Leading transfer pricing professionals agree that appropriate related party agreements, often referred to as ‘intercompany agreements’ or ‘ICAs’, are an intrinsic part of transfer pricing compliance. Nevertheless, many practitioners and corporates suffer from misconceptions about ICAs and how they need to work. In some cases, these misconceptions lead to errors which can be fatal to the implementation of a group’s transfer pricing compliance strategies. This article explains 5 of the most common misconceptions, and the reality behind them.
Misconception #1: Functional analysis is more important than ICAs
Functional analysis (in simple terms, who does what within a group) alone cannot fully ‘delineate’ or define a transaction between related parties. In many cases, a fact pattern as regards the functions performed by a particular legal entity can be consistent with a number of different legal interpretations, each of which can have a very different risk profile and therefore may require different pricing.
Operational reality needs to match both the functional analysis and the ICAs.
Misconception #2: Pricing clauses in ICAs should be left vague
In the past, this approach was commonly found in intercompany agreements, but it is now recognised as being ineffective. The outdated thinking was that leaving pricing clauses vague or open would give corporates more flexibility when filing tax returns. However, the reality is that there can be no contractual allocation of risk without a legally binding contract, and under many legal systems specifying a price with legal certainty is a pre-requisite for a valid contract to exist at all.
More fundamentally, if the pricing of an intercompany agreement is not clearly specified in an agreement, the directors or the legal entities involved are unlikely to have the opportunity to review and consider the arrangements - meaning that those directors are exposed to liability for failing to comply with their legal duties.
Misconception #3: ICAs should be implemented after the year end, when filing transfer pricing documentation
The reality is that contractual allocation of risk cannot be backdated. As stated in the OECD’s Transfer Pricing Guidelines:
“The purported assumption of risk by associated enterprises when risk outcomes are certain is by definition not an assumption of risk, since there is no longer any risk.”
(OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2017 edition, p 63)
This means that in order to be effective in allocating contractual risk, intercompany agreements need to be put in place in advance, not after the event.
Misconception #4: ICAs are artificial, since they are between group entities
ICAs are not just essential for transfer pricing compliance. They can also make a significant difference to the position of creditors in corporate insolvency situation, since they determine the rights and liabilities of individual legal entities. Intercompany agreements enable directors to comply with their legal duties regarding the legal entities of which they are directors, by giving those directors a clear statement as to the arrangements they are being asked to approve.
Misconception #5: ICAs are ‘too difficult’ to implement and maintain
As with anything, implementing and maintaining effective intercompany agreements does require focus. However, practical tools, resources and support are available, including our cost-effective document automation platform for creating draft intercompany agreements – we call it our ‘fast track’ intercompany agreements drafting service.