15.5% transfer pricing safe harbour for IT services: what changes in 2026

Indian subsidiaries that write software, run back-office work or do research for a foreign parent have a simpler transfer pricing option from tax year 2026-27. Rule 89 of the Income-tax Rules, 2026, notified on 20 March 2026 and in force from 1 April 2026, puts software development, IT-enabled services (ITeS), knowledge process outsourcing (KPO) and software-related contract research and development (R&D) into one “information technology services” category. For an eligible entity that validly opts in, the tax department will accept the declared price if the operating profit margin is at least 15.5% of operating expense and the aggregate operating revenue of the transaction is up to ₹2,000 crore.

Under the old rules the same services needed margins of 17% to 24%, and the limit was ₹300 crore. The new option, once accepted, runs for five consecutive tax years. Alongside it, the Finance Act, 2026 fixes calendar deadlines for Transfer Pricing Officer (TPO) orders, lets returns be filed in line with an advance pricing agreement (APA) and sets a fee for a late accountant’s report. The Central Board of Direct Taxes (CBDT) also signed a record 219 APAs in FY 2025-26.

The bottom line: for a captive IT unit that carries little risk, a 15.5% margin on costs can now buy five years of certainty. The five-year lock-in, the short withdrawal window and the treatment of ESOP costs need checking first.

What changed

The IT services safe harbour

The table compares rule 10TD(2A) of the Income-tax Rules, 1962, which applied up to assessment year 2026-27, with rule 89 of the 2026 Rules, which applies for three-year blocks from tax year 2026-27 unless modified (rule 89(4)). Margins are operating profit as a percentage of operating expense.

How the new option works

• Five years. Once validly exercised, the option stays in force for five consecutive tax years (rule 91(1)). Returns for each of those years must follow the safe harbour (rule 91(8)). For each of the four years after the first, a statement of eligible transactions, their quantum and profit margins is due by the return due date (rule 91(13)).
• Filing. Form No. 49 goes electronically to the Director General of Income-tax (Systems) by the return due date under section 263(1)(c) for the first year (rule 91(3), (15) and (16)).
• Checking. Eligibility is verified electronically, with acceptance or rejection intimated within two months from the end of the month of filing. Defects can be removed before any rejection, and a rejection must give reasons (rule 91(4) to (7)).
• Withdrawal. A withdrawal declaration cannot be made after six months from the end of the first tax year. A company that withdraws cannot opt in again until the five years end (rule 91(9) to (12)).
• What still applies. Documentation under section 171 and the accountant’s report under section 172 continue (rule 89(6)). No comparability adjustment or allowance under section 165(3)(a)(ii) is made to an accepted price (rule 89(5)), and the mutual agreement procedure under a tax treaty cannot be invoked (rule 93).

Finance Act, 2026: deadlines, APA returns and report fees

APAs: a record year

A Ministry of Finance release of 31 March 2026 says the CBDT signed 219 APAs in FY 2025-26, against 174 in FY 2024-25 and 125 the year before. They include 84 bilateral APAs, up from 65, with 13 treaty partners. The total since the programme began is 1,034: 750 unilateral and 284 bilateral. The release calls safe harbour a faster, lower-cost alternative to an APA and says the APA scheme, with the safe harbour rules, aims to fix pricing methods and arm’s length prices in advance for up to five years. It credits the Finance Act 2026 with the safe harbour changes; the conditions themselves are in rules 86 to 93 of the 2026 Rules.

Who is affected

The IT services safe harbour is open to a person providing software development, ITeS, KPO or contract R&D wholly or partly relating to software development, “with insignificant risk”, to a non-resident associated enterprise, which the rules call the foreign principal (rule 87(1)(a)). Rule 86 defines each service. ITeS include back-office operations, contact centres, data processing, payroll, revenue accounting and website services. KPO includes engineering and design, business and financial analytics, and market research. None of these three includes research and development services.

The Director General of Income-tax (Systems) judges insignificant risk with regard to five factors in rule 87(2):

• the foreign principal performs most of the economically significant functions, including conceptualisation, product design and strategic direction;
• it or its group provides the capital, funds and intangibles, and the Indian entity is only paid for its work;
• the Indian entity works under the direct supervision of the foreign principal or its group, which actually controls or supervises the work;
• the Indian entity has no economically significant realised risks, and conduct prevails over the contract where they differ;
• the Indian entity has no legal or economic ownership of intangibles or research outcomes.

Who isn’t covered: transactions with an associated enterprise in a country or territory notified under section 176, or in one where the maximum rate of income-tax is less than 15% (rules 86(m) and 92); transactions whose aggregate operating revenue exceeds ₹2,000 crore in the first year; and entities that fail the insignificant-risk test.

In practice, this matters most for founder-led startups that moved their holding company abroad but kept founders and product leadership in India. Where strategy and product decisions are in fact taken in India, the conduct test in rule 87(2)(d) may count against the Indian entity, whatever the agreement says. Settle this with an adviser before filing.

How the margin is measured

Rule 86 defines the three terms.

• Operating expense is the costs incurred in the tax year in relation to the international transaction in normal operations, including costs of an Employee Stock Option Plan (ESOP) or similar stock-based compensation provided by associated enterprises to the Indian entity’s employees; reimbursements to associated enterprises at cost; amounts recovered from them at cost for expenses incurred on their behalf; and depreciation and amortisation. It excludes interest, provisions for unascertained liabilities, pre-operating expenses, foreign exchange losses, extraordinary expenses, loss on transfer of assets or investments (other than assets whose depreciation is in operating expense), income-tax and other expenses not relating to normal operations.
• Operating revenue is the revenue earned in the tax year from the transaction in normal operations, also including those ESOP or similar costs. It excludes interest income, foreign exchange gains, income on transfer of assets or investments (other than assets whose depreciation is in operating expense), income-tax refunds, provisions written back, extraordinary income and other non-operating income.
• Operating profit margin is operating profit, being operating revenue in excess of operating expense, as a percentage of operating expense.

In practice, because ESOP cost sits in both operating expense and operating revenue, profit in rupees does not change, but the base on which 15.5% is measured grows. A cost-plus rate that clears 15.5% on cash costs can fall short once the parent’s stock options are counted.

Worked example

Take an Indian subsidiary that develops software for its US parent and bills it at cost plus 16%. The figures are illustrative.

1. Add the ESOP cost to both sides. Operating expense = ₹10,00,00,000 + ₹50,00,000 = ₹10,50,00,000. Operating revenue = ₹11,60,00,000 + ₹50,00,000 = ₹12,10,00,000.
2. Operating profit = ₹12,10,00,000 − ₹10,50,00,000 = ₹1,60,00,000.
3. Margin = ₹1,60,00,000 ÷ ₹10,50,00,000 = 15.24%. Without the ESOP cost it would be 16%.
4. Minimum operating revenue at 15.5% = ₹10,50,00,000 × 1.155 = ₹12,12,75,000.
5. Shortfall = ₹12,12,75,000 − ₹12,10,00,000 = ₹2,75,000.
6. Aggregate operating revenue of ₹12,10,00,000 is far below ₹2,000 crore.

In practice, invoices of ₹11,62,75,000 for the year, or cost plus 16.275% on the ₹10 crore of other costs, would clear 15.5%. The company would also need to meet the insignificant-risk conditions, and the margin would have to hold in each of the five years.

Calculate your safe harbour margin

Enter operating revenue and operating expense as rule 86 defines them, any ESOP cost the foreign group bears for your staff, and revenue from other IT services transactions with group companies for the ₹2,000 crore test. The calculator shows your margin, whether it meets 15.5%, the extra revenue needed and where you stand against the limit.

Safe harbour or APA

In practice, safe harbour suits a low-risk captive whose margins already sit near 15.5%. A group with complex transactions, a treaty-country parent or a view that its arm’s length margin is below 15.5% may weigh an APA, at higher cost.

What to do now

1. Map your services to the rule 86 definitions and list each group company you bill, with its country.
2. Test the five insignificant-risk factors in rule 87(2) against how the business actually runs, not only the agreement.
3. Recompute the margin for tax year 2026-27 using the rule 86 definitions, with ESOP costs borne by the group on both sides; if it is short, review intercompany pricing with your adviser.
4. Decide whether to start the five-year option with tax year 2026-27 or a later year, keeping the six-month withdrawal window in mind.
5. File Form No. 49, certified by the chief executive officer or chairman and managing director, by the return due date, and track the electronic intimation.
6. Keep section 171 documentation and furnish the Form No. 48 accountant’s report at least one month before the return due date (rule 85(2)); a late report attracts the section 428 fee.
7. If you have an APA, diary the three-month window under section 169(1) and the Form No. 52 annual compliance report (rule 113).

Key dates

In practice, Form No. 49 filed in October or November 2027 for tax year 2026-27 would come after that year’s withdrawal window has closed.

What the rules don’t say yet

• The margin conditions apply for a three-tax-year block from 2026-27 (rule 89(4)), while the option runs for five tax years (rule 91(1)). The rules don’t say what happens to an existing option if the conditions are modified for the next block.
• For other transactions, rule 90(8) lets the Assessing Officer adopt the safe harbour margin when the declared price falls short. Rule 91 has no equivalent; it only requires returns in accordance with the safe harbour for each of the five years.
• Rule 91 does not say whether eligibility, including insignificant risk, can be revisited in later years if the business changes.
• The rules don’t say how ESOP or similar stock-based compensation should be valued for operating expense and operating revenue.

Frequently asked questions

Is 15.5% a mark-up on invoices or a margin on costs?

It is operating profit as a percentage of operating expense, using the rule 86 definitions. If you bill cost plus a mark-up, the mark-up must be at least 15.5% of operating expense, with group-borne ESOP costs on both sides.

Can we leave the option if our margins fall?

Only by a withdrawal declaration made within six months from the end of the first tax year. Otherwise the rules require returns in accordance with the safe harbour for all five years, and a company that withdraws cannot opt in again until the five years end.

Who can file a return after an APA is entered into?

Under the substituted section 169(1), the person who entered into the APA shall, and any other person being an associated enterprise may, furnish a return or modified return limited to the agreement within three months from the end of the month in which it was entered into. In practice, this matters where an agreement changes the income of more than one group entity that files returns in India.