How to Choose the Right Profit Level Indicator (PLI) in Indian Transfer Pricing: Operating Margin, Cost Plus or Berry Ratio
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With the transfer pricing report for FY 2025-26 due on 31 October 2026, the choice of profit level indicator (PLI) is back on the table for many finance teams and CAs. It also matters more than before. The Income Tax Department's March 2026 brochure on Form 48 says the new form asks specifically for details of margins and comparables (brochure). The PLI is where those margins come from, so a poorly chosen one now shows up directly in the filing.
Quick answer
A PLI is the ratio used to test whether a related-party transaction is at arm's length under the transactional net margin method (TNMM). The right one depends on what the tested party actually does, which financial base is least distorted by the controlled transaction, and whether the comparable companies publish the data needed to compute the same ratio reliably.
The legal basis in India
Rule 10B(1)(e) of the Income-tax Rules, 1962 allows the net profit margin to be computed in relation to costs, sales, assets, or any other relevant base. The rule does not prescribe one PLI for all cases. Where the range concept applies, the arm's length range runs from the 35th to the 65th percentile of the comparable results (Rule 10CA). For FY 2025-26 the 1962 Rules continue to apply, and the Income-tax Rules, 2026 renumber these provisions, so check the new rule numbers when you start working on tax year 2026-27.
The common PLIs and what each one measures
- Operating profit to sales (operating margin). Measures profit against revenue. It suits entities such as distributors where revenue is a meaningful, undistorted base.
- Operating profit to operating cost (net cost plus mark-up). Measures profit against the cost base. It suits contract manufacturers and service providers, where costs are more stable than revenue.
- Berry ratio (gross profit to operating expenses). Measures the return on the entity's own operating expenses and ignores the cost of goods sold. It suits limited cases, covered below.
- Return on assets or capital employed. Suits capital-intensive businesses, where profit is better linked to the assets deployed.
Each ratio answers a different question. The choice is really about which relationship best isolates the value the tested party itself adds.
A four-step way to choose
Step 1: Start from the function, not the industry
A limited-risk distributor, a contract manufacturer, and a support-service provider can all sit in the same industry and still need different PLIs. A contract manufacturer working to a customer's specification usually fits operating profit to operating cost. A distributor that carries brand investment and market risk may not fit a simple margin test at all and may point toward a different method.
Step 2: Check whether the financial base is distorted
Before fixing the PLI, ask whether the base is affected by items unrelated to the controlled transaction. Does revenue include pass-through items such as freight recharges? Does the cost base include one-off charges like impairments or restructuring costs? Has an acquisition or disposal made the asset base unreliable this year? A suitable ratio can still mislead if the figures behind it have not been cleaned.
Step 3: Confirm the comparables can support the same PLI
A PLI is only as good as the data available for the comparable set. Gross profit, for example, is not always disclosed in a form that supports a reliable Berry ratio across companies drawn from public filings. Check data availability before committing, and accept a less theoretically pure PLI if it can be computed consistently across the set. Record the trade-off.
Step 4: Document the reasoning
The file should explain why the PLI was chosen, not just state the result. It should show the tested party and why it was selected, the PLIs considered and why each was kept or rejected, the exact financial base with any adjustments, and confirmation that the comparables support the same ratio.
What Indian courts and tribunals have said on the Berry ratio
The Berry ratio is the PLI that attracts the most disputes, and the decisions are worth knowing:
- The Delhi High Court, in Sumitomo Corporation India Pvt. Ltd., held that the Berry ratio can be applied only where the value of the goods is not directly linked to the quantum of profits and profits depend mainly on the expenses incurred. It pointed to stripped-down distributors with no financial exposure or risk in the goods as an example (KPMG flash news).
- In Mitsui & Co. India Pvt. Ltd. (ITAT Delhi, August 2015), the Tribunal dealt with an entity providing support services to group trading companies that had used the Berry ratio. It held that the support-service transactions could not be treated as trading transactions (report).
- In Marubeni-Itochu Steel India Pvt. Ltd. (ITAT Delhi), the Tribunal upheld use of the Berry ratio, rejecting the argument that Rule 10B(1)(e)(i) does not permit it. It accepted that the ratio is suitable only where current assets are not significant, and found the tax officer had not shown that they were (PwC alert).
The common thread is that the Berry ratio is not wrong in itself, but it is accepted only where the facts fit: limited risk, pass-through goods, and profits driven by the entity's own costs.
A worked illustration (hypothetical figures)
Take a limited-risk distributor with revenue of ₹200 crore, cost of goods sold of ₹170 crore (mostly the principal's product cost passed through), operating expenses of ₹24 crore, and operating profit of ₹6 crore.
- Operating margin: 6 / 200 = 3.0%.
- Operating profit to operating cost: 6 / (170 + 24) = 3.1%.
- Berry ratio: (200 − 170) / 24 = 1.25.
The first two figures are almost identical because the pass-through cost of goods dominates both revenue and total cost. Neither does much to isolate what the distributor itself contributes. The Berry ratio strips out the cost of goods and measures profit only against the entity's own expenses, which can be a cleaner measure for this entity. Whether it is usable still depends on Step 3: if the comparable distributors do not disclose gross profit consistently, and given the court decisions above, operating margin or cost plus may remain the more practical choice.
Common mistakes
- Using operating margin for every distributor without checking for pass-through revenue.
- Switching PLI from year to year without explanation, which raises the question of whether the change was results-driven.
- Choosing a PLI the tested party's own data supports without checking that the comparables' data does too.
- Discovering during benchmarking that the chosen PLI cannot be computed consistently for the candidate companies.
- Applying the Berry ratio to an entity that holds significant inventory, receivables, or other current assets.
Frequently asked questions
Is there one PLI that India requires?
No. Rule 10B(1)(e) allows margins to be measured against costs, sales, assets, or another relevant base, so the choice must fit the facts.
When is the Berry ratio appropriate?
Mainly where the cost of goods is a pass-through, the entity has limited risk in the goods, and its profits depend chiefly on its own operating expenses.
Can the PLI change from year to year?
Yes, if the entity's function or the available data has genuinely changed. Any change should be explained in the file.
Conclusion
A PLI is a measurement choice, and a defensible file shows why it was chosen. With Form 48 asking for margins and comparables, the reasoning behind the PLI is now closer to the surface than it was. Choose from the function, test the base for distortions, confirm the data, and write down why.
