Transfer Pricing Between a US Parent and Its India Subsidiary: What the IRS and Indian Tax Officers Both Check

Every dollar a US parent pays its Indian subsidiary is income in India and a deduction in the US. Every dollar it charges the other way works in reverse. That is why two tax authorities with opposite interests look at the same invoice, and why a price that satisfies one can still be challenged by the other. Getting transfer pricing for an India subsidiary of a US parent right means building one defensible file that answers both sets of questions.

This guide explains what each side checks, where the two systems disagree, how the 2026 safe harbour for IT services changes the options, and how to document your arrangement so it survives review on both sides of the border.

Why Both Authorities Care

The arm's length principle is shared. Related parties should price their dealings as independent parties would. The incentive to deviate runs in opposite directions. India wants enough profit left in India, and the US wants enough profit left in the US.

For a US parent with an Indian captive or services subsidiary, the typical flow is a services fee paid to India. The IRS asks whether the fee is too high, because that shifts US profit offshore. India asks whether it is too low, because that leaves too little profit in the Indian company. Both are testing the same number from opposite directions.

The Transactions Most Often Examined

Software development and IT services

The most common arrangement is a captive centre that provides engineering, support or back-office services to the parent for a cost-plus fee. It is the easiest to benchmark and, in India, now has a safe harbour option.

Management and head-office charges

Here both authorities ask whether the Indian subsidiary actually received a service. Charges for shareholder activities, such as parent-level oversight or group strategy, are usually not chargeable. Charges for real services such as finance support, HR or IT shared services need evidence of the work and the benefit.

Royalties and intellectual property

Where the Indian entity uses the parent's technology or brand, a royalty may be due, and the question of who developed and controls valuable intangibles drives who is entitled to the return. These are higher-risk transactions in both countries.

Loans and guarantees

Interest on intercompany loans and fees for guarantees must be at arm's length. Loans from a foreign parent to an Indian company are also regulated under FEMA as external commercial borrowings, so pricing and regulatory conditions both matter. The annual FLA return reports foreign liabilities and assets, and the numbers should agree with the transfer pricing file.

Reimbursements and cost sharing

Pass-through costs paid on behalf of the parent are often treated as reimbursements, but tax officers test whether a markup should apply and whether the Indian entity acted as principal or agent. Be clear on the substance before you label an item a reimbursement.

What the IRS Checks

On the US side, the starting point is Section 482 of the Internal Revenue Code, which lets the IRS reallocate income between related parties to reflect arm's length results. For services, the regulations offer methods that include a services cost method for low-margin back-office services, as well as comparable profit and cost-plus approaches. Your section 482 transfer pricing analysis should show which method you used and why.

Three questions come up repeatedly in review.

• Was there a real benefit? The IRS looks at whether a service gave the payer a benefit that an independent party would pay for, and excludes some activities that merely protect the parent's investment.

• Is the price supportable? The analysis should show comparable companies or transactions, the margin range and how your result sits within it.

• Is the documentation in place? To qualify for penalty protection, the documentation generally has to exist when the return is filed and be provided within a short period if the IRS asks. Penalties for substantial valuation misstatements can be significant, so contemporaneous documentation matters.

The US parent also reports these dealings. A US corporation that owns the Indian subsidiary generally files Form 5471, and the schedule that reports transactions with the foreign company records the service fees, royalties and loans. Our guide to Form 5471 obligations for US persons owning an Indian company explains who files and what is reported.

For the wider picture of your US reporting, our US tax and CPA services can coordinate the US file with the Indian one.

What Indian Tax Officers Check

In India, the rules on international transactions with associated enterprises are administered by transfer pricing officers who examine cases referred to them. The checks fall into a few groups.

• Documentation and reporting. Companies with international transactions above the threshold must maintain India transfer pricing documentation and obtain an accountant's report. The report is filed as Form 3CEB filing, generally by 30 November for transfer pricing cases. Larger groups may also need a master file and country-by-country reporting. Documents must be in place by the filing date and produced when the officer asks.

• Functional analysis. The officer asks who performs which functions, uses which assets and takes which risks. A subsidiary that claims low risk but makes real decisions, or the reverse, invites adjustment.

• Benchmarking. The officer reviews your comparables. Common challenges are the choice of companies, filters for turnover and related-party income, working capital adjustments and whether the margin is measured on the right cost base.

• Service benefit and evidence. For payments from the Indian entity, such as management fees, the officer asks for proof that a service was received and that the price is justified.

• Penalties. Failure to maintain or furnish documents, and failure to file the accountant's report, attract specified penalties. Under-reporting and misreporting of income can attract heavier ones, so a thin file is costly.

• Numbering note. From 1 April 2026, the Indian income tax law was restated in the Income-tax Act, 2025, so section numbers and form names may differ from older references. Confirm current references with your adviser.

The 2026 Safe Harbour for IT Services

For many captive centres, the biggest change is the safe harbour. The Union Budget 2026-27 brought software development, IT-enabled services, KPO and contract software R&D into a single information technology services category with a uniform margin of 15.5% on operating costs and an eligibility threshold of ₹2,000 crore, applying from 1 April 2026.

The safe harbour is optional. Electing it gives certainty on the Indian side in return for a prescribed margin, and the choice has conditions on eligibility and procedure. It does not bind the IRS. A margin that is accepted in India still has to be supportable under US rules, so check that the same margin passes the arm's length test in the US analysis.

Our practical guide to setting up a captive centre explains where the safe harbour fits in the wider structure, and why it should be elected deliberately and not assumed.

Where the Two Systems Disagree

Several differences cause double taxation or double work if you ignore them.

Year-end adjustments. Parents often "true up" prices after year end to reach a target margin. India is cautious about adjustments made after the year closes and may not recognise a downward true-up in the return. The US has its own conditions for when such adjustments are respected. Decide your approach in advance and document it in the agreement.

Range and comparables. The two systems use different rules for the acceptable range, the data used and the choice of comparable companies. A margin that sits in the Indian range can fall outside the US one, and vice versa.

Secondary adjustments. If an Indian adjustment increases the Indian entity's income, India can require the excess money to be brought back from the parent, and otherwise treat it as a deemed advance with imputed interest. Bringing money back must comply with FEMA, and our overview of FEMA compliance explains the framework.

Timing of documentation. The US expects documentation to exist at filing and be produced within a short window on request. India expects documents by the filing date for the report, with produce-on-request deadlines. Align both to the earlier date.

Build One File That Works for Both

A single well-built file saves effort and prevents inconsistent positions.

1. Sign an intercompany services agreement first. The agreement should describe the services, the pricing method, billing and payment timing, IP ownership, how adjustments are handled and who bears which risks. Sign it before the first invoice, ideally at incorporation, as in our India incorporation services.

2. Do the functional analysis once. Describe functions, assets and risks in a way that both tax authorities can read, and make sure it matches what the team actually does.

3. Choose one method and benchmark it for both countries. Where possible, run an analysis that covers both sets of rules, and note differences in ranges.

4. Match invoices to the agreement. Fees, currency and billing frequency should follow the contract, with exceptions documented.

5. Collect payment through proper channels. Receipts for exported services should come through the banking system in the prescribed period, as our company bank account guide explains.

6. File on both sides. File the Indian accountant's report and the transfer pricing documentation on time, and report the transactions on the US return.

7. Review annually. Business changes, such as new services or a changed risk profile, should trigger an update to the file.

Settling Disputes: MAP and APA

If both countries claim the same income, the India-US tax treaty provides a mutual agreement procedure to relieve the double taxation, and either country's competent authority can be approached. Advance pricing agreements let you agree a method with the tax authorities in advance, and in India they can provide certainty for several years. Both take time and resources, so they suit larger or higher-risk arrangements. For many smaller captive centres, the safe harbour and a clean file are the practical route.

Mistakes to Avoid

The same problems recur. The agreement is signed after the services start, or not at all. Management fees are charged without evidence of benefit. The Indian entity claims to be low risk but makes real decisions. A year-end true-up is booked without a policy. The Indian report is filed late, or the US schedule omits the same transactions. Benchmarking uses companies that do not resemble the Indian entity. And nobody owns the calendar, so the file is rebuilt in a rush each year.

The Takeaway

Two tax authorities will test the same price from opposite sides. The way through is a clear agreement signed in advance, a functional analysis that matches reality, a benchmarked method that works for both, on-time filings in both countries and a careful approach to year-end adjustments. Treat the file as a living document, not a once-a-year scramble.

Want one transfer pricing file that stands up in both countries? Talk to Accorp Partners about transfer pricing documentation, intercompany agreements and US-India tax coordination.

Frequently Asked Questions

1. Do both the IRS and Indian tax officers review the same transaction?

Yes, they can. The Indian subsidiary's income is taxed in India and the US parent's deduction is reviewed by the IRS. Each looks at whether the price is arm's length from its own side, which is why one consistent file matters.

2. What is the safest pricing model for a captive India centre?

A cost-plus fee is the usual model. It recovers the Indian entity's operating costs plus a markup that is supportable by benchmarking. For eligible IT services, the Budget 2026-27 safe harbour gives an option with a prescribed margin, but you must elect it and the US analysis still has to hold.

3. Is Form 3CEB required for every Indian subsidiary?

It is required where the company has international transactions with associated enterprises above the prescribed threshold. The accountant's report is generally due by 30 November for transfer pricing cases. Check the current threshold and due date with your adviser.

4. Can we adjust the price after the year ends?

It is risky. India is cautious about post-year-end adjustments, and the US has its own conditions. If you need a true-up mechanism, put it in the agreement, apply it consistently and document the reasons, and get advice on how it will be treated in each country.

5. Do we need a transfer pricing study if the amounts are small?

India has thresholds below which the full documentation and the accountant's report are not required, but the arm's length principle still applies, and a short written analysis is wise. In the US, documentation is what gives penalty protection, so a small file is still better than none.

6. What happens if India makes an adjustment?

Indian income increases, and you may face tax, interest and penalties on the adjusted amount. If the same income is taxed in the US as well, you can seek relief through the mutual agreement procedure. Secondary adjustment rules may also require repatriation of the excess money.

7. Does a safe harbour election bind the IRS?

No. It gives certainty with Indian tax authorities for the covered transaction. The US still applies its own rules, so the margin should be supportable under both systems.