Documenting intra group profit-split arrangements: a question from a call earlier this week

One of the most common questions we are asked by transfer pricing professionals and their multinational clients is what form intercompany agreements should take, to document a profit split arrangement within a group. It came up again on a conference call earlier this week with participants from Australia, Italy and the UK. Here is the answer we gave on that call.

When it comes to the form of intercompany agreements and how they are signed up, there are basically two choices: Firstly, a global agreement which is signed by all the participating entities. Secondly, a series of bilateral agreements which are entered into between service provider and service recipient.

For example, the parent company (or key trading company) may provide a bundle of strategic services and intellectual property to five operating subsidiaries within the group. From a transfer pricing perspective, a profit split method may be adopted, and this would be reflected in the formula for calculating the fee is payable by each of the five subsidiaries to the parent. (From a legal perspective, structuring this as a profit sharing partnership would be unhelpful.)

It would be possible for this to be documented in one single ‘global’ agreement, entered into between all six companies (parent plus 5 subsidiaries). Alternatively it could be documented in five separate bilateral agreements, one between parent and subsidiary 1, the next between parent and subsidiary 2 and so on.

Usually, our clients choose to take the bilateral agreement approach. The main reason for this is that they have more control over how they disclose and manage the arrangements. For example, if subsidiary 1 is subject to a tax audit in its ‘home’ country, and a copy of the relevant supporting agreement needs to be provided, this can be done without automatically disclosing what variations in the agreement may exist for the other subsidiaries. Because the intercompany agreements for that type of supply are in a standardised form across the group, the additional paperwork involved is minimised. And of course, the agreements are kept as short as possible, without compromising functionality.

In this example, the supply involved is a “one to many” relationship. In other words, there is a single service provider (the parent), providing the relevant services to multiple recipients. The same approach of using bilateral agreements can also apply to “many to one” supplies, such as if a group has multiple R&D centres, which are all providing services to the same IP owning company.

Where the relationship is one of “many to many”, then a global agreement is usually required. For example, within an international consulting group, client engagements may be entered into by different local subsidiaries, depending on the head office location of the respective clients. For any given client engagement, a number of subsidiaries may provide fee earning support to the subsidiary which is acting as ‘lead contractor’ and is receiving the third party fee income. The methodology for sharing fees between the various subsidiaries which provide fee earning support would need to be documented in a global agreement, since the supply of services may be in any direction.

For an overview of our current range of services regarding intercompany agreements for multinational groups, click here.