations (TPR) (2001). These parts (replacing the older section 92) in the Income Tax Act, 1961 define crucial terminology such Associated Enterprise, Arm’s Length Price (ALP) and international transactions. The procedure for determining the ALP, as well as other relevant Compliance Procedures and Documents were also established keeping in mind international principles. From 2005-06 to 2014-15, the number of transfer pricing audits quadrupled, from 1000 to 4290.[1]

What is Transfer Pricing?

In an intercompany transaction, a transfer price is the amount charged between linked parties (e.g., a parent company and its controlled foreign firm). Transfer prices have a direct impact on the distribution of taxable income among national tax jurisdictions. As a result, to the degree that tax rates fluctuate between national jurisdictions, a company’s transfer-pricing strategies can have a direct impact on its after-tax income.[2]

The following are the main goals of transfer pricing[3]:

  • Creating a distinct profit for each division and allowing each division’s performance to be evaluated individually.
  • Transfer pricing would have an impact on not just the reported earnings of each centre, but also on how a company’s resources are allocated.

Transfer pricing refers to the prices of “controlled transactions” between cross-border associated businesses (AE), which may occur under conditions different from those found between independent companies, as intra-group exchanges between the associated enterprises are not subject to market forces. It is primarily used to reduce or tax liability by storing funds in Associated Enterprises situated in tax havens.[4] The term “transfer pricing” refers to the value placed on the transfer of goods, services, and technology between connected companies as well as the value placed on the transfer of goods, services, and technology between unrelated parties that share common ownership or control.

Importance of Transfer Pricing

Multinational corporations (MNCs) have some control over how income and costs are distributed to subsidiaries situated in various countries for management accounting and financial reporting purposes. Occasionally, a subsidiary of a firm may be segmented or reported as a stand-alone entity. Transfer pricing assists in properly allocating income and expenditures to such subsidiaries in these instances. A subsidiary’s profitability is contingent upon the pricing at which inter-company transactions occur. Governments are increasingly scrutinizing inter-company transactions these days. Transfer pricing may have an effect on shareholders’ wealth in this case since it affects the company’s taxable income and its after-tax, free cash flow. It is critical for businesses that conduct cross-border intercompany transactions to comprehend the transfer pricing idea, particularly in order to comply with legal obligations and avoid risk of non-compliance.[5]

Arm’s Length Principle

Globally, tax rates vary greatly. These disparities encourage multinational corporations to move earnings from high tax jurisdictions to low tax countries. To achieve this profit shifting, a holding company might provide financial or consulting services to its subsidiaries, a manufacturing branch can offer finished goods to a distribution branch, and so on. MNEs can establish the pricing and terms of these transactions, affecting the profit and hence the tax due. Therefor tax administrators in the various governments created the Arm’s-Length Principle (Article 9 of the OECD Model Convention), which mandates that controlled transactions be done at market prices. As a result, the arm’s length concept might be described as “entities that are associated by management, control, or capital in their controlled transactions should agree on the same terms and conditions as non-related organizations for analogous uncontrolled transactions.” If this criterion is followed, one can deduce that the transaction’s terms and conditions are ‘at arm’s length.’[6] Income Tax Act, 1961 (ITC) Section 92F defines an arm-length price in Indian tax law, which means a price which is applied to transactions between entities that are not Associated Enterprises in uncontrolled circumstances.

Transfer Pricing Methodology

The Indian Transfer Pricing Regulations contain primarily six TP techniques that multinational companies (‘MNEs’) and tax authorities can employ to calculate an appropriate arm’s length price (‘ALP’) for foreign transactions/specified domestic transactions between connected firms.

Computation of ALP can be done by the following methods:

1. Comparable Uncontrolled Price (‘CUP’) method

Comparable transactions (between similar entities) are compared to see whether there are any differences in pricing or terms (between unrelated entities). A commercial database is needed for this strategy to work. The idea of arms-length cannot be used if the economic and financial circumstances of the relevant companies alter between the two transactions. There should be no distinction between transactions that are same in terms of time or location, as long as the conditions are comparable.[7] This is the most effective approach for meeting ALP requirements. Each substantial aspect must be taken into account when establishing the comparability of controlled and uncontrolled transactions As a result, unless the products or services are extremely comparable, this approach should be avoided.

2. Resale Price Method or Resale Minus Method (‘RPM’)

Conventional purchasing approach for analyzing transfer pricing is the resale price method. First, the resale price of an item purchased by a comparable company and then sold to an independent group is considered in this method. The price at which a commodity is resold to a single entity is referred to as the resale price. Resale value is the price at which an independent business purchased the item. Reselling price margin is needed to determine the amount of money needed by the reselling party to meet the costs of linked sales and operational expenditures. Reselling a product or service without adding significant economic value is required for the implementation of RPM. It will be more appropriate in situations when just basic sales, marketing, and distribution operations are carried out.[8]

3. Cost Plus Method (‘CPM’)

The cost-plus technique is a basic transaction analysis method that examines a controlled transaction between the supplier and the consumer. This approach is typically employed when Associated Parties transact semi-finished items. The cost of suppliers is added to the product or service’s markup so that suppliers make a profit that is appropriate for the role they performed and the current market circumstances. The arm’s length price of the transaction is the aggregate price.[9]

An Analysis of Purpose and Methods of Transfer Pricing

4. Profit Split Method (‘PSM’)

By comparing the profits gained by parties engaging in analogous uncontrolled transactions, this strategy meets the arm’s length requirement. The use of PSM is evaluated in transactions involving the transfer of unique intangibles or when the activities of the parties to the transaction are so intertwined that the contributions of individual parties cannot be valued independently. As a result, PSM works best when AEs supply bundled services in a single transaction. To begin, calculate the total net profit of all AEs involved in the International Transaction/Specified Domestic Transaction. After that, FAR Analysis is used to determine the proportionate contribution of each of the AEs. The AEs share a portion of the total net profit based on their participation. According to the Transfer Pricing Guidance Note, an alternate option is to distribute a basic return to the AEs first, taking into account market dynamics. The remaining earnings would then be distributed to the AEs in the manner described above. When an AE has deployed unique intangibles, this strategy might be effective.[10]

5. Transactional Net Margin Method (‘TNMM’)

MNCs like TNMM because it compares the net profit margin obtained in a regulated transaction to the net profit margin achieved by a third party in a similar transaction, thereby meeting the arm’s length principle. It can also take into account a third party’s net margin on a similar transaction with another third party. In calculating the net profit margin, this technique takes into account elements such as costs incurred, sales, assets used, and so on. The Indian TP laws do not offer a precise definition of net profit margin. For this strategy, the OECD recommends using operating margins. For correct contrast between the International Transaction/Specified Domestic Transaction and the similar uncontrolled transaction, all functional differences must be addressed.[11]

6. Other Method

Rule 10AB of the CBDT has now retroactively prescribed the “other method” with effect from April 1, 2012. The Assessment Year 2012-13 (i.e., FY 2011-12) and future years are covered by Rule 10AB. In this regard, a new rule was developed that compares the real price of uncontrolled transactions, which looks to be comparable to the CUP Method. The idea of hypothetical third-party transactions is introduced by the regulation. It suggests that you use a price that would have been charged or paid in an uncontrolled transaction, such as quotes, price publications, and so on. The other method, which is in conformity with the OECD Guidelines, allows for a flexibility in the selection of five recommended procedures for determining ALP.[12]

[1] Ministry of Finance, Government of India. Annual Report: 2013-14. 2014, sites/default/files/AnnualReport2013-14.pdf.

[2] JOHN MCKINLEY, Transfer pricing and its effect on financial reporting, (2013)

[3] Himanshu Jain, Transfer Pricing in India: Purpose & Methodologies, 2021,

[4] Naina Bhardwaj, Transfer Pricing Regulations in India, 2021

[5]ClearTax, Transfer Pricing – Purpose & Methodologies, 2021,,different%20countries%20(with%20exceptions).

[6] Abhishek Sharma, Understanding Transfer Pricing Regulations in India, 2021

Understanding Transfer Pricing Regulations in India

[7] Himanshu Jain, Transfer Pricing in India: Purpose & Methodologies, 2021

[8] ClearTax, Transfer Pricing – Purpose & Methodologies, 2021,,different%20countries%20(with%20exceptions).

[9] Himanshu Jain, Transfer Pricing in India: Purpose & Methodologies, 2021

[10] Karan Batra, Transfer Pricing: Methods of Computation of Arm’s Length Price, 2021

[11] AAPTaxLaw, What are the most appropriate transfer pricing methods in the world’ Transfer Pricing Methods in India. 2021,


Author Bio

Qualification: LL.B / Advocate
Company: N/A
Location: CHENNAI, Tamil Nadu, India
Member Since: 23 Apr 2022 | Total Posts: 1

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