Export-oriented captive manufacturing units in India face significant transfer pricing compliance obligations under the Direct Tax Code (DTC) 2025. Transactions between the captive unit and its overseas parent or group companies must be priced at arm's length and properly documented. This guide analyses the transfer pricing implications for export-oriented captive manufacturing units.
The Transfer Pricing Framework
Section 161 — The Arm's Length Principle
Section 161(1) requires that "Any income arising from an international transaction or a specified domestic transaction shall be determined having regard to the arm's length price". Section 161(2) extends this to "Any allowance for any expense or interest".
Section 162 — Associated Enterprise
The captive unit and the overseas parent become associated enterprises (AEs) under Section 162 when:
- The parent holds, directly or indirectly, shares carrying not less than 26% of the voting power in the captive unit
- The parent participates in the management or control or capital of the captive unit
- The parent has the power to appoint more than half of the board of directors
Section 163 — International Transaction
The export of goods or services by the captive unit to its overseas parent or group companies constitutes an international transaction under Section 163.
Common Captive Manufacturing Transactions
1. Export of Manufactured Goods
- Supply of finished goods to overseas parent
- Supply of components to overseas group companies
- Export of products under the group's brand
2. Toll Manufacturing
- Manufacturing on behalf of the overseas parent
- Using raw materials supplied by the parent
- Providing manufacturing services
3. Contract Manufacturing
- Manufacturing products under contract
- Following specifications provided by the parent
- Providing manufacturing services
4. Research and Development
- Product development for the parent
- Process improvement for the parent
- Testing and quality assurance
5. Shared Services
- Shared procurement
- Shared logistics
- Shared quality control
Determination of Arm's Length Price
Applicable Methods
Section 165(1) prescribes six methods. For captive manufacturing, the most appropriate method is typically:
1. Transactional Net Margin Method (TNMM): Compares the net profit margin of the captive unit with that of comparable independent enterprises. This is the most widely used method for contract manufacturing.
2. Cost Plus Method: Compares the markup on costs of the captive unit with that of comparable independent enterprises.
3. Comparable Uncontrolled Price Method (CUP): Compares the price charged in the controlled transaction with the price charged in comparable uncontrolled transactions.
Transfer Pricing Scrutiny
Transfer pricing disputes in India within the realm of contract manufacturing have been mostly confined to the determination of an appropriate cost base and the corresponding arm's length mark-up to be applied to such cost base.
Functional Analysis
- Functions: Manufacturing, quality control, procurement, logistics, administration
- Assets: Plant and machinery, intellectual property, brand, reputation
- Risks: Market risk, operational risk, key person risk, inventory risk
Documentation Requirements
Section 171 — Maintenance of Information and Documents
Rule 84(1) prescribes the information and documents to be maintained:
- Description of the ownership structure
- Profile of the multinational group
- Description of the business and industry
- Nature and terms of the international transaction
- Functional analysis
- Method selection and application
Rule 84(2) — Threshold
If the aggregate value of international transactions does not exceed ₹1 crore, the documentation requirements shall not apply.
Section 172 — Report from an Accountant
Every person who has entered into an international transaction or specified domestic transaction shall obtain a report from an accountant and furnish it on or before the specified date.
Special Considerations for Export-Oriented Units
1. Export Incentives
- Duty drawback
- Merchandise Exports from India Scheme (MEIS)
- Service Exports from India Scheme (SEIS)
- These incentives may affect the transfer pricing analysis
2. Foreign Exchange Rates
- Export income is denominated in foreign currency
- Exchange rates affect the transfer pricing computation
- Hedging strategies may need to be considered
3. Customs Valuation
- Customs valuation may be different from transfer pricing
- The arm's length price for customs may affect the transfer pricing analysis
- Consistency is desirable
4. Safe Harbour Rules
- For auto components: Safe harbour margins of 12% (core) and 8.5% (non-core)
- The 90% OEM sales test must be met
- For IT services: Safe harbour margin of 15.5%
Practical Compliance
1. Conduct Transfer Pricing Study
- Conduct a functional analysis
- Identify comparables
- Determine the arm's length price
- Document the analysis
2. Maintain Robust Documentation
- Maintain contemporaneous documentation
- Ensure documentation is complete and accurate
- Retain documentation for nine years
3. Consider Safe Harbour
- If the unit manufactures auto components, consider the safe harbour rules
- If the unit provides IT services, consider the IT services safe harbour
4. File Report
- Obtain a report from an accountant
- File the report on or before the specified date
5. Monitor Compliance
- Regularly monitor compliance with transfer pricing rules
- Update documentation as necessary
Consequences of Non-Compliance
Transfer Pricing Adjustment
If the transfer price is determined not to be at arm's length:
- The income may be adjusted
- Interest and penalty may be levied
Penalties
- Section 442: Penalty of 2% of the value of each international transaction
- Section 457: Penalty of 2% for failure to furnish information
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on transfer pricing for export-oriented captive manufacturing units. Our direct tax experts help captive units understand their obligations, prepare documentation, and navigate the regulatory framework. We assist in TP study preparation, report filing, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on transfer pricing or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex transfer pricing framework for export-oriented captive manufacturing units requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- TP Assessment: Evaluation of transfer pricing obligations
- Documentation: Assistance with TP study and documentation
- Safe Harbour: Guidance on safe harbour eligibility
- Representation: Representation before Transfer Pricing Officers
Contact us for expert legal guidance on your transfer pricing matters.