Intercompany Agreements for TP

Background

Intercompany agreements (“ICAs”) are written legal contracts covering specified intra-group transactions within multinational groups.  They especially determine the transfer prices charged for the provision of products, services, or intangible assets covered by it.

They become a frequent topic when preparing transfer pricing (“TP”) documentation.  The OECD specifically list them as a necessary part of their Local File (“LF”) standard.  Furthermore, important ICAs need to be listed in a group’s Master File.  Accordingly, the lack of written ICAs can easily lead to challenges during examinations, possibly enabling tax authorities to levy penalties for incomplete documentation or even allowing them to reassess the transfer prices.

Accordingly, ICAs are an important means for tax compliance as well as audit risk mitigation.  As part of our TP support, they are a recurring topic.  In the following, we therefore want to address important general topics, mainly the required formal and content aspects of ICAs.

Formal Aspects

From a purely legal perspective, it could be argued that even merely verbal contracts are valid.  Obviously, such an argument is problematic from a documentation perspective.  Written evidence such as TP policies, purchase orders, and intercompany invoices might provide the necessary details.  Nonetheless, it is advisable to prepare an ICA as a formal contract.

As ICAs do not involve the same risk of litigation as agreements between independent parties, they are typically much less extensive and detailed than regular written agreements.  In principle, this is acceptable, if it still contains sufficient details to allow for legal enforcement, even if this may never become relevant in practice.

Retroactive contracts should be avoided whenever possible.  This also applies to written documentation of contracts concluded verbally at an earlier date.  Whenever it can’t be avoided, it should be made sure that the contract is still concluded during the ongoing financial year and is accurately dated.

For cross-border transactions between different permanent establishments of a legal entity, contracts might seem meaningless from a legal perspective.  Nevertheless, for documentation purposes it is still advisable to prepare pro-forma agreements in a similar matter as for such transactions between different legal entities of a multinational group.

Contents

From a valuation perspective, the central issue of an ICA is the accurate description of the functions performed, and risks assumed by the parties to it.  While this does not require the full extent of a detailed functional analysis, it should be based on the same.  Like with the detailed functional analysis, issues during tax audits often arise, where the functions and risks described in the ICA differ from those actually performed and assumed.

Hence, it is advisable to regularly review the actual transaction and compare it with the descriptions in the ICA.  Typically, this is done together with the preparation of the LF and the review of the functional analysis contained therein.  While this is not a bad approach per se, it might not always lead to timely results, as LFs are usually only prepared after the end of a given financial year.

Besides functions and risks, the TP method is the second core item needed for a well-prepared ICA.  As explained above, prices are a vital component of legally valid contracts.  For TP purposes, these are usually only contained in the intercompany invoices, but the ICA should contain the exact calculation method for price setting.  Where this is different from the outcome testing method, the ICA should also explicitly mention that year-end adjustments are to be made, to ensure arm’s-length outcomes.

Practical Aspects

Required to be legally valid contracts, ICAs should in the first place be addressed with legal experts.  In many cases, it might be sufficient to handle this matter with the internal legal department of the group.  Nonetheless, especially for larger and more TP risk-prone it is advisable to involve external lawyers that regularly engage with similar contracts between unrelated parties.  Their expertise can be valuable to ensure that the ICA itself reflects typical market conditions.

Where such a comprehensive approach is not warranted by the economic importance of the controlled transaction, more pragmatic ways should be acceptable to reasonable examiners.  Nonetheless, for any such high-level approach, a due minimum of effort should still be demonstrated.  Especially, it should be avoided to rely solely on invoices and general policies.  Tax law as well as internal regulations regularly explicitly mention written contracts, making it difficult for individual examiners to ignore a situation where written ICAs cannot be provided by the taxpayer.

How We Can Help

As already mentioned, ICAs need to be addressed in the first place by legal experts.  We can provide complementary services from an economic valuation perspective, such as:

• Reviewing the completeness of drafted ICAs after having performed a detailed functional analysis.
• Collecting evidence of relevant arm’s-length as part of comparable contract searches.
• Reviewing the accuracy of existing ICAs during TP monitoring or updates of functional analyses.

For any such questions, do feel free to contact us at any time under info@bdanalysis.ch.