A key function of intercompany agreements is to specify the price for the relevant transactions. In general, this requires that the actual amount of the price to be charged is either ascertained or is ascertainable by reference to objective criteria.
It is not enough for the parties to agree that the price shall be equal to an arm’s length price to be determined from time to time or an annual basis. The price involved may, for example, relate to the price of goods, fees for services, royalties for the licence of intellectual property, or interest charges.
Clearly, the legal expression of pricing in an intercompany agreement should be consistent with the transfer pricing method or methods which are intended to be used to support the price in the event of challenge by tax authorities. The five main transfer pricing methods, as referred to in Chapter 1 of the OECD’s 2022 Transfer Pricing Guidelines are as follows.
1. Comparable Uncontrolled Price (CUP) Method
The CUP method compares the price charged in a controlled transaction (between related parties) with the price charged in a comparable transaction between independent parties. These comparables may be internal (involving one of the parties and a third party) or external (between two unrelated entities).
Drafting implication: CUP does not necessarily dictate a specific clause structure. Instead, it requires that the pricing terms mirror those found in independent transactions — whether per unit, per user, royalty-based, or subject to volume discounts.
Case law: In Medtronic v. Commissioner, the taxpayer used CUP based on a related-party agreement. The U.S. Internal Revenue Service (IRS) rejected this, arguing the benchmark lacked comparability. The Eighth Circuit twice vacated the Tax Court’s ruling, underscoring the need for robust, factually supported comparables.
2. Resale Price Method (RPM)
The Resale Price Method starts with the price at which a product is resold to an independent party. From this resale price, an arm’s length gross margin is subtracted (adjusted for costs), leaving the transfer price for the original transaction. RPM is typically used in distribution models where the reseller adds limited value.
Drafting implication: RPM may support clauses that define pricing as a function of resale margins. However, it’s often used as a testing method rather than a pricing mechanism, especially in service or IP-heavy contexts.
Case law: In Coca-Cola v. Commissioner, the IRS rejected Coca-Cola’s longstanding “10-50-50” formulary method — which effectively allocated profits between the U.S. parent and foreign bottlers — arguing it failed to reflect arm’s length pricing. The Tax Court sided with the IRS, applying CPM (see Cost Plus Method below) and concluding that Coca-Cola’s foreign affiliates earned excessive profits compared to independent bottlers.
3. Cost Plus Method
The Cost Plus Method calculates the transfer price by identifying the supplier’s costs and adding an arm’s length mark-up. It’s commonly used for routine services and goods, especially when direct comparables are unavailable. The method is most effective when the supplier performs low-risk, non-strategic functions and does not own significant intangibles.
Drafting implication: Cost Plus supports structured clauses. Agreements should define:
- The nature of services or goods supplied (e.g. HR, IT, finance), and the benefit received by the recipient
- Exclusions (e.g. shareholder services like group audit)
- Categories of cost included (e.g. salaries, rent, depreciation)
- Allocation keys for shared services (e.g. headcount, revenue)
- Mark-up percentages (e.g. 5% for IT, 10% for tax)
- Treatment of third-party costs (with or without mark-up)
Case law: In Judgment 9C_37/2023 (Swiss Federal Supreme Court), the court examined whether tax expenses should be included in the cost base when applying the Cost Plus Method. The taxpayer — a power plant operator — had invoiced services to shareholders using a cost-plus approach. The court ruled that “production costs” under Swiss law include recorded tax expenses, affirming a full-cost interpretation. While the judgment applies to domestic law, it underscores the importance of clearly defining cost components and exclusions in intercompany agreements.
4. Transactional Net Margin Method (TNMM)
TNMM tests whether the net profit margin earned in a controlled transaction is consistent with margins earned in comparable uncontrolled transactions. It focuses on the financial outcome rather than the price of individual goods or services, making it especially useful when the tested party performs routine functions and does not own significant intangibles. As with all transactions, it is critical to be clear whether this method is used as an ex-ante price-setting method, as an ex-post outcome testing method, or as corroboration alongside one or more other methods
Drafting implication: Where TNMM is used as the primary price-setting method, the contractual implementation may take the form of residual outcome price clauses. These define the price as the amount needed to achieve a target margin within a specified range, over a financial period. Agreements often include true-up mechanisms to reconcile forecasted and actual results, ensuring the intended margin is achieved.
Case law: In Amazon v. Commissioner, the IRS challenged Amazon’s use of the Comparable Uncontrolled Transaction (CUT) method for valuing intangibles transferred to a Luxembourg affiliate. The Tax Court rejected the IRS’s approach and upheld Amazon’s use of TNMM, validating outcome-based pricing where comparables are limited and functions are routine.
5. Transactional Profit Split Method (PSM)
The Profit Split Method allocates the combined profit from a transaction between related parties based on their relative contributions. It’s typically used when both parties contribute unique intangibles, assume significant risks, or operate in highly integrated business models.
Drafting implication: Where the PSM relates to the splitting of actual profits, the contractual implementation will requires clauses that create a legally binding framework which will specify the actual amounts of adjusting payments required to be made in respect of each financial period. The granularity required will be similar to that required of Cost Sharing Arrangements under the US Treasury Regulations, and will include the definition of profit splitting factors, accounting principles to be applied, and a common currency for calculations.
Case law: In GlaxoSmithKline v. HMRC, the dispute centred on the pricing of pharmaceutical intangibles and marketing intangibles across jurisdictions. HMRC challenged the allocation of profits between GSK’s UK and U.S. entities. The case highlighted the difficulty of valuing overlapping contributions and the importance of clearly defining how profits are split. Although settled before final judgment, the litigation underscored the need for robust documentation and defensible allocation logic when applying PSM.
Relationship Between Transfer Pricing Method and Structure of Pricing Clauses
For any given type of intercompany transaction, the structure of the pricing clause is not necessarily dictated by the transfer pricing method. This is because a group may use more than one method to support the pricing of a particular intragroup transaction.
While the OECD’s Transfer Pricing Guidelines do not require taxpayers or tax authorities to apply multiple methods, they do acknowledge that this may be appropriate in complex or “difficult” cases.
The Cost Plus Method lends itself to a structured drafting approach, with defined cost bases, mark-ups, and allocation keys. By contrast, the other methods — CUP, Resale Price, TNMM, and Profit Split — do not prescribe a specific clause format.
The CUP Method implies that pricing should reflect the structure found in comparable independent transactions. These may take various forms, such as per-unit pricing, royalty rates, or volume discounts, depending on the nature of the comparable.
The Resale Price, TNMM, and Profit Split Methods may suggest clauses based on margin or profit allocation. However, they are often used to test or adjust the outcome of a transaction, rather than to define pricing directly.
Agreements to Agree
It’s not uncommon to find intercompany agreements that omit pricing altogether, leaving it to the parties to agree terms on a case-by-case basis. This approach is sometimes used in commercial contracts between unrelated parties, where the agreement serves as a framework for placing orders. However, in the context of intercompany arrangements, this is generally not recommended.
First, an agreement that does not specify price in an objectively ascertainable way fails to provide audit-ready support for the charges applied during the relevant period.
Second, if the transfer pricing relies on a guaranteed level of return — for example, for an intragroup distributor — that return must be specified with legal certainty. Without it, there is no enforceable guarantee. While “agreements to agree” may be binding in some jurisdictions, many legal systems do not recognise them as creating enforceable obligations.
Third, a party’s decision to assume contractual risks should be evaluated against the expected return. Without a clear pricing framework, the allocation of risk lacks context.
Fourth, from a governance perspective, leaving pricing to be agreed per transaction would require board-level approval for each instance. This is rarely practical. If pricing decisions are made centrally without formal delegation, it risks undermining the legal responsibilities of the participating entities’ directors.
Transfer Pricing / Tax Audit Adjustment Clauses
In the past, some practitioners have included clauses in intercompany agreements that attempt to adjust pricing or other terms if challenged by tax authorities. A typical example reads:
“If any provision of this agreement is challenged by [name of tax authority] or any other tax authority on the basis that it is not fully on arm’s length commercial terms, but would be if amended, that provision shall apply with such deletions or amendments as may be strictly necessary to make it arm’s length.”
While this approach has supporters, it is generally not considered tenable for several reasons.
First, the arm’s length principle applies to the overall conditions of a transaction — including pricing, risk allocation, and termination rights — not to isolated provisions. Adjusting a single clause does not address the full scope of the transaction.
Second, legal certainty requires that any adjustment reflect the position of a single tax authority. It cannot accommodate multiple jurisdictions, which may have conflicting views.
Third, this type of clause reflects a narrow, tax-centric view of intercompany agreements. It overlooks their broader role in governance, statutory accounts, regulatory compliance, and director liability. As noted earlier, pricing clarity is essential for evaluating risk and approving transactions. An agreement should not be amended solely because one tax authority raises a challenge.
Interaction Between Prices for Different Transactions
The intragroup charges payable by a legal entity may cover multiple transaction types — for example, a mix of back-office support, strategic services, intellectual property licences, and goods.
These services and supplies may be provided by one or more group entities. It may or may not be appropriate to document them in the same agreement. Either way, it’s important to consider how the different charges interact and how the overall cost is allocated — both for transfer pricing and for indirect tax purposes (e.g. VAT, withholding tax, customs duties).
In some cases, a ‘waterfall’ arrangement may be appropriate. This involves specifying the order in which different pricing elements are calculated and applied — particularly where multiple entities contribute value along a supply chain.
Main Options for Drafting Pricing Clauses
This section outlines the main legal structures for pricing clauses in intercompany agreements, along with key drafting considerations. The primary options are:
- Fixed prices
- Cost-based charges
- Residual outcome approach
- Royalty-type arrangements
Variations and combinations of these may also be used, depending on the transaction type and transfer pricing method.
Fixed Prices
‘Fixed’ means the price is either stated directly or is ascertainable using objective criteria that do not vary based on the supplier or recipient’s circumstances. Examples include:
- List prices for goods
- Fixed hourly or daily rates for services
- Annual licence fees for intellectual property, calculated as a fixed amount or per capita
Cost-Based Charges
Cost-based pricing includes “cost plus” arrangements and cost recharges without mark-up. These clauses define the price as the cost incurred by the supplier in making the relevant supply, with or without an additional margin expressed as a fixed percentage.
Key Elements of Cost-Based Clauses
- Subject matter of the supply Define the services or goods provided — e.g. HR, IT, legal, tax, finance and accounting.
- Exclusions Exclude shareholder services that benefit the parent rather than the recipient — e.g. group audit, consolidation reporting, investor relations.
- Types of cost included Typically includes:
- Salaries and employment costs (apportioned to relevant activities)
- Travel expenses
- Professional fees
- Depreciation on assets used
- Rent for dedicated office space
- Raw materials or goods (if applicable)
- Allocation of costs between multiple recipients Where services are shared across entities, specify how costs are split. Common allocation keys include:
- Headcount (for HR or IT)
- Revenue (for finance or legal)
- Balance sheet totals
- Time spent (if trackable)
- Mark-up (Cost Key) Define the margin applied to the cost base. This may vary by service type and location.
- Treatment of third-party costs Clarify whether external costs incurred specifically for a recipient are recharged with or without mark-up.
Allocation Key Mechanics
There are two main approaches:
- Hard-wired keys: Fixed allocation rules embedded in the agreement. Suitable for simpler groups.
- Policy-type keys: Reference a separate allocation policy document. The agreement should specify which party (usually the supplier) has discretion to apply the policy fairly and reasonably.
Whether different keys are needed for different services depends on the group’s complexity, risk profile, and materiality of the transactions.
Drafting Example: Hard-Wired Allocation Table
Residual Outcome Approach
This drafting approach defines the price as the amount required to achieve a specified financial outcome over a given period — typically an operating margin for the tested party. It is commonly used with the Transactional Net Margin Method (TNMM), and may also support the Resale Price or Profit Split Methods.
A typical clause might state that the Customer shall pay a fee calculated to ensure that it achieves an operating margin of [X]% for each financial year. The agreement would then define “Operating Margin” using a standard formula, such as:
Operating Margin = Operating Revenue – (Cost of Sales + Operating Expenses + Depreciation + Amortisation)
Each capitalised term should be defined elsewhere in the agreement. The reference to “[the Customer]” may be bracketed to allow for flexibility — for example, where a legal entity performs multiple functions (e.g. distribution and resale), and each function is remunerated under a different pricing method. In such cases, the margin may apply to a specific business unit rather than the entity as a whole.
Although the clause targets an annual outcome, pricing must often be applied to individual shipments or monthly service charges. This requires forecasting and periodic adjustments. Agreements typically include a true-up mechanism, allowing for retrospective correction based on actual results. Interim charges may be based on budgeted figures, with a balancing payment made after year-end.
However, reliance on post-period true-ups can create complications. For example, customs authorities may not refund duties if a true-up reduces the price paid by an intragroup distributor. In such cases, the adjustment may be better characterised as a service charge rather than a price correction. These risks should be addressed through careful forecasting and intra-year pricing discipline, minimising the need for large post-period adjustments.
Royalty-Type Arrangements
Royalty-type clauses define the price as a percentage of a financial metric — such as revenue, gross margin, or net profit — earned by the recipient of the goods or services. These arrangements are commonly used for licensing intellectual property or allocating value tied to intangible assets.
Key Drafting Elements
- Royalty rate: Specify the percentage or tiered percentages to be applied.
- Base metric: Define the financial measure to which the royalty applies e.g. gross sales, net revenue, operating profit.
- Exclusions and adjustments: Clarify any deductions or exclusions from the base — such as rebates, intercompany sales, or non-qualifying revenue streams.
- Payment periods: State the accounting periods for which royalties are calculated — typically quarterly or annually.
- Interim payments: Provide for estimated payments during the year, with final settlement based on actual results.
- Dispute resolution: Include a mechanism for resolving disagreements over calculation or interpretation, often by reference to independent audit or expert determination.