The government is introducing changes to the transfer pricing regulations to simplify compliance for multinational companies and provide tax stability. Clarifications regarding the proposed changes, introduced in the Union Budget, are expected to be released within three months. The budget has introduced a block assessment mechanism for transfer pricing, ensuring tax stability for three years in line with global best practices. A predetermined arm’s length price will apply to similar transactions for three years (the initial year plus two additional years), streamlining the process for businesses.
Transfer pricing refers to the pricing mechanism used in transactions between subsidiaries, affiliates, or commonly controlled companies within the same enterprise. One division of a company may charge another division for goods and services provided, ensuring financial accountability across operations.
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Understanding transfer pricing
Due to varying tax rates across jurisdictions, multinational enterprises have an incentive to set transfer prices in a way that minimises the group’s overall tax liability. Companies sometimes manipulate transfer prices by charging higher prices to divisions in high-tax countries and lower prices to divisions in low-tax countries, thereby increasing profit in the low-tax jurisdiction.
While multinational corporations are legally permitted to allocate earnings among their subsidiaries and affiliates, such practices can result in tax savings for corporations while leading to tax revenue losses for governments. The Organisation for Economic Co-operation and Development (OECD) estimates that tax base erosion due to transfer pricing manipulation globally could be between $100 billion and $240 billion annually.
The Internal Revenue Service mandates that transfer prices in intercompany transactions reflect arm’s length prices, as if the transactions occurred between unrelated parties. One of the most notable transfer pricing disputes involves Coca-Cola and the IRS. Between 2007 and 2009, Coca-Cola transferred intellectual property (IP) value to its subsidiaries in Africa, Europe, and South America. The company maintains that its $3.3 billion transfer pricing for a royalty agreement is justified. However, the IRS and Coca-Cola remain engaged in ongoing legal proceedings over the matter.
Transfer pricing disputes in India
India has also seen its fair share of transfer pricing disputes. A significant case involved Kellogg India concerning the distribution of Pringles in the country. Kellogg India, acting as the Indian distributor, argued that the Singaporean entity supplying Pringles should be the tested party for benchmarking the transaction price. However, the Indian tax authorities disagreed, insisting that Kellogg India should be the tested party. The authorities applied the transactional net margin method (TNMM), which resulted in a significantly lower arm’s length profit margin, suggesting potential profit shifting to Singapore.
Ultimately, the Income Tax Appellate Tribunal ruled in favour of Kellogg India, accepting its choice of the tested party and concluding that the transaction price did not require adjustment. The case highlighted the complexities and potential for disagreement in determining appropriate transfer pricing methodologies.
Transfer pricing framework in India
India introduced transfer pricing regulations over two decades ago, and they have undergone several changes to align with evolving global and economic landscapes. However, transfer pricing remains one of the most complex areas of the Direct Tax statute. A recent Deloitte survey shows that the interpretation of transfer pricing laws has been a major source of litigation, leading to substantial tax demands and prolonged legal disputes. A lack of clarity on complex transfer pricing issues has further exacerbated the problem. One of the key expectations from the Union Budget was the simplification of legal provisions in transfer pricing regulations to align them with global standards.
The government is proposing amendments to transfer pricing regulations through the Finance Bill, 2025. These amendments, set to take effect from April 1, 2026, pending parliamentary approval, would allow taxpayers to opt for a multi-year ALP determination process. This marks a significant shift from the current system (Sections 92 to 92F of the Income-tax Act), which requires annual ALP determination for each transaction—often leading to repetitive assessments and increased compliance costs.
However, there are concerns that the new measures may have limited impact due to their restriction to “similar transactions.” Finance Ministry officials have indicated that the government may expand the scope of these measures after implementation, based on their observed impact, and take further action accordingly.
Contrary to claims that these provisions are indisputable, transfer pricing assessments can still be contested in the primary year as well as in the subsequent two years. Nonetheless, there is growing demand for the Central Board of Direct Taxes (CBDT) to address additional concerns, including the applicability of these provisions to prior years and ongoing proceedings.
Encouraging private sector participation
Transfer pricing is a critical aspect of tax compliance and investment decisions for both Indian and foreign multinational corporations. These companies engage in cross-border transactions with related entities, requiring them to determine appropriate transaction prices. Currently, transfer pricing assessments are conducted annually, creating a significant compliance burden. By introducing block assessments, the government aims to alleviate this pressure. Instead of assessing transfer pricing for similar transactions each year, businesses can now undergo a single assessment covering a three-year period. This simplifies the process and provides greater certainty for businesses.
The Budget proposal shows the government’s commitment to fostering private sector participation in India’s growth. Clear and predictable rules create a more stable and transparent business environment, encouraging investment and economic expansion. Moreover, ensuring that businesses pay their fair share of taxes will create a more level playing field for both domestic and multinational companies. This approach will also help prevent tax evasion through profit shifting and could lead to increased tax revenue for governments.
Aligning with global best practices
International organisations such as the OECD continually update their guidance on transfer pricing. The OECD’s work in this area aims to prevent double taxation by promoting the arm’s length principle, as outlined in its transfer pricing guidelines. These guidelines serve as the global standard for cross-border transactions between related parties, helping to minimise tax disputes and ensure fair competition.
For India to attract major multinational corporations, it must update its regulations to align with these global standards and prevent tax base erosion. As the government moves forward with the proposed transfer pricing reforms, businesses and tax authorities will need to navigate the evolving regulatory landscape while ensuring compliance with international norms.
The proposed changes mark a significant step toward simplifying transfer pricing regulations, reducing litigation, and enhancing India’s appeal as a global business hub. However, the ultimate success of these reforms will depend on their implementation, clarity in guidelines, and adaptability to emerging challenges in global taxation.