India’s Transfer Pricing Overhaul Demands a Company Risk Review

Now that India’s revised transfer pricing rules have been in effect for two months, the focus of multinational enterprises has shifted from understanding what changed to assessing the pros and cons of electing into the new safe harbor regime.

Safe harbors can reduce corporate reporting requirements based on effective tax rates, parent-entity location, or tax incentive-related activities.

The updated rules offer a more streamlined framework for routine information technology, IT-enabled software development, software research and development, and data center service providers in India. The most visible benefits include fewer benchmarking requirements and more predictable multiyear pricing. For eligible low-risk captive service providers known as global capability centers, these changes provide a respite from recurring transfer pricing audits and annual benchmarking exercises.

However, the safe harbor shouldn’t be viewed as a default solution. A fixed return for a multinational’s India operations can have consequences outside India, particularly for US-headquartered groups that must maintain consistency with Internal Revenue Code Section 482, as well as with global tax and transfer pricing policies.

Key Planning Questions

The new transfer pricing rules improve the commercial viability of India’s safe harbor. They consolidate certain technology services into a broader category, prescribe a 15.5% operating margin for eligible IT services, increase the transaction threshold to INR 2,000 crore ($210 million), and provide tax certainty through a one-time election (for either one or five years). The rules also introduce a separate safe harbor for data center services, with a prescribed 15% operating margin.

The more significant issue for taxpayers is how the rules affect transfer pricing planning. Multinationals should assess the following:

• Is the prescribed margin consistent with the group’s global value chain?
• Does the entity’s functional risk profile support safe harbor eligibility?
• Would a safe harbor election reduce controversy in India while increasing the risk of mismatches, double taxation, or inconsistent positions elsewhere?

Risk and Considerations

A consolidated IT services category should reduce one of the most persistent sources of Indian transfer pricing controversy: disputes over whether activities are software development, IT-enabled software development, knowledge process outsourcing, or R&D services. This is important because each service category previously had a separate transfer pricing margin.

For global capability centers with integrated delivery models, the change might lower the risk of Indian tax authorities recharacterizing routine services into higher-margin categories. But the risk of whether the provided services fall within the four categories still exists.

Taxpayers need to maintain clear documentation of global capability centers’ risk profile, including evidence that strategic decisions, economically significant risks, and ownership of valuable intangibles remain outside India. A valid safe harbor election might reduce the need for annual benchmarking analyses for covered transactions, but tax authorities still might expect to verify eligibility, review disclosures, and assess whether the facts supporting the election remain unchanged.

Multinationals might need to continue preparing robust documentation outside India to support consistency with global transfer pricing policies and the arm’s-length standard in other jurisdictions. Specifically, US-headquartered groups should note that even when India accepts the prescribed safe harbor margin, the IRS isn’t bound by that result.

Benchmarking remains preferable if the taxpayer expects business changes during the five-year period, or when the Indian entity’s activities don’t fit comfortably within the eligible service categories.

APAs Still Matter

The revised rules create a more attractive safe harbor option, but they don’t eliminate the need for advance pricing agreements. Taxpayers should view the new regime as one point on the broader spectrum of obtaining tax certainty.

They also should consider whether a safe harbor’s fixed return could cause problems with allocating residual profits or losses elsewhere in the group, especially as global capability centers have expanded in terms of roles and responsibilities since they were established in the early 2000s.

The qualifications of personnel employed by global capability centers have also evolved. They now hire senior management who often are involved in strategic and operational leadership, as well as AI and machine learning initiatives.

However, in many cases, the transfer pricing model still treats these centers as routine service providers: The Indian entity is reimbursed for its costs and earns a fixed markup, rather than receiving a return that reflects the higher-value work it may now be performing. Undertaking a robust functional analysis, along with traditional benchmarking, will help with profit allocation.

Bilateral APAs remain relevant when taxpayers need certainty in both India and a counterparty jurisdiction, such as for groups with a US parent, because Indian safe harbor acceptance doesn’t bind the IRS. Where transactions are material, margins differ from US transfer pricing conclusions, or double taxation risk is significant, a bilateral APA can provide more complete protection than a unilateral safe harbor election.

Before electing the safe harbor, taxpayers should continue to model whether the prescribed Indian margin is consistent with the return otherwise supported under the group’s transfer pricing policies. The interaction with the 15% global minimum tax known as Pillar Two also should be considered. A higher fixed return in India might increase India’s jurisdictional effective tax rate, but it could shift income away from other jurisdictions or affect the group’s blended minimum tax analysis.

Practical Steps

Multinationals considering an election first should confirm that the Indian entity’s functions, assets, and risks are consistent with a low-risk service provider profile. This analysis should consider contractual terms, actual conduct, decision-making authority, risk control, and ownership or use of valuable intangibles.

Taxpayers then should compare the prescribed safe harbor margin with existing benchmarking analyses and intercompany policies, model the effect across jurisdictions, and evaluate whether the safe harbor election or an APA provides the best route to certainty. These options aren’t interchangeable. The appropriate choice will depend on transaction materiality, risk profile, expected business changes, and the need for bilateral protection.

Finally, taxpayers should preserve documentation, even if annual benchmarking requirements are reduced. The ability to demonstrate eligibility, factual consistency, and alignment with the global transfer pricing framework will remain important throughout the election period.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Sowmya Varadharajan is a principal in Crowe’s tax group and leads the firm’s transfer pricing practice.

Carol Adebowale is a Crowe transfer pricing services manager based in Austin.

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