VW's Skoda unit will lead the project to develop components and vehicles.
VW is looking for new markets as it recovers from its diesel emissions scandal.
Tata Motors, which is India's largest vehicle company and owns Jaguar Land Rover, is also hoping to claw back domestic market share.
They have signed a memorandum of understanding on a partnership they hope will potentially lead to Tata Motors launching new vehicles by 2019.
Guenter Butschek, chief executive and managing director, Tata Motors, has put in place a restructuring programme to help build up Tata's lost sales for passenger and commercial vehicles by improving efficiencies, cutting production delays and building economies of scale.
He said: "We strongly believe that both the companies, by working together, can leverage from each other's strengths to create synergies and develop smart innovative solutions for the Indian and overseas market."
VW is investing in self-drive vehicles and greener technology such as electric cars and would like greater familiarity with the Indian market.
Matthias MÃ¼ller, chief executive of Volkswagen AG, said: "By offering the appropriate products, we intend to achieve sustainable and profitable growth in very different parts of the world."
A previous attempt by VW to expand into emerging markets through an alliance with Suzuki Motor Corp ended in 2015, following bitter disagreements.
Carmakers are attempting to win a greater share of expanding emerging markets through the sale of budget cars, which in turn increase familiarity of their brand.
VW is still dealing with the aftermath of the company's emissions-cheating scandal which came to light in September 2015.
VW pleaded guilty to three criminal charges in the US in January this year, and would pay fines totalling $4.3bn (Â£3.5bn) to settle charges over the scandal.
In November last year Volkswagen announced plans to cut 30,000 jobs worldwide with about 23,000 of the losses to be borne in Germany.
VW and Tata have agreed to form a strategic partnership to help both companies boost economy car sales in India and emerging markets.