Transfer pricing

Also called: Arm's length principle · Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Beyond NCERT

Meaning

Transfer pricing means the prices that units of the same multinational enterprise (MNE, a company group that works in many countries) charge each other. An example is an Indian subsidiary paying its foreign parent for a brand licence. Tax law says these prices must match the arm's-length price (ALP), which is the price that unrelated parties would charge each other.

Why it matters:

• A group can move profit to a low-tax country just by setting a wrong internal price.
• The country where the real work happens then loses tax.
• So transfer pricing is a key tool of profit shifting.

Formula (using the note's worked example):

• Profit shifted out = ALP − transfer price actually charged
• Tax adjustment = the taxable profit is raised to the ALP-based profit

Explanation

How the trick works

• Related parties set their own prices. No outside buyer bargains with them, so the group can pick any price.
• Low price on sales to a low-tax unit
• The Indian unit shows little profit, so it pays little tax in India.
• The sister unit abroad shows high profit, but it is taxed at a lower rate.

• The group as a whole pays less tax.

• High price on purchases from a low-tax unit. This has the same effect. Examples are royalties, brand fees, interest and management charges paid to the parent.

• Only the internal price changes. The product, the work and the final customer stay the same.

Worked example

• An Indian unit makes software at a cost of ₹100.
• It sells the software to its Singapore sister unit for ₹105. An unrelated buyer would pay ₹150, so the ALP is ₹150.
• Profit shown in India = 105 − 100 = ₹5
• ALP profit = 150 − 100 = ₹50
• Profit shifted to Singapore, where tax is lower = ₹45
• The tax officer adjusts India's taxable profit up to ₹50.

The arm's-length principle: the rule behind the check

• The arm's-length principle is the standard, and the ALP is the number it produces.
• Here "arm's length" means the two sides deal like strangers, each trying to get the best deal for itself.
• If the related-party price differs from the ALP, the tax department rewrites the profit as if the ALP had been charged.

Tools that reduce disputes

• Advance Pricing Agreement (APA): the firm and the tax department agree in advance on the pricing method for future years. This avoids long court fights.
• Unilateral APA: between the firm and the Indian tax department only.

• Bilateral APA (BAPA): the tax authority of the other country also signs. This protects the firm from double taxation (the same income being taxed by two countries) on both sides.

• Safe-harbour rules: fixed profit margins that the tax department accepts without scrutiny. If a firm reports at least that margin, no questions are asked.

In India

• Law: Sections 92–92F of the Income-tax Act, in force since 2001.
• Who manages it: the CBDT (Central Board of Direct Taxes, the top body for income tax) signs APAs. Tax officers carry out transfer pricing adjustments.
• APA programme: started in 2012.

Year	APAs signed by CBDT
FY 2021-22	62 [4]
FY 2022-23	95 [3]
FY 2023-24	125 (a record at the time) [2]
FY 2024-25	174, including 65 BAPAs [1]
FY 2025-26	219 (highest ever), including 84 BAPAs [1]

• Total APAs since the programme began passed 1,000 (1,034) by FY 2025-26 [1].
• India signed its first bilateral APAs with France, Ireland, Indonesia and Sweden in FY 2025-26 [1].
• Global link: transfer pricing abuse is a main form of BEPS (Base Erosion and Profit Shifting, meaning tax planning that uses gaps between countries' rules to move profit to low- or no-tax places). The OECD/G20 BEPS project ran from 2013 to 2015 and produced 15 actions.

Don't confuse with

• Treaty shopping: this means routing investment through a treaty country, such as a shell company in Mauritius, only to claim treaty benefits. Transfer pricing instead misprices deals inside one group. India tackles treaty shopping with the PPT (Principal Purpose Test, added through the MLI) and tackles transfer pricing with ALP adjustments.
• Double taxation / DTAA: double taxation means two countries taxing the same income. Transfer pricing abuse usually causes the opposite problem, too little tax. A transfer pricing adjustment in one country can create double taxation, and a bilateral APA prevents it.
• Global minimum tax (Pillar Two): this sets a 15% floor on the effective tax rate for groups with €750 million+ revenue. It works after profit is shifted, by collecting top-up tax. The ALP works before, by stopping the shift at the pricing stage.
• Arm's-length principle vs transfer price: the transfer price is the price the group actually charges. The arm's-length price is the benchmark that the tax officer compares it with.

Prelims Hooks

• Transfer pricing = prices charged in deals between related units of the same MNE. ALP = the price unrelated parties would charge each other.
• Legal base: Secs. 92–92F of the Income-tax Act, in force since 2001. APAs started in 2012.
• Unilateral APA = firm and the Indian tax department only. Bilateral APA = the foreign tax authority also agrees, which protects against double taxation on both sides.
• CBDT signed a record 219 APAs in FY 2025-26, including 84 BAPAs. The cumulative total reached 1,034 [1].
• Safe-harbour rules = fixed margins the tax department accepts without scrutiny. They are not the same as an APA, which is negotiated for each firm.
• Trap: transfer pricing itself is legal and normal inside a group. Only a price that departs from the ALP gets adjusted.

Mains Points

• From disputes to prevention: transfer pricing was once one of India's biggest sources of tax litigation.
• The APA count rose from 62 in FY 2021-22 to 219 in FY 2025-26 [4][1].

• This gives firms tax certainty (knowing their tax bill in advance), which is itself a reason to invest. The Vodafone retrospective-tax episode showed the opposite effect.

• Protecting India's tax base: India hosts many MNE subsidiaries in IT, pharma and back-office services.

• Low internal prices move their profit to low-tax places.

• Strong ALP enforcement keeps the profit taxable where the work is done. This fits with India's backing of BEPS and the Two-Pillar deal.

• Balance between enforcement and ease of doing business:

• Aggressive adjustments can lead to double taxation and scare investors.
• Soft enforcement lets profit leak abroad.
• Bilateral APAs (such as India's first ones with France, Ireland, Indonesia and Sweden) and safe harbours help strike this balance [1]. Link this to GS-III themes of black money and tax administration reform.

Related concepts

• Tax haven
• Double Taxation Avoidance Agreement
• Retrospective taxation
• Base Erosion and Profit Shifting
• Significant economic presence
• Equalisation levy
• Pillar One
• Global minimum tax
• Automatic exchange of information

Read more

• International taxation: treaties, profit shifting and the global minimum tax