Transfer Pricing Methods : A Guide for Indian Businesses

Is your business operating across borders? Maybe you’re invoicing a US parent from India or licensing software from your Singapore HQ. If so, transfer pricing isn’t just a formality. It’s critical for staying compliant, avoiding penalties, and protecting your bottom line.

Get it right, and you ensure fair tax treatment and smoother audits. Get it wrong, and you might end up facing tax penalties, legal disputes, or even double taxation.

This guide will explain transfer pricing methods, why they matter, how to select the right one, and what real-world challenges Indian businesses face.

What is transfer pricing, and why does it matter?

Transfer pricing refers to the prices charged between related entities, like a parent company and its subsidiary, for goods, services, or intellectual property.

These internal prices affect:

• Taxation: They influence where your profits are reported and taxed.
• Regulatory compliance: Authorities want to ensure they get their fair share.
• Profit allocation: Businesses use transfer pricing to divide income across jurisdictions.

Tax authorities worldwide, including India, are tightening their policies. Authorities want to prevent profit shifting when companies set artificially high or low prices to reduce tax liabilities in high-tax countries.

As a result, businesses are expected to maintain thorough documentation, select the right method, and prove their pricing is at arm's length, just like it would be between unrelated parties.

Why is transfer pricing crucial for cross-border businesses?

Let's break down why Indian entrepreneurs, freelancers, and startups with global operations should pay close attention.

1. Fair profit allocation

Imagine your Indian company provides design services to your US parent. If you undercharge, India loses tax revenue, and you risk scrutiny here. If you overcharge, the US parent takes the hit. Transfer pricing ensures each country gets its fair share, keeping both sides of the transaction aligned and defensible.

2. Meeting regulatory expectations

Transfer pricing is a compliance obligation. Under Section 92 of the Indian Income Tax Act, all cross-border transactions with associated enterprises must follow arm's length principles, meaning the pricing should reflect what independent parties agree to.

3. Avoiding costly disputes

Tax authorities don't just look at your numbers; they want to see how you arrived at them. Without documentation, audits and penalties are likely. And if you use the wrong method, you could face double taxation.

4. Structuring intercompany transactions thoughtfully

If you're structuring intercompany contracts, licensing your IP to a US entity, offering backend tech support from India, or funding joint R&D with a Singapore subsidiary, transfer pricing affects how you price, document, and report those relationships

With the high stakes, how do tax authorities ensure businesses play fair? That's where the different transfer pricing methods come in.

Now that you’re familiar with the main transfer pricing methods, the next question is: how do you decide which one works best for your business?

To choose the best transfer pricing method, you need an understanding of your business operations, intercompany transactions, and comparable data.

Here's how to approach this selection:

Understand the nature of the transaction

• Tangible goods: If your Indian subsidiary manufactures products for a foreign parent company, methods like the CUP or cost-plus method might be suitable.

Let's say an Indian textile manufacturer sells fabrics to its UK-based parent. The company can apply the CUP method to ensure arm's length pricing by comparing prices charged to independent UK buyers.

• Services: The TNMM is often preferred for service-oriented transactions, such as IT support or customer service, due to the difficulty of finding exact comparables.

A Bangalore-based IT firm provides backend support to its US affiliate. TNMM analyzes the net profit margins of similar independent service providers to help establish appropriate pricing.

• Intangible assets: The profit split method can be effective when dealing with intellectual property or brand licensing, especially when both entities contribute significantly to value creation.

An Indian startup and its German counterpart co-developed a software platform. Since both contribute to R&D and marketing, PSM allows for a fair division of profits based on each party's contribution.

2. Assess the availability of comparable data

Methods like CUP and RPM work best when you have access to solid, comparable transaction data. But in industries where that kind of data is hard to come by, you can use NMM or PSM as they’re typically more flexible and practical in those cases.

3. Evaluate functional profiles and risk allocation

Take a step back and look at the big picture: Who’s performing which functions? What assets are involved? Who’s bearing the risk? A functional analysis helps you choose a method that reflects how the transaction actually works in the real world.

4. Consider regulatory preferences

Tax authorities often have preferences or provide guidance on acceptable methods. For instance, the Indian Income Tax Department may favor TNMM for service transactions due to its practicality and data availability.

Even with the right method in place, transfer pricing is rarely simple. Let's explore some common challenges businesses face.

Transfer pricing is about staying consistent, compliant, and coordinated across borders. Here are some of the most common challenges businesses face, especially in the Indian context:

Heightened regulatory scrutiny

With global initiatives like the BEPS framework and tighter local enforcement, your pricing structures must withstand serious scrutiny.

For instance, if an Indian pharmaceutical company supplies active ingredients to a related entity abroad at a price lower than what it charges independent buyers, the tax office may question whether profits are being shifted out of India. Such concerns can lead to audits, reassessments, penalties, and prolonged disputes.

Documentation gaps and inconsistencies

Accurate documentation is your first line of defense during a transfer pricing audit. Yet, many companies fall short either by reusing old reports, skipping updates, or failing to align their reports with real business activity.

Consider a Bengaluru startup offering digital marketing services to its US group company. If it relies on a three-year-old benchmark report that doesn't reflect current market rates or cost structures, it risks facing questions during an audit about the credibility of its pricing logic.

Operational complexity across jurisdictions

Managing transfer pricing in one country is tough enough. Doing it across multiple tax systems, currencies, and regulatory timelines multiplies the challenge.

Take a tech company operating in India, the US, and Germany. Aligning transfer pricing policies across these entities means juggling different expectations, tax rates, and reporting formats. Without centralized coordination, inconsistencies can creep in, triggering flags in audits or delaying group-level reporting.

Risk of double taxation

Even with solid documentation, there's always the risk that two countries take opposing views on where the value was created and try to tax the same income.

Let's say an Indian IT firm provides backend services to its UK affiliate. If India views the service margin as too low, it might propose an upward adjustment. But if the UK doesn't reduce the affiliate's income, the same profit could be taxed twice, hurting cash flow and triggering the need for time-consuming dispute resolution.

Strained intercompany relationships

Transfer pricing can impact internal dynamics. When adjusted or challenged, profit allocations can affect performance evaluations, bonus structures, and even future collaboration between entities.

Imagine a case where an Indian subsidiary's profits are adjusted downward due to a change in pricing policy. The local leadership may feel they're being penalized for decisions made at the group level, leading to frustration and friction with the parent company.

Knowing the risks is just one side of the coin; staying compliant means understanding how India's transfer pricing regulations apply to your cross-border setup.

If your Indian business deals with overseas group companies like selling services, licensing IP, or sharing resources, then transfer pricing rules apply. These laws are there to make sure profits aren't shifted unfairly between countries.

In India, transfer pricing laws are governed by:

• Sections 92 to 92F of the Income Tax Act
• Rules 10A to 10E of the Income Tax Rules

If your business is part of a multinational group, BEPS-related documentation may also apply:

• Master file – a global overview of the MNE group, ownership, and operations.
• Local file – detailed information about Indian entity transactions and transfer pricing justifications.

Country-by-Country Report (CbCR) – a high-level snapshot of global income, taxes paid, and business activities across jurisdictions.

Getting the method right is just the start. The real test is whether you can back it up with documentation and logic that will stand up in an audit.

During an audit, Indian tax authorities assess whether your pricing:

• Matches actual functions, assets, and risks assumed by each entity
• Allocates profit based on who does what and where
• Uses credible and current comparables
• Consistently reflected in financials and tax filings

To stay compliant, businesses should maintain:

• A detailed transfer pricing report explaining your method, assumptions, and benchmarks.
• Form 3CEB, signed by a chartered accountant.
• Supporting documents like intercompany agreements, contracts, and cost records.
• Master File and Local File (if thresholds are met).
• CbCR, if you're part of a large international group.

Practical compliance tips

• Update benchmarks annually. Market comparables don't stay static.
• Tailor reports each year. Don't recycle documents blindly.
• Draft intercompany agreements carefully. Involve legal and finance teams early.
• Keep documents ready before filing, not just when an audit notice arrives.

Transfer pricing is a strategic lever that influences how your profits are allocated, how regulators view your business, and how ready you are for audits. Choosing the right transfer pricing method depends on the types of transactions you have, the data you can access, and how convincingly you can defend your pricing approach.

For Indian startups, freelancers, and global businesses, transfer pricing decisions can directly impact everything from tax compliance to cash flow. 

This is where Xflow steps in. 

Xflow is built specifically for Indian businesses and freelancers who operate globally, offering a suite of features designed to simplify your cross-border transactions:

• Transparent FX rates are close to the mid-market rate, so you get fair value for currency conversions.
• No hidden fees. You see exactly what you get, with clear, upfront pricing.
• Fast settlements directly to your INR account, keeping cash flow smooth and efficient.
• Support for BIRC documentation  (Bank Inward Remittance Certificate), a newer, digitally generated document that replaces the traditional physical FIRC and compliance workflows to easily meet regulatory requirements.
• Seamless integration with your existing tools and workflows to easily manage payments and transfer pricing compliance in one place.

Start with Xflow today and keep more of what you earn!