When a multinational relocates manufacturing, back-office, or R&D functions to a lower-cost jurisdiction, it typically realises meaningful cost savings, cheaper labour, lower rent, favourable input costs. The transfer pricing question this raises is deceptively simple to state and genuinely difficult to resolve: do those savings belong to the group entity that relocated, or should some portion be shared with the local entity, the local market, or even priced into the transaction with independent customers?

Location Savings vs Location-Specific Advantages

The OECD distinguishes between location savings, net cost reductions from operating in a particular location, such as lower wages, and broader location-specific advantages (LSAs), which include factors like access to a large consumer market, a skilled labour pool, or agglomeration benefits from industry clusters. LSAs are harder to quantify because they are not simply a cost differential; they can also enhance revenue or market position in ways that go beyond the cost side of the ledger.

The Allocation Question

Where location savings exist, the OECD Guidelines indicate that whether and how much of the saving should be allocated to the local entity depends on what independent parties would have agreed under comparable circumstances, which in turn depends on factors like the competitive intensity of the local market, whether the savings are passed through to customers via pricing pressure, and the bargaining power of the local operation relative to the rest of the group. In highly competitive local markets, market forces may erode most of the saving through pricing pressure regardless of TP policy; in less competitive markets, the group may retain more of the benefit.

India and China: The Jurisdictions That Pushed This Issue

India and China have historically taken assertive positions that a meaningful share of location savings realised through captive service centres and manufacturing operations should be retained locally, arguing that comparables drawn from developed-market service providers understate the value created by operating in a high-growth, cost-advantaged jurisdiction. This has driven demand for India-specific and China-specific comparable sets and has been a recurring source of dispute for captive IT/ITES and R&D centres benchmarked against global comparables.

Practical Implications for Captive Structures

Groups operating captive centres in cost-advantaged jurisdictions should proactively assess whether their remuneration model, typically cost-plus, adequately reflects any bargained-for share of location savings, rather than assuming a standard markup insulates the arrangement from challenge. Where the local entity performs functions that are strategically important, not merely cost-driven, a pure cost-plus model detached from any location-saving allocation is increasingly vulnerable to audit adjustment in jurisdictions that have signalled this as a priority area.

Evidencing the Counterfactual

Any claim that location savings should, or should not, be shared with the local entity ultimately rests on a counterfactual: what would an independent local operation have negotiated in its place. Building that counterfactual credibly requires evidence of local market competitiveness, the bargaining leverage the local entity would realistically have held as a standalone business, and, where available, third party benchmarks of comparable arrangements in similarly cost-advantaged markets, rather than an assertion that no sharing was commercially warranted.

Conclusion

Location savings are not addressed by a discrete OECD method; they are a comparability factor under Chapter I that can distort a benchmarking study's reliability wherever the tested party operates in a materially lower-cost jurisdiction than its comparable set. Where a jurisdiction, India and China chief among them, has signalled that local retention of location savings is expected, the benchmarking study should build that allocation into the tested margin rather than leaving it to be litigated after a transfer pricing officer raises it.