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Can a single clause in an intercompany agreement make a 20% difference to the pricing of a controlled transaction?

Intercompany Agreements

7 October 2019

In real life, a single clause (or even a single word) in a legal agreement can make a huge difference to the commerciality of an arrangement. Exclusive vs non-exclusive licences. Recourse vs non-recourse factoring. One month vs 12 month subscription terms. Overdrafts repayable at will vs term loans with no right of prepayment.

Intercompany transactions are no different, and the 2017 OECD Transfer Pricing Guidelines provide a worked example of the impact of a single clause on the pricing of transactions involving limited risk distributors. The clause is a very simple one: an obligation on the principal / supplier to buy back unsold stock. The provision has the effect of moving inventory risk from the distributor to the principal, and in the OECD’s worked example, the clause makes a 20% difference in the margin which the distributor can expect to achieve. You can see a slide with the relevant commentary here.

This should be no surprise: the allocation of inventory risk is a key feature of a limited risk distribution arrangement, along with product liability risk, credit risk, and a guaranteed minimum return. Of course, for a clause like that to have any effect at all, it needs to be incorporated in a legally binding agreement, which is entered into in advance of the relevant transactions. Otherwise it’s just an attempt to re-write history with no substance.

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Article by
Paul Sutton
LCN Legal Co-Founder

Free Guide: Effective Intercompany Agreements for TP Compliance