This article contains adapted extracts from our guide for Tax and Transfer Pricing professions on how to put in place effective intercompany agreements for transfer pricing.
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It is worthwhile being clear about the basic requirements of intercompany agreements.
In relation to any intra-group supply, the relevant intercompany agreements obviously need to be consistent with the group’s transfer pricing policies as regards the nature of the supply, the terms of supply (including the allocation of risk) and the pricing of the supply. They need to appropriately differentiate the terms of the supply from other reference points. They also need to be consistent with the reality of how the arrangements are operated and managed in practice. Complicated change control or reporting provisions which have been imported from an arm’s-length commercial contract will do nothing to enhance a group’s transfer pricing position if they are not actually followed.
The terms of the intercompany agreements must be consistent with the legal and beneficial ownership of any relevant assets. For example, an intra-group agreement where a company purports to grant a licence over intellectual property which it does not actually own, may be likely to create confusion rather than promoting the group’s transfer pricing objectives.
The legal agreements should reflect an arrangement which the directors of each participating company can properly approve as promoting the interests of that particular company. (Arrangements which give rise to ongoing losses in a particular entity can be problematic.) In many ways, this basic principle – which focuses on the statutory duties of directors – can be seen in a legal context as the wider principle of alignment of form and substance. See, for example, action point 9 in the OECD’s Action Plan on Base Erosion and Profit Shifting issued on 19 July 2013, which sets the following objective: ‘Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital.’ The contractual assumption of risks by a company which does not have the economic substance to bear them is unlikely to be an arrangement that the company’s directors can properly approve.
Finally, the intercompany agreements must be capable of being legally binding. From an English legal perspective, this is not difficult to achieve, since there are few formal requirements. (Notable exceptions include land conveyances, leases, guarantees and documents granting powers of attorney.) However, the key terms of the arrangement must have ‘legal certainty’. This principally applies to the description of what is being supplied and the price of the supply, so those provisions must be objectively ascertainable from the terms of the agreement.