Companies usually spend a lot of time and money on the analysis and documentation of their transfer pricing arrangements. But the implementation of those arrangements is equally important. Intercompany agreements are an integral part of that process.
In this article, we discuss what intercompany agreements are, why they are important, what needs to be considered when drafting them, and what they normally include.
What are intercompany agreements?
An intercompany agreement (also known as: “intra-group agreement” or “transfer pricing agreement”) is a (signed) contract between two or more associated enterprises. Such contract governs the terms and conditions (T&C) of controlled transactions, such as the provision of goods or services from one associated enterprise to another associated enterprise.
In this image you can see a manufacturer engaged in business with two parties: an associated distributor within the same group, and a third-party distributor. Transactions within a group are subjected to transfer pricing regulations, and intercompany agreements should be in place (as explained in this article). Third-party agreements are naturally at arm’s length.
How do intercompany agreements differ from regular agreements?
Intercompany agreements are fundamentally different from third party-agreements (also known as commercial contracts). An intercompany agreements is signed by two enterprises that are part of the same group. They can be assumed to have the same goal: increase the group’s bottom line. They have the freedom to arrange the transaction as they see fit, and it is unlikely for a dispute to arise. At first glance, the intercompany agreement is a formality.
A third-party agreement , on the other hand, is the result of negotiations on the T&C by two independent enterprises securing their own interest. Normally, such an agreement is carefully drafted and reviewed before being accepted by both enterprises. It is unlikely that one of the parties can unilaterally dictate the T&C of the agreement.
To visualize:
| Intercompany agreement | Third-party agreement |
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Why are intercompany agreements important?
In practice, companies often neglect intercompany contractual obligations. And even when intercompany agreements are put in place, they are often badly drafted, out-of-date, and don’t reflect the economic reality of controlled transactions. The absence of (quality) intercompany agreements can be a risk for a variety of reasons. These are the three most important ones:
- Transfer pricing documentation and transfer pricing policies lay down the appropriate transfer pricing arrangements. However, these are not legally binding. Intercompany agreements are therefore needed to implement and formalize the transfer pricing arrangements in a legally enforceable contract. At the same time, it provides evidence to internal and external stakeholders that transfer pricing arrangements have indisputably been implemented.
- An increasing number of countries have laws that require taxpayers to document their transfer pricing arrangements in intercompany agreements. In addition, qualifying MNEs must disclose their intercompany agreements in a Master Files and Local Files.
- Tax authorities normally request copies of intercompany agreements when doing a tax investigation or audit. An inability to provide them is considered a “red flag” and likely fuels further scrutiny of the transfer pricing position. If you can show a clear, comprehensive and up-to-date agreement in line with reality, this tremendously helps in defending your transfer pricing positions.
Example of wrongly implemented intercompany contracts:
The following example illustrates what can happen without transfer pricing agreements:
Pjotr Plastic has spent a lot of time and money on developing a transfer pricing analysis and documentation. The transfer pricing arrangements are applied to the controlled transactions and this way it operates for a couple of years.
One fine day the tax authorities knock on the door to inquire about the transfer pricing arrangements and how these are documented. Pjotr Plastic tells them that there is transfer pricing documentation but there are no intercompany agreements evidencing that all associated enterprises have consented to the transfer pricing arrangements.
The tax authorities are not convinced that Pjotr Plastic is compliant with transfer pricing laws. It wants to verify (i) whether the allocation of risks, assets and functions on which the transfer pricing arrangements have been based is in line with the actual arrangements and (ii) whether the associated enterprises have consented to the transfer pricing arrangements. Without intercompany agreements, Pjotr Plastic now has to furnish other evidence and convince the tax authorities that its transfer pricing position is indeed as it claims it is—potentially, a time consuming and costly discussion. This could have been prevented…
What not to forget when drafting intercompany agreements
Drafting an intercompany agreement is best done using a cross-discipline approach. Tax and finance professionals prepare the transfer pricing documentation but might not have the required skills to prepare legal documentation. Similarly, legal professionals are usually in the dark about transfer pricing rules. It is thus important to ensure the right people and skills are on board.
As for the content of intercompany agreements, we highlight three key principles:
- Ensure that the agreement is in line with reality; if you invoice a cost+ mark-up of 4% while an (old) agreement states 6%, this will raise eyebrows. This might seem obvious, but over time such discrepancies often happen within large dynamic enterprises.
- Ensure that the agreement is consistent with transfer pricing documentation; same as above. If the conclusion of TP documentation is that a royalty fee should be 5% of the annual net revenues while the agreement provides for a royalty fee of 15%, this will probably not be accepted by the tax authorities.
- Ensure that the agreement incorporates market standards; the starting position with transfer pricing is that associated enterprises should transact with each other as if they were third parties. Hence, you expect market standard terms and conditions in the agreement. For example, if third party lenders normally require a borrower to provide securities for the repayment of a certain type of loan, the agreement best reflects this practice.
What should be included in intercompany agreements?
The content of intercompany agreements largely depends on the nature of the controlled transaction and the jurisdictions where the controlled transaction(s) take(s) place. Complicated controlled transactions, such as licensing of intellectual property, require detailed contracts. Contracts for straightforward controlled transactions, such as the provision of management services, can be kept simple.
Having said that, there are basic requirements that are to be included in every intercompany contract:
- Parties
- Considerations
- Controlled transaction
- Arm’s length remuneration
- Term
- Taxes
- Amendments
- Governing law and Jurisdiction.
In our course we offer a more detailed description of these requirements. We stress again that the content of the intercompany contract should meet the three principles discussed above.
Types of intercompany agreements:
Intercompany agreements can cover various controlled transactions. Below, we provide an overview of the most common ones:
Type of controlled transaction | Example |
Supply of goods | Apple US sells two containers of iPhone 10 to Apple Canada |
Provision of management services | The CEO of Apple, based in their US Headquarters, renders strategic advice to an operating company of Apple Ireland. |
Provision of support services | The Shared Service Center of Apple in Manila renders administrative services to Apple Hong Kong and Apple China. |
Granting of license | Apple US, who owns the Apple brand, grants a license to Apple Netherlands to use the brand name in the Netherlands only. |
Sale of business / assets | Apple Austria transfer its stocks and client list to Apple Germany. |
Provision of loan | Apple Bermuda grants a loan to Apple Mexico to expand the business. |
Summary
Transfer pricing arrangements between associated enterprises must be formalized in intercompany agreements to make them legally binding, comply with transfer pricing laws, and ensure a proper line of defense against challenges from tax authorities. Not doing this puts your business at serious and unnecessary risk.
It is important to ensure that intercompany agreements are in line with reality, are consistent with transfer pricing documentation and are in line with market standards.
The best way to create your intercompany agreements?
If you are in need of transfer pricing compliant intercompany agreements for your controlled transactions, we have something for you…
We created a number of simple Word file templates for the most common controlled transactions. You can directly download them, easily customize them to your situation, and use them as often as you like!
You can find them by Clicking Here…
