—Guide
Benchmarking in Transfer Pricing: Comparables, TNMM and the Arm's Length Range
How transfer pricing benchmarking works in India: searching for comparable companies, applying TNMM, and testing results against the arm's length range.
Benchmarking is the heart of a transfer pricing study: comparing your related-party results with those of independent companies to show your pricing is arm's length. It's also where most disputes with the tax department arise. This guide explains how it's done.
Choosing the Method
Indian rules recognise several methods. For services, distribution and contract manufacturing, the transactional net margin method (TNMM) is most common. It compares the net profit margin of the tested party — usually the Indian entity — with margins of comparable independent companies.
The Tested Party
Usually the less complex party, often the Indian service provider or distributor, whose functions are easier to compare with independent companies.
The Profit Level Indicator
The margin being compared — for example, operating profit as a percentage of operating costs for a service provider, or of sales for a distributor.
Searching for Comparables
- Search databases of Indian company financial data for businesses in similar activities.
- Apply quantitative filters — such as turnover, related-party transaction levels, and persistent losses.
- Apply qualitative review — reading business descriptions to confirm functional similarity.
- Settle on a final set of comparable companies.
The Arm's Length Range
Where there are enough comparables, India uses a range based on percentiles of the comparables' results. If the tested party's margin falls within the range, the price is accepted. If it falls outside, the adjustment is generally to the median.
Where Disputes Arise
- Inclusion or exclusion of particular comparables.
- Functional differences, such as the tested party taking more or less risk than assumed.
- Adjustments for working capital or risk.
- Use of current-year versus multiple-year data.
Tips
- Document the reasons for accepting and rejecting each comparable.
- Refresh the benchmarking every year.
- Make sure the functional analysis matches the chosen comparables.
Getting Help
Think Filing performs transfer pricing benchmarking and defends it in assessments.