Navigating the Transfer Pricing Issues both from Indian and German perspective, while expanding business operations into India

last updated on 16 July 2025 | reading time approx. 5 minutes

When a multinational enterprise (‘MNE’) establishes its footprint into India, its business model typically evolves in a phased manner from initial market support functions to trading, and eventually to partial or full-scale manufacturing. At each stage of this transition, the nature of intercompany transactions changes, requiring a corresponding realignment of the transfer pricing (‘TP’) policy to ensure compliance with Indian regulations.

This article outlines the typical operational phases adopted by German MNEs in India and highlights the key TP considerations at each stage. In addition, it also discusses certain nuances from a German group company’s point of view, so that expansion strategy also complies with the German TP regulations.

Phase Wise Evolution of Business Operations:

A German MNE depending upon the market strategy being developed for India can always follow a more cautious approach that typically involves following the standard phase wise market entry or it can directly enter into India with bigger presence and substantial investments. For the sake of discussion, the typical phases of a market entry into India are outlined below:

Phase 1: Initial Market Entry – Marketing and Support Services

At the outset, when a German MNE enters the Indian market, it generally incorporates a subsidiary in India to support its commercial activities in the territory. Given that the group’s products may be new to the Indian market, the Indian entity typically undertakes low-risk, non-core functions such as:

Identifying potential customers in India
Promoting the group’s products
Facilitating communications between Indian customers and the group headquarters

These activities are often categorized as marketing and support services. Since the Indian subsidiary operates in a limited risk capacity and does not undertake entrepreneurial functions, it is generally remunerated with a stable and steady operating margin.

Phase 2: Business Expansion – Starting with Distribution Activities

Once the group establishes a stronger presence and customer base in India, it often upgrades the operational profile of the Indian subsidiary to a distributor model. Under this model, the Indian entity:

Purchases finished goods from its associated enterprise
Imports and holds inventory
Undertakes sales to Indian customers on its own account

The Indian subsidiary, therefore, assumes more functions and certain market risks, including credit risk, inventory risk, and marketing risk. The pricing policy in this stage usually reflects the increased functions and risks by granting the Indian subsidiary a gross margin over its resale revenue.

Phase 3: Advanced Stage – Local Assembly and Manufacturing Activities

With a growing market presence and rising demand, the group may eventually decide to localize part of its manufacturing or assembly operations in India. This strategic decision is often driven by the need to reduce import duties, optimizing costs through local value addition and access to India’s skilled and cost-effective labour pool.

Under this phase, the Indian subsidiary starts performing core business functions such as:

Assembling or manufacturing group products
Sourcing raw materials or semi-finished goods, nearby increasing localization
Quality control and local vendor management

However, it is important to note that while the Indian subsidiary undertakes manufacturing activities, ownership of intellectual property (IP), including product design, Research & Development, brand intangibles, and technical know-how typically remains with the overseas group entity. Accordingly, the group company may license such intangibles to the Indian subsidiary company, for which it charges a royalty or license fee.

Critical transfer pricing issues to be addressed from Indian perspective:

The transition from a distribution to a manufacturing model or straight away initiating with manufacturing activities marks a significant shift in the value chain. At this point, it is crucial for the group to reassess its TP policy, particularly with respect to:’

Properly evaluating change in functions, assets, and risks (FAR) profile: With a gradual shift in business model, the functional profile of the Indian entity for relevant for the TP analysis also changes significantly. Thus, a comprehensive FAR analysis is essential to establish appropriate functional characterization of the Indian entity and associated enterprises.
Entering into new intercompany agreements and determining arm’s length price: The change in business model will bring on the existence of new intercompany transactions, that's also highlighted in previous paras. This will necessitate determining the arm’s length price/ remuneration for each such intercompany transaction.
Revisiting import pricing of components and materials: For instance, once the Indian subsidiary transitions from a distribution model to undertaking manufacturing or assembly functions, the original pricing mechanism used during the trading phase may no longer be appropriate. In distribution, goods are typically imported at a finished-product price. However, in a manufacturing setup, the subsidiary imports same components or semi-finished goods, and then adds value through assembly or processing, and then sells the finished product. It is critical to revisit and adjust the pricing policy at this stage.
Alignment of transfer prices with Indian custom regulations and assessing the impact: Any possible reduction of the past transfer prices a particular product or charging of license fees for IPs may lead to certain consequences under declarations already made by the Indian entity from an Indian customs perspective. Thus, it is important that a proper analysis is undertaken to evaluate the changes and the possible justifications or the reasons that can be documented, including conducting an impact analysis of associated costs that may arise if any adverse stand is taken by the Indian customs authorities vis-à-vis by Indian tax authorities through TP adjustments.

Critical transfer pricing issues to be addressed from German perspective:

The commencement and expansion of functions in- or outbound does not necessarily trigger a relocation of functions / business restructuring in the German tax sense. There are various prerequisites for this.

A prerequisite for a business restructuring is a function being transferred or ceded to a foreign company together with the business opportunities, risks and intangible assets or other benefits attached to it. A restriction of the function at the transferring company is no longer necessary following the changes of the German Foreign Tax Act (AStG). Both the transfer of a function (e.g. founding a new production company) and the expansion of existing functions (e.g. taking up assembly, service business, sales) of the receiving company can lead to a business restructuring under certain circumstances.

The result of a business restructuring is the sale of the function together with the associated business opportunities, risks and assets or other benefits as a so-called transfer package. In order to avoid a transfer package valuation and thus the sale of intangible assets with the disclosure of hidden reserves, there is still one of three escape clauses remaining following the amendment to Section 1 para. 3b AStG. This requires that neither intangible assets nor other benefits were the subject of the business restructuring. According to law, such a constellation exists if the acquiring company performs the function exclusively for the transferring company and is remunerated on the basis of the cost-plus method.

In our opinion, the option of licensing the whole transfer package or parts of the transfer package instead of a sale is still possible as part of an arrangement predating the business restructuring.

Conclusion:

The transformation of a German MNEs Indian operations, typically from a marketing support provider to a full-fledged manufacturing setup demands a carefully structured TP policy. As the business expands and the Indian entity undertakes more significant functions, the pricing mechanisms must be continuously reviewed and updated to align with German and Indian tax regulations.

There is no single, universally applicable approach to structuring such arrangements. Each transition phase brings new considerations, and the arm’s length principle is required to be applied considering the specific functions, assets, and risks of each party involved.

A robust TP strategy, backed by appropriate documentation and benchmarking, not only would ensure compliance but would also reduce associated TP risks, which will eventually ensure the sustainable growth for the German MNE in the Indian market.