Captive Centre Transfer Pricing in India: Cost-Plus Markup Explained

You raised in the US or Singapore, set up an Indian subsidiary, and now most of your engineering team sits in Bengaluru building for the parent. That setup has a name, and it has a transfer pricing rulebook.

The captive centre transfer pricing question comes down to one thing: what price should your Indian company charge the foreign parent for the work it does? Get it wrong on the low side and you invite an adjustment, tax on the shortfall, interest and a penalty. This guide walks through why cost-plus is the natural answer, what belongs in the cost base, a full rupee worked example, and the choice between a benchmarked markup and the 15.5% Safe Harbour.

1 What a captive centre actually is

A captive dev centre, also called a Global Capability Centre or GCC, is an Indian company that does software development, product or support work only for its own group, usually the foreign parent that funds it. It does not sell to the open market, does not carry sales or product risk, and does not own the intellectual property it helps build. It gets paid to run a team, and that is the whole business model.

In transfer pricing terms, this profile matters more than the label. Under a FAR analysis (functions, assets, risks), a captive is a routine, low-risk contract service provider. It performs functions, uses assets the parent largely funds, and bears little entrepreneurial risk. The parent takes the upside and the downside; the captive just needs to be reliably paid for its work.

That FAR profile is why the reward is a stable markup on cost rather than a slice of group profit. A low-risk service provider that earns a modest, dependable margin is exactly what an independent contractor would accept, and the arm’s length principle asks precisely that: what would an unrelated party charge for the same work?

2 Why cost-plus TNMM is the natural method

There are five prescribed methods under Sec 165 (old Sec 92C): CUP, Resale Price Method, Cost Plus Method, TNMM and Profit Split Method. For a captive dev centre, the Transactional Net Margin Method on a cost-plus basis wins almost every time, and it is worth understanding why.

• CUP needs a near-identical third-party transaction to compare price against. Bespoke internal software work rarely has a clean public comparable, so CUP usually fails on data.
• Profit Split is for cases where both sides own valuable, unique intangibles and share the entrepreneurial risk. A captive owns neither, so splitting group profit would overpay it.
• TNMM tests the net cost-plus markup your centre earns against the markups independent service providers earn. It tolerates minor functional differences, and reliable comparables exist for Indian IT and IT-enabled services. It fits the captive’s FAR profile precisely.

The tested profit level indicator (PLI) for a captive is Operating Profit divided by Operating Cost, often written OP/OC. If independent comparables earn, say, a 14% to 16% net cost-plus margin, your centre should land inside that range. That single ratio is the heart of captive dev centre transfer pricing.

3 What goes into the cost base

Once you have chosen cost-plus, the next question decides the actual rupee number: which costs does the markup sit on? The general rule is that the base is the total operating cost of running the centre. Typical inclusions are:

• Salaries, wages and employee benefits of the delivery team and support staff.
• ESOP cost recognised in the books (handle the cross-charge carefully, see below).
• Rent, utilities and facilities for the centre.
• Software licences, cloud and infrastructure used to do the work.
• Depreciation on the centre’s own assets.
• A reasonable allocation of management and administrative overheads.

The pass-through question

Not every rupee that flows through the centre should be marked up. A genuine pass-through cost is a third-party expense the centre incurs but adds no value to, and simply recovers. Classic examples are a specialist third-party licence bought purely on the parent’s instruction, or reimbursed travel. These are billed to the parent at cost, with no markup, and excluded from the base the markup is applied to.

Marking up a pure pass-through inflates the centre’s margin artificially; hiding a value-adding cost as a pass-through understates it. Either way an auditor will unpick it, so the intercompany agreement must state clearly which costs are marked up and which pass through.

4 A full worked example

Numbers make this concrete, so here is the flagship captive setup with real rupee maths.

The mechanics never change, only the inputs. Get the cost base right, apply a defensible markup, and the invoice to the parent falls out of the arithmetic. The comparables that justify that 15% come from a benchmarking study, which we cover in the benchmarking guide.

5 Benchmarked markup versus the 15.5% Safe Harbour

You have two legitimate ways to fix the markup, and the choice is a genuine trade-off between a lower margin and certainty.

From TY 2026-27 the Safe Harbour for software development, IT-enabled services, KPO and contract software R&D is unified to a 15.5% markup on operating expenses (down from the older 17% to 24% tiers), available where the transaction value stays within the prescribed limit (about ₹2,000 crore). That limit is far above where a startup captive operates, so the route is genuinely open to you.

The honest way to decide: run the benchmarking first. If your arm’s length range clusters around 15% to 16%, the extra half a percent for Safe Harbour certainty is often worth it. If credible comparables support a materially lower margin and you are prepared to defend it, the benchmarked route keeps more profit outside India. Read the full mechanics in our Safe Harbour guide.

6 Mistake #2: setting the markup too low

This is the single most common and most expensive error I see in captive setups, so it gets its own section. The temptation is obvious: every rupee of markup is cash leaving the parent and tax paid in India, so founders quietly set the markup at a token 5% or even bill “at cost” to keep the group’s outflow down.

The problem is that a captive earning below the arm’s length range is exactly what a transfer pricing assessment is designed to catch. The department restates your margin to the benchmark, taxes the shortfall, and adds interest and a penalty. Worse, the excess profit that was allowed to sit with the parent can trigger a secondary adjustment (Sec 92CE concept): the money must be repatriated to India within the prescribed time, failing which it is treated as a deemed advance to the parent and notional interest is charged on it year after year.

7 Mistake #1: get the intercompany agreement signed first

Before any of the pricing matters, there has to be a document that says the two companies agreed to it. A surprising number of captives operate for a full year on invoices and goodwill, with no signed intercompany service agreement. In an audit, the absence of that agreement undercuts everything: your cost base, your markup, your pass-through treatment, all of it looks retrofitted.

The service agreement should be signed before the year begins and should set out the scope of services, the cost base, the markup and how it was determined, which costs pass through at cost, invoicing and payment terms, and how ESOP and other cross-charges are handled. It is the spine your entire TP position hangs from.

8 Your captive TP checklist

1. Sign an intercompany service agreement before the financial year begins, with scope, cost base, markup and pass-through rules spelt out.
2. Confirm the centre’s FAR profile is a routine, low-risk contract service provider, and adopt cost-plus TNMM with PLI = OP/OC.
3. Build the cost base from all operating costs; tag each line as marked-up or pass-through and keep the ledger through the year.
4. Fix the markup by a benchmarking study, or elect the 15.5% Safe Harbour via Form 3CEFA if certainty is worth more than the extra margin.
5. Never set a token 5% to 10% markup to please the parent; price to the arm’s length range.
6. Keep the TP study / Local File if aggregate international transactions exceed ₹1 crore (Sec 171, Rule 10D).
7. File Form 3CEB, signed by a CA, by 31 October, for the AE transaction regardless of value (Sec 172).
8. Watch the linked traps: interest-free intercompany loans and ESOP cross-charges, both of which carry their own TP consequences.

9 FAQs

Disclaimer: This article is general information as of August 2026 and is not tax or legal advice. Transfer pricing law, Safe Harbour rates, section numbering and thresholds change, and your arm’s length position depends on your own facts and comparables. Confirm your specific obligations with a qualified professional before acting.