Start with the transaction and the tested party
Under Section 92C(1)(e) and Rule 10B(1)(e) of the legacy law, the transactional net margin method (TNMM) compares net margins from the controlled and comparable uncontrolled transactions against the same appropriate base. It is one of the prescribed methods. The choice depends on the transaction, available data, comparability and reliability of adjustments. Product differences can matter if they affect the margin. For tax years governed by the Income-tax Act, 2025, see Section 165 and Rules 79 and 81 of the Income-tax Rules, 2026; Section 536 governs the transition.
Select a tested party whose transaction margin and comparable data can be analysed reliably, considering functions, assets and risks. It need not be the Indian party in every case. Choose an economically relevant profit level indicator and use the same accounting perimeter for the tested and comparable transactions. Operating profit over operating cost (OP/OC), sales (OP/sales) and relevant assets are possible bases. Document the classification of pass-through costs, finance income or expense, unusual costs and other items; their treatment depends on the pricing facts and comparability, not a universal exclusion list.
Build a reproducible search
Commercial databases such as CMIE Prowess and Capitaline can help identify candidates. No rule prescribes either product or requires two databases. Record the source, version or search date, classifications, query and exports. Verify audited financial data, relevant segment accounts and related-party notes against the underlying disclosures. Geography matters when it changes economic conditions; a database’s brand or country of origin does not by itself establish comparability.
| Screen | How to use it | What to retain |
|---|---|---|
| Data and financial year | Start with the applicable period. If year-ends differ, assess whether reliable aligned data can be assembled. | Source dates, segment data and the period bridge. |
| Turnover | A documented scale screen such as one-tenth to ten times turnover may be a starting point where scale matters. It is not a statutory cutoff. | Rationale, consistent application and sensitivity to the bounds. |
| Related-party transactions | A sample ceiling such as 25%, or 10% in a justified narrower search, tests independence. Define numerator and denominator consistently. | Annual report notes and calculation; independent segment evidence if available. |
| Service mix and exports | A 75% service or export screen can be tested if it addresses relevant economics. Neither is universally required. | Functional and market rationale and exact computation. |
| Losses and exceptional events | Investigate the reason for losses, restructuring and unusual margins. A three-year loss screen is a practical choice, not law. | Evidence that the event affects comparability and whether a reliable adjustment is possible. |
| Functions, assets and risks | Review product IP, brand, onsite and offshore activities, delivery model, and segment separation. | Accept/reject reasons for each serious candidate and why a segment is or is not usable. |
Under Rule 10B(2)–(3), consider the transaction features, functions, assets and risks, contractual terms and market conditions. A material difference can be addressed only if a reasonably accurate adjustment is possible. A large company, a high margin or a diversified business is a signal to investigate the relevant segment and conditions. It is not an automatic result.
Use the correct dataset and range
Rule 10B(4)–(5) and Rule 10CA govern the relevant years and dataset. Start with current-year data. For the specified methods, if current-year information is unavailable at filing, the immediately preceding year may be used subject to the statutory test. When current-year data becomes available in assessment proceedings, consider it as required. Combine current-year and preceding-year comparable observations only where the rule’s comparability and availability conditions are met; do not average every company over three years by default. For TNMM use the relevant denominator as the weight, such as operating costs when the margin is OP/OC.
| Dataset position | Rule 10CA treatment |
|---|---|
| At least six eligible entries and an eligible method | For CUP, resale price, cost plus or TNMM, construct the 35th to 65th percentile range. A price in range is accepted; a price outside is compared with the dataset median. |
| Range rule does not apply | Use the arithmetic mean under Rule 10CA(7). Check the applicable notified price tolerance for the assessment year and transaction. This is measured against the actual transaction price, not the profit-margin percentage or a standard deduction. For AY 2025–26, Notification 157/2025 specifies 1% for defined wholesale trading and 3% for other cases. |
Sort the valid entries from low to high. Multiply the number of entries by 35%, 65% and 50%. If the product is not an integer, use the next higher rank. If it is an integer, average the entry at that rank and the next one. Apply the resulting margin to the proper base to derive the price. The threshold is the number of valid dataset entries, not the number of raw company-year observations.
Working capital: align the adjustment with the profit indicator
Assess whether differences in trade receivables, inventory and trade payables materially affect the comparison. Use representative balances, preferably averages when available and meaningful, and a supported rate appropriate to the market, currency and period. Neither Rule 10B nor TNMM prescribes SBI PLR or MCLR for every adjustment. Use the same denominator as the profit indicator and document the sign convention. In the simplified model below, the comparable margin is reduced by the difference between its working capital ratio and the tested party’s ratio, multiplied by the assumed financing rate. This normalises the comparable toward the tested party’s working capital level.
Six worked examples
The companies and data below are illustrative. All examples with historical filing periods use the applicable legacy rules.
1. Range from nine valid entries
| Rank | Illustrative weighted OP/OC margin |
|---|---|
| 1 | 8.20% |
| 2 | 9.50% |
| 3 | 11% |
| 4 | 12.80% |
| 5 | 14% |
| 6 | 15.50% |
| 7 | 17.20% |
| 8 | 18.50% |
| 9 | 21% |
With nine eligible entries the 35%, 65% and 50% rank products are 3.15, 5.85 and 4.50. Ranks 4, 6 and 5 give 12.80%, 15.50% and 14.00%, respectively. On a common cost base, Dynatech’s FY 2024–25 margin of 13.50% corresponds to a price within range. No pricing adjustment arises on these assumptions.
2. Margin below the range
With the same dataset and ₹50 crore of operating cost, an actual margin of 11.50% gives ₹5.75 crore of profit and ₹55.75 crore of revenue. Applying the 14% median gives ₹7 crore of profit and a ₹57 crore price. The illustrated adjustment is ₹1.25 crore. At a 25.168% effective Section 115BAA rate the incremental tax is ₹31,46,000. The amount exceeds the historical ₹1 crore threshold, but the separate secondary adjustment analysis still requires a Section 92CE trigger and applicable repatriation dates.
3. Working capital adjustment for a cost-based indicator
| Measure in crore unless stated | Orion, tested party | TargetSys, comparable |
|---|---|---|
| Operating sales | ₹112 | ₹150 |
| Operating cost | ₹100 | About ₹130.4348 |
| Unadjusted OP/OC | 12% | 15% |
| Trade receivables | ₹14 | ₹37.50 |
| Inventory | Nil | Nil |
| Trade payables | ₹5.60 | ₹7.50 |
| Net operating working capital | ₹8.40 | ₹30 |
| Net working capital / operating cost | 8.40% | 23.00% |
At an assumed 10% annual rate, the 14.60 percentage-point working capital ratio difference gives a 1.46 percentage-point adjustment. The comparable’s adjusted OP/OC is 15% − 1.46% = 13.54%. As a separate cross-check, receivables correspond to about 46 and 91 days of sales; payables days need relevant purchase or cost data. Dividing working capital by sales would give 7.50% and 20.00%, but those ratios cannot simply be subtracted from a cost-based margin. One adjusted comparable alone does not establish the final range.
4. Large proposed comparables
Global BPO has ₹35 crore of turnover and an 11.50% margin. In a hypothetical dispute, two proposed comparables have turnover of ₹4,500 crore and ₹80,000 crore (about 128.57 and 2,285.71 times the tested entity’s turnover) and margins of 24.50% and 22%. An assumed proposed ₹4.20 crore adjustment is given, not derived from those two margins alone. Review actual segment functions, brand and intangibles, onsite and offshore delivery, and the effect of scale before deciding whether to include them. Agnity India Technologies and Pentair Water illustrate fact-specific review of comparability; they do not prescribe a universal ten-times turnover ceiling.
5. Related-party share exceeds the chosen screen
Two possible comparables show margins of 8.50% and 22.50%. The second reports ₹28 crore of related-party sales and ₹100 crore of total sales, giving 28%. A consistent 25% sales-based screen would exclude it on the stated data unless a reliable independent segment and the search rationale support a different treatment. The 25% screen is an analytical choice, not a statutory disqualification. The Quark Systems principle, discussed by the Tribunal in Xansa India, concerns the ability to object to an unsuitable comparable even after originally selecting it; it does not set a universal RPT percentage.
6. Capacity and segment evidence
Assume Precision Auto’s export line operated at 35% capacity for six months while its domestic line operated at 85%. Isolate the export segment, check how the alleged logistics disruption affected utilisation, and distinguish recurring overhead from an exceptional cost. At ₹54 crore cost and ₹57.672 crore revenue the starting OP/OC is 6.80%. If, and only if, evidence supports a ₹3.50 crore comparability adjustment on a consistent basis, an illustrative cost-base sensitivity is ₹50.50 crore and profit ₹7.172 crore, yielding about 14.20%. An overhead is not automatically non-operating, and the sensitivity does not establish acceptance or a range.
Document and review
Keep the transaction map and functional analysis, dated database evidence, screening log, statutory year selection, calculation worksheets, source disclosures and a sensitivity analysis for each material adjustment. Make the documentation contemporaneous as required and reconcile it to Form 3CEB for legacy periods or the applicable report for the new regime. Review any new proposed comparable against disclosed evidence and the statutory criteria; request the material needed to respond.
Frequently asked questions
Can a dataset contain single-year observations?
Yes, where the applicable data and comparability conditions lead to that result. Document year selection and update the analysis if relevant current-year data becomes available.
Is a 45% margin automatically excluded?
No. Investigate what drives it. The percentile rule changes the range endpoints, but every included entry must still be supported as comparable.
Can a limited-risk taxpayer seek a risk adjustment?
Yes, where a material difference is demonstrated and can be adjusted reasonably accurately. Do not infer a standard percentage or presume a particular model is mandatory.
Can the TPO introduce new comparables?
The TPO can examine different comparables. Ask for the basis and relevant material and test it against the law and facts; the taxpayer’s chosen thresholds are not binding by themselves.
How do OP/OC and OP/sales differ?
They use different denominators. Use the base that best fits the facts and compute tested and comparable margins and any adjustments consistently.
Can an overseas database be used?
Yes, if the data are reliable and economically comparable. Document geography, market conditions and how the source supports the selection.
Sources
- Income-tax Act, 1961: sections 92C, 92CA, 92CE, 92D and 115BAA
- CBDT Notification 83/2015: Rules 10B and 10CA and statutory illustrations
- Income Tax Department: transfer pricing and comparability guidance
- Income-tax Act, 2025: sections 165 and 536
- Notified Income-tax Rules, 2026: methods, comparability and dataset rules
- Delhi High Court: CIT v Agnity India Technologies, ITA 1204/2011
- Bombay High Court: CIT v Pentair Water India, Tax Appeal 18/2015
- CBDT Notification 157/2025: AY 2025–26 price tolerance
- OECD Transfer Pricing Guidelines 2022: Chapter III annex on working capital, as guidance
- ITAT: Xansa India discussion of the Quark Systems comparability objection