Most India captives are paid cost plus a margin, agreed once at setup and never revisited. The agreement is usually fine. What gets adjusted is what went into “cost” and whether the margin was ever tested.
An Indian subsidiary providing services to its foreign parent must be paid an arm’s length price, and the method used for captives is almost always TNMM on a cost-plus basis. From tax year 2026-27 the safe harbour margin for IT and ITeS services is a single 15.5% of operating expenses, replacing the previous 17% to 24% bands, with the transaction limit raised to ₹2,000 crore. The adjustments that bite are cost base exclusions and undocumented intercompany terms, not the headline margin.
Running an India captive and unsure the margin holds up? WhatsApp us your cost base and margin.
Quick Summary
| Item | Position |
| Who it applies to | Any international transaction with an associated enterprise |
| Usual method for captives | TNMM, net cost plus |
| Safe harbour margin, IT/ITeS, from TY 2026-27 | 15.5% of operating expenses, unified |
| Previous margins | 17% software development, 17–18% ITeS, 18% KPO, 24% contract R&D |
| Transaction limit | ₹2,000 crore, tested in the first year of the block (previously ₹300 crore) |
| Safe harbour period | Five consecutive tax years for IT services |
| Approval | Automated, rule-based, through the e-filing portal |
| Accountant’s report | Required annually with the return |
💡 TaxKitab Tip Keep the cost base separable in the ledger from day one. The margin is applied to operating costs, so the whole dispute is usually about which costs belong in the base — pass-through expenses, shareholder costs, one-off restructuring, stock compensation, costs of serving third parties rather than the parent. A chart of accounts that tags each cost as in-base or out-of-base makes the computation a report. One that does not makes it an annual reconstruction, and a reconstruction is what gets challenged.
Why Cost-Plus, and What It Means
An Indian captive serving only its parent has no third-party revenue to benchmark against. So the tested party is the Indian entity, the tested indicator is net margin on costs, and the method is the Transactional Net Margin Method.
In practice: operating cost × (1 + margin) = the charge to the parent.
Two consequences people underestimate.
The Indian entity must be profitable. A captive running at a loss, or reimbursed at cost with no mark-up, invites an adjustment. The Indian authorities will impute a margin whether or not one was charged.
The margin is on cost, not revenue. A 15% mark-up on ₹10 crore of cost is ₹1.5 crore of profit and a charge of ₹11.5 crore — which is a 13% net margin on revenue. Confusing the two is a common drafting error in intercompany agreements.
The 2026 Safe Harbour Change
Safe harbour lets a taxpayer declare a margin that the authorities will accept without audit, in exchange for giving up the right to argue for a lower one.
From tax year 2026-27, the IT and ITeS safe harbour margins were consolidated into a single 15.5% of operating expenses, covering software development, ITeS, KPO and software-related contract R&D. The earlier structure ran from 17% to 24% depending on category, so for KPO and contract R&D captives this is a meaningful reduction.
The eligible transaction limit was raised to ₹2,000 crore, tested in the first year of the block, from ₹300 crore. That brings a much larger population into scope. Approval is now automated through the e-filing portal rather than officer-driven.
The trade-off remains. Safe harbour is an election with a multi-year lock-in. You accept the prescribed margin and give up the ability to benchmark lower. For a captive whose genuine arm’s length margin is below 15.5%, safe harbour costs real tax. For one at or above it, it buys certainty cheaply.
Budget 2026 also introduced a fast-track unilateral Advance Pricing Agreement route for IT services with a shorter target timeline, which is the alternative where safe harbour does not fit.
What Actually Gets Adjusted
Rarely the headline margin. Almost always one of these.
What went into the cost base. Pass-through costs recharged without mark-up, shareholder costs that belong to the parent, one-off items, costs of work done for anyone other than the parent. Each is arguable, and each argument is won or lost on contemporaneous records.
No intercompany agreement, or one that does not match reality. An agreement describing software development while the team runs customer support is worse than no agreement. The agreement should be signed, dated before the period, and describe what actually happens.
Cost reimbursement with no margin. The single most common adjustment in this structure. If the parent reimburses costs, expect a margin to be imputed.
Documentation assembled after the fact. The requirement is contemporaneous. Papers prepared when a notice arrives carry much less weight.
Inconsistency with the group’s own words. Investor decks and annual reports describing the India team as core R&D sit badly alongside a transfer pricing file describing low-value routine support. Both sides read the same documents.
The Annual Compliance
An accountant’s report on international transactions is filed annually with the return, and transfer pricing documentation must be maintained. Under the Income-tax Act, 2025 the transfer pricing provisions sit in a renumbered series covering international transactions, arm’s length price determination and reference to the Transfer Pricing Officer, safe harbour, Advance Pricing Agreements, and documentation and the accountant’s report.
A caution on form numbers. The accountant’s report was Form 3CEB under the 1961 Act framework, and secondary sources do not yet agree on the form and section numbering under the 2025 Act and the 2026 rules. Confirm the current form and due date on the income tax portal before filing rather than from any summary, including this one.
How It Connects to the Books
Transfer pricing is a reporting problem before it is a tax problem. The computation runs off the Indian ledger, so the ledger has to carry the cost tagging, the intercompany balances have to agree to the parent’s records, and the charge has to be recognised in the same period on both sides. That structure is in two sets of books for an India subsidiary, and the wider compliance map in who files what, and where.
It also interacts with permanent establishment. A properly priced and documented captive supports the position that the parent has no PE in India; a loss-making or unpriced one undermines it — see when your India team becomes a taxable presence.
Frequently Asked Questions
Can we just reimburse costs with no margin? You can pay that way, but expect an adjustment. An Indian entity providing services to its parent generally needs an arm’s length return.
Is 15.5% our margin now? Only if you elect safe harbour and qualify. Otherwise your margin is whatever a benchmarking study supports, which may be higher or lower.
Should we take safe harbour? It buys certainty at the cost of flexibility, with a multi-year lock-in. Worth modelling against a benchmarking study before electing, not instead of one.
What if we have been doing this wrong for years? Fix the current year properly and take advice on prior years. Voluntary correction is a materially better position than an adjustment on audit.
Does transfer pricing apply if we are small? The provisions apply to international transactions with associated enterprises, without a general small-company exemption. Documentation requirements scale with value, but the arm’s length principle does not.
Does TaxKitab prepare the transfer pricing study? We maintain the books and the cost tagging the study runs on, and we work with the specialists who prepare the benchmarking and the accountant’s report. The study itself is specialist work.
References
- Income-tax Act, 2025 — transfer pricing provisions covering international transactions, arm’s length price, reference to the Transfer Pricing Officer, safe harbour, Advance Pricing Agreements, documentation and the accountant’s report
- Safe harbour margins for IT, ITeS, KPO and software-related contract R&D, unified at 15.5% of operating expenses from tax year 2026-27, with the eligible transaction limit raised to ₹2,000 crore
- Budget 2026 — fast-track unilateral Advance Pricing Agreement mechanism for IT services
⚠️ Safe harbour margins, thresholds, form numbers and section references changed with effect from 1 April 2026 and secondary sources are not yet consistent on the new numbering. Confirm against the notified rules on incometax.gov.in and with a transfer pricing specialist before electing or filing.
