Transfer Pricing Methods in India: CUP, RPM, CPM, TNMM & PSM — Section 92C and Rule 10B Complete Guide

Legal Framework: Section 92C and Rule 10B

Section 92C(1) of the Income-tax Act, 1961, lists the five prescribed methods. Section 92C(2) provides that the most appropriate method, having regard to the nature of transaction, class of associated persons, and functions performed, shall be applied for determination of arm’s length price. The proviso to Section 92C(2), as amended by Finance Act, 2009, provides the tolerance band — where the variation between the arm’s length price so determined and the price at which the international transaction has actually been undertaken does not exceed the notified percentage (3% for non-wholesale trading, 1% for wholesale trading per CBDT Notification), no adjustment shall be made.

Rule 10B prescribes the detailed mechanics of each method — sub-rule (1)(a) for CUP, (1)(b) for RPM, (1)(c) for CPM, (1)(d) for PSM, and (1)(e) for TNMM. Each sub-rule specifies the computation formula, the comparability factors to be considered, and the adjustments required.

Rule 10CA, introduced by CBDT Notification dated 19 May 2015, prescribes the range concept — where six or more comparable entities are identified, the arm’s length range is the 35th to 65th percentile of the dataset. Where fewer than six comparables exist, the arithmetical mean of the PLIs is used.

Method 1: Comparable Uncontrolled Price (CUP) — Rule 10B(1)(a)

How CUP Works

The CUP method compares the price charged or paid in a controlled transaction with the price charged or paid in a comparable uncontrolled transaction in comparable circumstances. Rule 10B(1)(a) prescribes the following steps:

Step 1: Identify the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction.

Step 2: Make adjustments to account for differences, if any, between the international transaction and the comparable uncontrolled transaction, or between the enterprises entering into such transactions, which could materially affect the price.

Step 3: The adjusted price is the arm’s length price for the international transaction.

CUP can use internal CUPs (the same enterprise transacts with both an AE and an independent party for the same or similar product/service) or external CUPs (comparable transactions between two independent parties, sourced from public data or databases).

When CUP Is the Most Appropriate Method

CUP is the most direct of the five methods — it compares prices, not profits. It is the preferred method when reliable comparable uncontrolled transactions exist with sufficient similarity to the controlled transaction. The OECD Transfer Pricing Guidelines (Chapter II, paragraph 2.14) state that where a CUP can be applied, it is the most direct and reliable method.

CUP is most commonly applied in India for:

Interest on intercompany loans: The interest rate charged on a loan from the Indian entity to its foreign AE (or vice versa) is compared with interest rates on comparable loans between independent parties. For INR-denominated loans, SBI’s base rate/MCLR/EBLR for the relevant tenor and credit quality serves as an external CUP. For foreign currency loans, SOFR (which replaced LIBOR) plus a credit spread appropriate to the borrower’s credit rating is the benchmark. The Mumbai ITAT in multiple decisions has accepted bank lending rates as valid CUPs, subject to adjustments for credit risk differentials.

Royalty and licence fee payments: Where comparable licence agreements for similar intangible property exist between independent parties — sourced from databases like RoyaltyStat, ktMINE, or publicly available agreements filed with the MCA — the royalty rates in those agreements serve as external CUPs. The comparability factors are critical: the nature of the intangible (brand vs. technology), the industry, the geographic territory, exclusivity, and the stage of the product lifecycle.

Corporate guarantee fees: The guarantee commission charged for issuing a corporate guarantee on behalf of an AE is compared with guarantee fees charged by banks or financial institutions for similar guarantees. The ITAT in Everest Kanto Cylinder Ltd. and other cases has considered bank guarantee rates as valid CUPs, while acknowledging that corporate guarantees and bank guarantees differ in nature and credit enhancement effect.

Purchase/sale of commodities: Where the controlled transaction involves commodities with publicly quoted prices (metals, crude oil, agricultural commodities), the quoted price serves as a CUP with adjustments for quality, delivery terms, volume, and timing. The CBDT, following OECD BEPS Action 10 recommendations, has strengthened the applicability of quoted prices for commodity transactions.

Challenges and Limitations of CUP

CUP’s primary limitation is the stringent comparability requirement. Even minor product or contractual differences can materially affect the price. For instance, a software licence with perpetual rights is not comparable to a software licence with annual renewal terms. An IT services contract with a fixed-price model is not comparable to one with a time-and-material model. These differences require adjustments that, if material, may render CUP unreliable.

In practice, Indian TPOs have frequently rejected CUP applications in service transactions on the grounds that exact comparability is impossible to establish for customised services. Conversely, TPOs strongly prefer CUP for financial transactions (loans, guarantees) where external market benchmarks are readily available.

Method 2: Resale Price Method (RPM) — Rule 10B(1)(b)

How RPM Works

RPM determines the arm’s length price of property purchased from an AE by deducting a normal gross profit margin from the resale price at which the property is resold to an unrelated party. Rule 10B(1)(b) prescribes:

Step 1: Identify the price at which property purchased or services obtained in the international transaction is resold or provided to an unrelated enterprise.

Step 2: Reduce the resale price by the amount of a normal gross profit margin accruing to the reseller, having regard to the functions performed, assets employed, and risks assumed by the reseller, adjusted for functional differences with comparables.

Step 3: Reduce the adjusted amount by expenses incurred in connection with the purchase of the property or services.

Step 4: The adjusted price is the arm’s length purchase price for the controlled transaction.

The formula: ALP = Resale Price — Normal Gross Profit Margin — Expenses incurred in connection with the purchase.

When RPM Is the Most Appropriate Method

RPM is most appropriate for distribution and reselling activities where the reseller does not add substantial value to the goods before resale. The PLI is the gross profit margin (Gross Profit / Net Sales). RPM works best when:

The reseller does not significantly alter the physical form of the product, does not own valuable intangibles (brand, technology) that contribute to the resale value, and the time between purchase and resale is short (reducing the impact of market price fluctuations).

In India, RPM is commonly applied for:

Import and resale of finished goods: An Indian subsidiary imports finished products from its foreign parent and resells them in the Indian market. The RPM tests whether the transfer price (the import price) leaves the Indian distributor with a normal gross margin comparable to independent distributors performing similar functions.

Distribution of branded products: Where the Indian entity acts as a limited-risk distributor — it does not own the brand, does not bear inventory risk beyond normal holding periods, and does not perform significant marketing beyond routine distribution. The gross margin earned should be comparable to independent distributors of similar products.

Comparability Factors for RPM

RPM is sensitive to functional comparability — the functions performed by the reseller drive the appropriate gross margin. A distributor that provides after-sales service, warehousing, and credit to customers performs more functions than a pure pass-through distributor, and should earn a higher gross margin. Key comparability factors include:

Level of distribution: Wholesale vs. retail. Wholesale distributors typically earn lower gross margins than retail distributors due to lower value-added functions.

Contractual terms: Whether the distributor bears credit risk, inventory risk, and warranty obligations. A limited-risk distributor bears fewer risks and should earn a correspondingly lower margin.

Product line: Distributors of high-value, low-volume products (industrial equipment) have different margin profiles from distributors of low-value, high-volume products (consumer goods).

Accounting consistency: Gross profit computation must be consistent between the tested party and comparables. Differences in the treatment of discounts, rebates, freight, and insurance in COGS vs. operating expenses can distort comparisons.

Limitations of RPM

RPM is less reliable when the reseller adds significant value — through processing, branding, bundling, or integration with proprietary services. It is also less reliable when accounting standards differ between the tested party and comparables, as the classification of costs between COGS and operating expenses varies. In such cases, TNMM (which uses operating profit, capturing all costs) is more appropriate as it is less affected by cost classification differences.

Method 3: Cost Plus Method (CPM) — Rule 10B(1)(c)

How CPM Works

CPM determines the arm’s length price by adding an appropriate mark-up to the costs incurred by the supplier in providing the goods or services to the associated enterprise. Rule 10B(1)(c) prescribes:

Step 1: Determine the direct and indirect costs of production incurred by the enterprise in providing the property or services in the international transaction.

Step 2: Determine the normal gross profit mark-up to such costs, having regard to the functions performed, assets employed, and risks assumed by the enterprise and comparable uncontrolled transactions.

Step 3: The sum of the costs and the normal gross profit mark-up is the arm’s length price.

The formula: ALP = Costs of production + Normal Gross Profit Mark-up.

When CPM Is the Most Appropriate Method

CPM is most appropriate for manufacturing, contract manufacturing, and service provision where costs are the primary determinant of value. It works best when:

The supplier performs routine manufacturing or service functions without contributing significant unique intangibles. The relationship between costs and market price is stable and predictable. Reliable data on gross profit mark-ups of comparable independent manufacturers or service providers is available.

In India, CPM is commonly applied for:

Contract manufacturing: An Indian subsidiary manufactures products under contract for its foreign parent, using the parent’s specifications, technology, and raw materials. The Indian entity earns a cost-plus return for its manufacturing services. The mark-up is benchmarked against independent contract manufacturers performing similar functions with similar risk profiles.

Contract R&D services: An Indian subsidiary performs R&D services for the foreign parent under a contract R&D arrangement — the parent owns the IP, bears the R&D risk, and directs the research. The Indian entity is compensated on a cost-plus basis. The mark-up is benchmarked against independent contract R&D service providers.

Back-office support services: Shared service centres that provide accounting, payroll, HR administration, and other support functions to the group are typically compensated on a cost-plus basis, with the mark-up reflecting the routine nature of the functions.

Cost Base Determination

A critical issue in CPM is defining the cost base. The cost base should include all direct and indirect costs attributable to the service or manufacturing activity — materials, labour, depreciation, allocated overheads. However, disputes arise on whether certain costs should be included or excluded:

Pass-through costs: Costs that the Indian entity incurs on behalf of the AE and passes through without any value addition (e.g., third-party licence fees, travel expenses). The OECD Guidelines (Chapter II, paragraph 2.50) suggest that pass-through costs may be excluded from the cost base for mark-up purposes, as the entity does not add value to these costs. Indian ITAT decisions have generally accepted the exclusion of pass-through costs from the mark-up base, provided the nature of the costs is properly documented.

Idle capacity costs: Whether costs of unused capacity should be included in the cost base or excluded as abnormal costs. The OECD position is that costs of idle capacity are borne by the party that bears the capacity risk — typically the principal in a contract manufacturing arrangement. We document the capacity utilisation and risk allocation clearly to support the appropriate treatment.

Method 4: Profit Split Method (PSM) — Rule 10B(1)(d)

How PSM Works

PSM determines the arm’s length price by first identifying the combined net profit of the associated enterprises from the international transaction, and then splitting that profit between the enterprises on a basis that reflects the division of profits that independent enterprises would have earned. Rule 10B(1)(d) prescribes two approaches:

Contribution Analysis (Rule 10B(1)(d)(i)): The combined net profit is divided between the enterprises based on the relative value of the functions performed by each enterprise, having regard to assets employed and risks assumed, using reliable external market data.

Residual Analysis (Rule 10B(1)(d)(ii)): The combined net profit is first allocated to each enterprise a basic return appropriate for the type of transactions in which it is engaged (determined using one of the other four methods). The residual profit (or loss) remaining after the basic allocation is then allocated based on the relative contribution of unique intangibles or functions that are not routine.

When PSM Is the Most Appropriate Method

PSM is the most appropriate method when both parties to the transaction contribute unique and valuable intangibles or functions, making it impossible to evaluate either party in isolation. It is the method of last resort in many jurisdictions, applied when the transactions are highly integrated and the other methods cannot be reliably applied.

PSM is applicable in India for:

Joint R&D and co-development: Where both the Indian entity and the foreign AE contribute proprietary technology, R&D capabilities, and bear development risk. Neither party is a routine service provider — both contribute unique intangibles. The profit from the jointly developed product is split based on relative R&D contributions, measured by R&D expenditure, number of patents, or other quantifiable metrics.

Integrated global trading operations: Where the Indian entity and the foreign AE together execute complex financial transactions (commodities trading, derivatives) with each party performing value-adding functions (sourcing, risk management, execution, client relationship).

Pharmaceutical co-development: Where the Indian entity contributes manufacturing know-how and clinical trial capabilities while the foreign AE contributes the molecular IP and regulatory expertise. The combined profit from the drug is split based on the DEMPE functions performed by each party.

Challenges of PSM in India

PSM is the most conceptually sound method for highly integrated transactions but is the most difficult to apply in practice. The challenges include:

Data requirements: PSM requires reliable data on the combined profits and the relative contributions of each party. This requires access to the foreign AE’s financial data, which the Indian entity may not have or may not be willing to disclose to the Indian tax authorities.

Allocation keys: The choice of allocation keys (R&D expenditure, headcount, capital employed, time spent) significantly affects the result. Different allocation keys produce different splits, and the selection involves substantial judgement.

Limited ITAT jurisprudence: PSM has been applied in relatively few Indian cases compared to TNMM. The ITAT has applied PSM in cases like Marubeni India Pvt. Ltd. (commodity trading) and Tata Elxsi Ltd. (software development with unique intangibles), but the body of case law is limited.

At Virtual Auditor, we apply PSM selectively — only where the economic substance warrants it. We find that in most India-specific transfer pricing situations, TNMM provides a more reliable result because the Indian entity’s role can be characterised and benchmarked in isolation, even when it contributes some intangibles. PSM is reserved for genuinely integrated transactions where neither party can be treated as the tested party.

Method 5: Transactional Net Margin Method (TNMM) — Rule 10B(1)(e)

How TNMM Works

TNMM compares the net profit margin of the tested party from the international transaction with the net profit margins earned by comparable independent enterprises from comparable uncontrolled transactions. Rule 10B(1)(e) prescribes:

Step 1: Compute the net profit margin realised by the enterprise from the international transaction, having regard to costs incurred, sales effected, or assets employed, as the case may be.

Step 2: Compute the net profit margin realised by comparable enterprises from comparable uncontrolled transactions, having regard to the same base (costs, sales, or assets).

Step 3: Adjust the net profit margin for functional and other differences between the enterprise and the comparable enterprises.

Step 4: The net profit margin thus adjusted is the arm’s length net profit margin for the international transaction, from which the arm’s length price is derived.

Why TNMM Dominates Indian Transfer Pricing

TNMM is, by a wide margin, the most commonly applied transfer pricing method in India. Based on CBDT data and our practice experience, TNMM is applied in over 80% of transfer pricing cases. The reasons are pragmatic:

Tolerance for functional differences: TNMM uses net operating profit, which captures all operating costs and therefore absorbs many functional differences that would distort gross margin comparisons under RPM or CPM. Two companies may classify costs differently between COGS and operating expenses, but their operating profit margins will be comparable if they perform similar overall functions.

Availability of data: Indian databases (Prowess, Capitaline) provide comprehensive operating-level financial data for thousands of companies, enabling robust comparable searches. This contrasts with CUP (where transaction-level pricing data is rarely available) or PSM (where combined profit data of both parties is needed).

Applicability across transaction types: TNMM can be applied to service transactions, manufacturing transactions, and even certain intangible property transactions. It is a versatile method that works when the tested party performs identifiable functions that can be benchmarked against comparable independent companies.

PLI Selection Under TNMM

The choice of Profit Level Indicator is critical. The most commonly used PLIs in Indian transfer pricing are:

Operating Profit / Total Cost (OP/TC): The most frequently used PLI for service transactions in India. Total Cost includes cost of goods sold plus operating expenses. This PLI measures the return earned on total costs and is appropriate when the tested party’s value contribution is proportional to its cost base. Indian IT/ITeS transactions are almost universally benchmarked using OP/TC.

Operating Profit / Operating Revenue (OP/OR): Used for distribution and trading activities. This PLI measures the operating margin and is appropriate when the tested party’s value contribution is proportional to the revenue it generates.

Operating Profit / Operating Expenses (OP/OE): A variant of OP/TC, sometimes used interchangeably. The distinction between OP/TC and OP/OE depends on whether cost of goods sold is included in the denominator. For pure service providers with no COGS, OP/TC and OP/OE are identical.

Berry Ratio (Gross Profit / Operating Expenses): Used in limited circumstances for intermediary and distribution activities where operating expenses are the primary driver of value. The Berry Ratio is appropriate when the intermediary does not take inventory risk and its compensation should be commensurate with its operating expenses rather than sales. Indian ITAT decisions have accepted the Berry Ratio in specific factual contexts, though it is less commonly applied than OP/TC or OP/OR.

Comparable Search and Filters

The TNMM comparable search process in India follows a well-established protocol. We document each step for TP Study Report compliance:

Quantitative filters: NIC/SIC code filter, turnover filter (0.1x to 10x of tested party), related party transactions filter (RPT less than 25% of revenue), financial year filter (same accounting year as the tested party), and availability of financial data for the relevant year.

Qualitative filters: Functional similarity (based on annual report review), exclusion of companies with extraordinary events (mergers, acquisitions, significant restructuring), exclusion of companies with different business models (product companies vs. service companies, B2B vs. B2C), and exclusion of companies operating in different market segments.

Working capital adjustment: Applied to normalise the PLIs of comparables for differences in working capital intensity. The adjustment uses the formula: Adjusted PLI = Unadjusted PLI — (Working Capital Adjustment Factor × Risk-free Rate). The working capital adjustment factor is computed from the difference in receivable days, payable days, and inventory days between the tested party and each comparable. The risk-free rate used is typically the SBI prime lending rate or the one-year government securities yield.

Risk adjustment: Where the tested party bears materially different risks from the comparables (e.g., the tested party is a captive service provider with guaranteed revenue, while comparables bear full market risk), a risk adjustment may be warranted. However, Indian ITAT decisions have been divided on the application of risk adjustments, with some benches accepting them and others rejecting them as subjective.

Selecting the Most Appropriate Method: Rule 10C

Rule 10C prescribes the factors for selecting the MAM:

Rule 10C(1): The most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, having regard to the following:

(a) The nature and class of the international transaction.

(b) The class or classes of associated persons entering into the transaction and the functions performed by them, taking into account assets employed or to be employed and risks assumed.

(c) The availability, coverage, and reliability of data necessary for the application of the method.

(d) The degree of comparability existing between the international transaction and the uncontrolled transaction, and between the enterprises entering into such transactions.

(e) The extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction.

(f) The nature, extent, and reliability of assumptions required to be made in the application of a method.

Rule 10C(2) clarifies that the data to be used for comparability shall be the data relating to the financial year in which the international transaction was entered into (the current year data), unless it can be demonstrated that the data available for the two years preceding the financial year (the prior year data) has a bearing on the determination of the arm’s length price. This multiple-year data provision is critical — it allows the use of a weighted average of the current year and two prior years’ PLIs, which smooths out year-specific fluctuations.

Decision Matrix for Method Selection

Based on our practice experience across hundreds of engagements, we apply the following decision matrix:

Financial transactions (loans, guarantees, interest): CUP is almost always the MAM. External market data (bank lending rates, SOFR, guarantee fees) provides reliable comparable pricing. We apply CUP for all financial transactions unless the transaction is so unique that no comparable pricing exists (rare).

Sale or purchase of tangible goods with quoted prices: CUP using quoted commodity prices, adjusted for quality, delivery terms, and timing. Where no quoted prices exist but comparable transactions between independent parties can be identified, CUP remains the MAM.

Distribution and resale (no significant value addition): RPM is the theoretically appropriate method, but in practice, TNMM with OP/OR as the PLI often produces more reliable results because comparable gross margin data is less reliably available and is more affected by accounting classification differences than operating margin data.

Contract manufacturing and contract services: CPM is theoretically appropriate for the supplier side. However, TNMM with OP/TC is preferred in Indian practice because it captures the full cost structure (including operating expenses) and provides a more complete profitability comparison. CPM and TNMM often converge when the same comparables are used.

IT/ITeS services (captive or contract basis): TNMM with OP/TC is the standard. This is the most common transaction type in India, and TNMM provides the deepest comparable pool. Companies may also consider Safe Harbour under Section 92CB as an alternative.

Royalty and brand licence payments: CUP using comparable licence agreements (from databases like RoyaltyStat or publicly available agreements). Where comparable agreements are unavailable, TNMM at the entity level is applied — testing whether the Indian entity’s profitability (after royalty payment) is comparable to independent entities.

Integrated operations with unique intangibles on both sides: PSM (contribution or residual analysis). This is the method of last resort, applied only when the transactions are so integrated that one party cannot be tested in isolation.

The Sixth Method: Rule 10AB

While Section 92C(1) prescribes five methods, Rule 10AB provides for “any other method” — colloquially called the “sixth method.” Rule 10AB states that for the purposes of Section 92C(1), the arm’s length price in relation to an international transaction may be determined by any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.

In practice, the sixth method is used in situations where the five prescribed methods cannot be reliably applied — for instance, in valuation of unique intangible property transfers, business restructuring transactions, or cost-sharing arrangements where none of the traditional methods fit. The Delhi High Court in Maruti Suzuki India Ltd. v. Addl. CIT observed that the “other method” should be applied only when the five prescribed methods are demonstrated to be inadequate.

For valuation-intensive transactions — such as the transfer of intangible property or business restructuring — we combine the sixth method with our IBBI-registered valuation capabilities to determine the arm’s length price. This is particularly relevant where the OECD BEPS Actions 8-10 guidance on hard-to-value intangibles applies.

OECD Alignment and Divergence

The OECD Transfer Pricing Guidelines (2022 edition) closely mirror the Indian framework, with important differences:

No method hierarchy: Both the OECD and Indian framework adopt a “most appropriate method” approach without a rigid hierarchy. However, the OECD Guidelines express a general preference for traditional transaction methods (CUP, RPM, CPM) over transactional profit methods (TNMM, PSM) when both can be applied equally reliably. Indian practice does not follow this preference — TNMM is applied as the MAM in the vast majority of cases regardless of whether CUP or RPM could theoretically be applied.

DEMPE framework: The OECD BEPS Actions 8-10 introduced the DEMPE concept for intangible property transactions. The entity performing Development, Enhancement, Maintenance, Protection, and Exploitation functions with respect to an intangible is entitled to the returns, regardless of legal ownership. India has incorporated this concept through the FAR analysis in transfer pricing regulations, and Indian TPOs actively apply DEMPE analysis to challenge royalty payments and cost-sharing arrangements.

Location savings: An India-specific concept recognised by the CBDT and applied by Indian TPOs and ITAT. Location savings arise when a multinational locates operations in India to benefit from lower costs (labour, infrastructure). The question is whether the Indian entity should share in these location savings. The Delhi ITAT in Li & Fung India Pvt. Ltd. held that location savings must be shared, and the Indian entity’s arm’s length return should include a portion of the savings. This has significant implications for IT/ITeS benchmarking, where the Indian entity’s cost advantage over competitors in developed markets is treated as a location-specific advantage that should be reflected in pricing.

Pricing for Transfer Pricing Method Selection and Application

Our transfer pricing method selection and benchmarking services are priced as part of the comprehensive TP Study Report engagement:

Method selection advisory (standalone): Starting from Rs. 40,000 + GST. For companies seeking guidance on the most appropriate method before engaging a full TP Study. Includes review of transactions, FAR analysis, and method recommendation with documented rationale.

Full TP Study with benchmarking: Starting from Rs. 75,000 + GST for basic engagements (1-3 transaction categories) to Rs. 3,00,000+ for complex engagements involving PSM, intangibles, or business restructuring. View detailed pricing.

Second opinion / review of existing TP Study: Starting from Rs. 50,000 + GST. We review the method selection, comparable set, and benchmarking analysis in an existing TP Study and provide a detailed critique with recommendations for strengthening the documentation.

Contact us for a free initial consultation on your transfer pricing method selection and compliance requirements.

Frequently Asked Questions

1. Is there a hierarchy among the five transfer pricing methods in India?

No. Unlike the pre-2009 position (where CUP held primacy), the current Indian framework under Rule 10C requires selection of the “most appropriate method” based on the specific facts and circumstances. There is no statutory hierarchy. However, in practice, the OECD Guidelines express a preference for traditional transaction methods (CUP, RPM, CPM) over profit methods (TNMM, PSM) when both can be applied equally reliably, and Indian TPOs sometimes adopt this preference when challenging the taxpayer’s method selection.

2. Can different methods be used for different transactions in the same TP Study?

Yes. The MAM selection is done at the transaction level, not at the entity level. A company may apply CUP for its intercompany loan (interest benchmarking), TNMM for its IT services provision (operating margin benchmarking), and CUP or TNMM for its royalty payment — each transaction is analysed independently and the most appropriate method for that transaction type is selected. The TP Study Report documents the MAM selection for each transaction category.

3. What is the difference between TNMM and CPM in practice?

CPM uses gross profit mark-up on costs as the PLI, capturing only production-related costs and gross margins. TNMM uses net operating profit relative to costs, sales, or assets, capturing the full operating cost structure including selling, general, and administrative expenses. In practice, for service transactions, both methods converge when the same comparables are used — the difference is in whether operating expenses are included in the margin computation. TNMM is preferred in India because it is less sensitive to cost classification differences between the tested party and comparables.

4. When should the Berry Ratio be used?

The Berry Ratio (Gross Profit / Operating Expenses) is appropriate for intermediary activities where the entity does not take inventory risk and its compensation should be proportional to its operating expenses, not its sales. This is relevant for commissionaire arrangements, buy-sell distributors with minimal inventory risk, and procurement service providers. Indian ITAT decisions have accepted the Berry Ratio in specific factual contexts, but it is not a commonly applied PLI. The OECD Guidelines (Chapter II, paragraph 2.106) provide guidance on when the Berry Ratio is appropriate.

5. Can the TPO change the method selected by the taxpayer?

Yes. The TPO has the authority under Section 92CA to determine the arm’s length price using the method the TPO considers most appropriate. The TPO may reject the taxpayer’s method and apply a different method, or accept the same method but with different comparables or adjustments. The taxpayer can challenge the TPO’s method selection before the DRP (under Section 144C) and the ITAT (under Section 253). The burden is on the TPO to demonstrate that the method adopted by the taxpayer is not the most appropriate and that the TPO’s method is more reliable.

6. How does TNMM handle loss-making comparables?

Loss-making comparables present a challenge. A comparable company with persistent losses (losses in 3 or more of the preceding 5 years) is typically excluded from the comparable set, as persistent losses suggest structural issues unrelated to the transaction being benchmarked. However, a company with a one-year loss due to cyclical or industry-wide factors may be retained if the loss is representative of the arm’s length outcome in that year. The Mumbai ITAT in several decisions has held that companies with persistent losses should be excluded, while one-year losses during industry downturns may be retained.

7. What role does the OECD Transfer Pricing Guidelines play in Indian proceedings?

India is not bound by the OECD Guidelines as a legal instrument. However, the OECD Guidelines are widely referred to as persuasive authority by Indian courts and tribunals. The Delhi High Court in Sony Ericsson Mobile Communications India Pvt. Ltd. and the Supreme Court in Union of India v. Azadi Bachao Andolan have acknowledged the OECD Commentary and Guidelines as valuable reference material. The CBDT also refers to OECD recommendations in its circulars. At Virtual Auditor, we align our TP documentation with both Indian regulations and OECD Guidelines to ensure the analysis is defensible at all levels.

8. How do Safe Harbour Rules relate to method selection?

Safe Harbour Rules under Section 92CB read with Rules 10TD and 10TE provide a pre-approved margin for specified transactions — if the taxpayer earns at least the safe harbour margin, the transfer price is deemed to be at arm’s length without the need for detailed benchmarking. Safe Harbour effectively bypasses the method selection process for eligible transactions. However, Safe Harbour is an option, not a mandate — companies can choose to apply the regular benchmarking process under Section 92C if it produces a more favourable result. We advise clients on whether Safe Harbour or regular benchmarking is more advantageous based on their specific profitability levels.

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