Cost Plus Method (CPM)

What Is the Cost Plus Method?

The Cost Plus Method (CPM) is one of six transfer pricing methods recognised under Indian law for testing whether a cross-border transaction between related companies is priced at arm's length. It works from the cost side rather than the price side: it starts with what it actually cost the Indian company to make the goods or deliver the service, then adds a mark-up that comparable, unrelated companies earn on similar work. The resulting cost-plus-mark-up figure is treated as the arm's length price for the transaction.

CPM sits alongside the Comparable Uncontrolled Price (CUP) method, the Resale Price Method (RPM), the Profit Split Method (PSM), and the Transactional Net Margin Method (TNMM) as one of the specified methods under section 165(1)(c) of the Income-tax Act, 2025 (section 92C(1)(c) of the Income-tax Act, 1961). For a full comparison of all the methods, see arm's length pricing.

Legal Basis

Section 165 of the Income-tax Act, 2025 (Section 92C of the Income-tax Act, 1961)

Section 165(1) requires the arm's length price of an international transaction or a specified domestic transaction to be determined by the "most appropriate method" out of: comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method, or such other method as the Central Board of Direct Taxes may prescribe. The method is not a free choice — section 165(2)(a) requires it to be selected having regard to the nature of the transaction, the class of transaction, the class of associated enterprise, the functions performed by those enterprises, and such other relevant factors as the Board may prescribe.

A specified domestic transaction is only tested under this chapter where the aggregate of such transactions in the tax year exceeds ₹20 crore, under section 164 of the Income-tax Act, 2025.

Section 165(3) allows a small tolerance between the price computed under the most appropriate method and the price actually charged: where only one price is determined by the method, the transaction is accepted if the variation does not exceed a percentage — capped by the Act at 3% of the transacted price — that the Central Government notifies for that year. Notification No. 157/2025 dated 6 November 2025 (S.O. 5053(E)) sets that percentage for assessment year 2025-26 at one per cent for wholesale trading and three per cent in all other cases. This tolerance band, not a hard equality test, is what taxpayers using CPM are actually measured against.

Rule 79(1)(c) of the Income-tax Rules, 2026 — How CPM Is Computed

Rule 79 of the Income-tax Rules, 2026 (Rule 10B of the Income-tax Rules, 1962) lays down the computational mechanics for each method named in section 165(1). For the cost plus method, Rule 79(1)(c) works in five steps: the direct and indirect costs of production incurred by the enterprise on the property transferred or the services provided to its associated enterprise are determined; the normal gross profit mark-up on such costs, "computed according to the same accounting norms", arising on the same or similar property or services in a comparable uncontrolled transaction is determined; that mark-up is adjusted for functional and other differences between the controlled and uncontrolled transactions that could materially affect the mark-up in the open market; the costs are increased by the adjusted mark-up; and the sum so arrived at is taken to be the arm's length price. For a tax year beginning before 1 April 2026, section 536(2)(c) of the Income-tax Act, 2025 keeps proceedings running under the repealed Income-tax Act, 1961, so the equivalent Rule 10B(1)(c) of the 1962 Rules is the text that applies to those years.

How the Cost Plus Method Works, Step by Step

1. Establish the cost base. Total the direct costs (materials, direct labour) and indirect costs (production overheads, quality control, factory-level administration) actually incurred in producing the goods or performing the service for the associated enterprise.
2. Find a comparable mark-up. Identify the normal gross profit mark-up on cost, computed according to the same accounting norms, that an independent party would earn for functionally comparable work — either from the Indian company's own transactions with unrelated customers (an internal comparable) or from unrelated companies performing similar functions (an external comparable).
3. Adjust for differences. Where the controlled and uncontrolled transactions differ in the functions performed, the risks carried, contract terms, or accounting treatment of costs, the comparable mark-up is adjusted so the comparison is like-for-like.
4. Apply the mark-up to the enterprise's own costs. The adjusted mark-up percentage is applied to the enterprise's direct and indirect costs, producing the arm's length price for the transaction.
5. Compare to the price actually charged. If the price actually invoiced falls within the tolerance band notified under section 165(3), the transaction is accepted as reported; if not, the Assessing Officer or Transfer Pricing Officer can substitute the computed arm's length price.

When CPM Is the Most Appropriate Method

CPM is best suited to transactions where the Indian entity performs routine, cost-driven functions and does not carry significant entrepreneurial risk or own valuable intangibles. It is the method most commonly applied to:

• Contract manufacturing — an Indian factory makes goods to the specifications of, and sells them back to, its foreign parent or group affiliate.
• Contract or captive research and development — an Indian R&D centre performs development work for a foreign principal that owns the resulting intellectual property.
• Shared services and back-office support — an Indian entity provides accounting, IT, or administrative services to group companies on a cost basis.
• Tolling and job-work arrangements — an Indian unit processes materials supplied by an associated enterprise for a processing fee.

CPM is generally not appropriate where the Indian entity bears substantial market or product risk, owns unique intangibles, or where reliable cost accounting data for comparable companies is not available — in those situations TNMM or the profit split method is more commonly used instead.

Compliance Requirements Tied to CPM

Choosing CPM as the most appropriate method carries the same compliance obligations as any other transfer pricing method:

• Contemporaneous documentation under section 171 of the Income-tax Act, 2025 (section 92D of the Income-tax Act, 1961) — the taxpayer must maintain records showing why CPM was selected, how the cost base was computed, and how the comparable mark-up was benchmarked. See transfer pricing documentation.
• Form 48 (formerly Form 3CEB), the accountant's report under section 172 of the Income-tax Act, 2025 (section 92E of the Income-tax Act, 1961), prescribed by Rule 85 of the Income-tax Rules, 2026 and furnished at least one month before the due date for the return of income under section 263(1)(c), certifying the international transactions entered into and the method applied to each.
• Reference to the Transfer Pricing Officer under section 166 of the Income-tax Act, 2025 (section 92CA of the Income-tax Act, 1961) — the Assessing Officer may refer a case to a Transfer Pricing Officer, who can re-examine the cost base, the comparables used, and the adjustments made, and substitute their own arm's length price.
• Where a foreign group prefers certainty over an annual benchmarking exercise, an Advance Pricing Agreement can fix the CPM mark-up (or another method) for a block of future years.

Why CPM Matters for Foreign Companies and Investors

Many foreign groups set up their Indian operation specifically as a low-risk contract manufacturer, contract R&D centre, or shared-services hub — precisely the profile CPM is designed to test. Getting the mark-up wrong has two costs. First, if the Transfer Pricing Officer substitutes a higher arm's length mark-up, the Indian company's taxable income is increased by the difference, and that increase is taxed at the ordinary corporate rate with no offsetting deduction — section 165(7) expressly bars any Chapter VIII deduction against the enhanced income. Second, a primary adjustment of one crore rupees or more triggers a secondary adjustment under section 170 of the Income-tax Act, 2025 (section 92CE of the Income-tax Act, 1961), which requires the excess money left with the associated enterprise to be repatriated to India within the prescribed time or treated as a deemed advance carrying interest. Because the comparable mark-up is a matter of judgment — which comparables are selected, and which adjustments are made — CPM benchmarking is one of the more frequently disputed areas of Indian transfer pricing audit.

Practical Example

Nordholm Components AB, a Swedish auto-parts manufacturer, sets up an Indian subsidiary to manufacture a sub-assembly exclusively for Nordholm's own use, bearing no market risk and holding no marketing intangibles. In a tax year, the Indian subsidiary incurs direct and indirect production costs of ₹40 crore. Benchmarking against unrelated contract manufacturers performing comparable functions shows a normal gross profit mark-up of 10% on cost for this type of work. Applying CPM: arm's length price = ₹40 crore direct and indirect costs + 10% mark-up = ₹44 crore. If Nordholm's Indian subsidiary actually invoices the parent ₹44 crore or a price within the tolerance band notified under section 165(3) of that figure, the transaction is accepted as reported. If it invoices only ₹41 crore, the ₹3 crore shortfall is 7.3% of the price actually charged, far outside the notified tolerance, and the Transfer Pricing Officer can bring that ₹3 crore into the subsidiary's taxable income, computed under section 165(6).

Common Mistakes

• Using an unadjusted external mark-up. Benchmarked companies rarely match the tested party's functions and risks exactly; failing to adjust the comparable mark-up for those differences is a frequent audit finding.
• Excluding indirect costs from the cost base. Leaving out production overheads or quality-control costs understates the base to which the mark-up is applied, and understates the resulting arm's length price.
• Applying CPM to a full-risk-bearing entity. If the Indian entity actually carries market risk, holds inventory risk, or owns intangibles, CPM's cost-based logic does not fit the facts, and the method itself becomes vulnerable to challenge regardless of how carefully it is computed.
• Treating the 3% tolerance as an entitlement rather than a notified figure. The tolerance band under section 165(3) is capped at 3% but is set by annual notification, and the notification in force for assessment year 2025-26 allows only one per cent for wholesale trading.

Frequently Asked Questions

Is the Cost Plus Method the same as cost-plus pricing in a commercial contract?

No. Commercial cost-plus pricing is a contractual pricing mechanism agreed between parties. CPM under section 165 of the Income-tax Act, 2025 (section 92C of the Income-tax Act, 1961) is a tax-law test applied after the fact to check whether the price actually charged between related parties matches what unrelated parties would have agreed for comparable work.

Who decides which transfer pricing method a company must use?

The taxpayer selects the most appropriate method under section 165(2), having regard to the nature of the transaction and the functions, assets, and risks involved, and documents that selection contemporaneously. The Assessing Officer or Transfer Pricing Officer can later disagree and apply a different method or recompute the same method differently.

What kind of Indian operations typically use CPM?

Contract manufacturers, contract or captive R&D centres, and shared-services or back-office units that perform routine functions for a foreign parent without bearing significant market risk or owning valuable intangibles typically test their pricing using CPM.

What happens if the Transfer Pricing Officer disagrees with the mark-up used?

Under section 166, the matter can be referred to the Transfer Pricing Officer, who can substitute their own comparable mark-up and arm's length price after giving the taxpayer an opportunity to respond. Any resulting addition to income is taxed under section 165(6), with no offsetting deduction permitted under section 165(7).

Can a company lock in its Cost Plus Method mark-up for future years?

Yes. An Advance Pricing Agreement with the Central Board of Direct Taxes can fix the methodology, and often the mark-up itself, for the international transaction for a block of future years, reducing the risk of an annual dispute over comparables.

See also: transfer pricing, arm's length pricing, and transfer pricing documentation.

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