Intercompany agreements, or ICAs, are one of the most important parts of any multinational group’s legal structure. They define the legal terms on which services, products, intangible assets and financial support are provided within the group.
For multinational groups, transfer pricing (TP) is one of the most challenging and high-risk areas of tax compliance. They therefore dedicate a lot of resources to preparing appropriate TP policies and documentation. However, these policies are of little use without intercompany agreements to define legally how they are actually implemented.
Moreover, ICAs are widely misunderstood. As a result, many groups are exposed to unnecessary tax risks, protracted tax enquires, audits, and avoidable disputes.
We’ll now answer some of the most common questions about intercompany agreements:
ICAs are legal agreements that define the terms under which transactions take place within a group of companies. These transactions can take many forms, for example:
- Head office and back office services (e.g. finance, tax, legal and HR services)
- Marketing services
- R&D services
- IT services and support
- Shared services arrangements
- Sale of goods
- Sales agency and commissionaire arrangements
- Intellectual property licences
- Revenue/profit sharing
- Cost sharing
- Contract manufacturing
- Toll manufacturing
- Loan facilities (e.g. term loans, revolving credit and overdraft facilities)
- Intercompany debt in security form (e.g. loan notes)
- Guarantees and other forms of security or financial support
- Cash pooling
- Secondment of staff and other mobility arrangements
Transfer pricing policies look forward, and explain how transactions within a multinational group are intended to work. Transfer pricing agreements describe what happens in practice, and how the policies are actually applied.
Master files, local files and other transfer pricing documents are prepared after the relevant transactions have taken place, and need to reflect what happened in reality. Having the correct legal agreements in place is clearly an essential part of this.
The OECD’s Transfer Pricing Guidelines require that master files contain ‘a list of important agreements relating to intangibles’, and that local files include copies of all intercompany agreements that the relevant local entities have entered into.
Intercompany agreements therefore perform a critical role in:
- Implementing related party transactions legally
- Defining their terms
- Allocating risk
- Specifying pricing, including any post year-end true-up or true-down arrangements
- Complying with the formal requirements of transfer pricing documentation
In short, ICAs are a fundamental part of transfer pricing compliance for multinational groups.
Many multinational groups fail to maintain a portfolio of agreements that is ready for a tax audit. This creates unnecessary risks, because tax administrations can easily identify any deficiencies. All they have to do is ask for copies of the ICAs and carry out a desktop review against master files and local files.
The following problems are common:
- ICAs which contradict the allocation of risk described in TP documentation, meaning that historic tax filings are incorrect
- Gaps in the intercompany transaction types covered by ICAs, so that certain transactions are not legally documented at all, leaving risk allocation and price open to the interpretation of tax administrations
- Agreements that are too long, use legalese language, which contain administrative provisions that are not followed in practice, and/or are poorly structured. All of this makes it much harder to get the agreements reviewed by everyone who needs to do so. The result can be that the agreements do not reflect how the group actually works, or do not take into account the needs of an important stakeholder
- Out-of-date ICAs which no longer reflect the group’s structure, its contracting structure, or the operations of the relevant business units
- Agreements that are unsigned, undated, incomplete, or not centrally archived
- Agreements which have not been updated to reflect revised benchmarking or revised TP policies and models
- Failure to integrate newly acquired or incorporated legal entities
- Over-reliance on local tax managers to maintain files of signed intercompany agreements, with no assurance that they are complete, and no contingency plans in place if those managers are unavailable or have left the group
Another common misconception is that groups can put off implementing ICAs until they need to deal with a tax challenge. This is a poor strategy for several reasons. (Read more about this here.)
Because in an area that is so complex and so widely misunderstood, you need to use the experts. And the experts are LCN Legal.
Since 2013, we have advised multinational groups with combined annual revenues of over $130billion. We know all the processes that are required to create and maintain intercompany agreements.
Three things make LCN Legal unique.
We are the leading experts in intercompany agreements. Our book ‘Intercompany Agreements for Transfer Pricing Compliance – A Practical Guide’ is the definitive work on the subject. Our online course on ICAs is recognised by the UK’s Chartered Institute of Tax, and by various other associations and organisations in other countries.
We have a global and cross-functional perspective. Around the world, large corporates and leading transfer pricing professionals choose us because we offer a unique skill set: we are commercial lawyers with an understanding of transfer pricing. This allows us to take a cross-functional approach to designing and implementing ICAs. We liaise with all the stakeholders involved (not just in tax) to ensure that the agreements support all of the group’s objectives.
We offer ongoing support and training to maintain audit-readiness. We focus on the end result that corporates need: a comprehensive central archive of signed intercompany agreements, which is aligned with TP policies and kept up-to-date. This enables them to respond quickly and effectively to tax audits, and reduces the risks of protracted investigations, adverse TP adjustments and double taxation.
A multinational group without appropriate ICAs in place is unable to clearly state what intragroup supplies are being made, or how risks are allocated between group companies. It is therefore exposed to many risks, including unnecessary transfer pricing adjustments, fines and penalties.
Some examples include:
- In certain jurisdictions, corporate groups are routinely subject to fines and penalties, simply for failing to produce signed ICAs when requested
- Expenses may be disallowed
- Post year-end ‘true up’ or ‘true down’ adjustments may be rejected
- Local tax authorities may be more likely to attempt to re-characterise a transaction as something other than that claimed by the taxpayer
- Groups may be subject to adverse transfer pricing adjustments and associated fines and penalties
- Analysis of VAT/GST charges
- Customs compliance
- Regulatory compliance (e.g. in the financial services and insurance sectors)
- Enforcement of intellectual property rights against third parties
- Reducing personal liability risks for directors
- Supporting the external and internal audit of group entities
- Exchange control and cross-border funds flows (for some countries, ICAs are part of the mandatory documentation required for any transfer of funds out of the country)
- Demonstrating ‘substance’, especially as regards control functions exercised in offshore jurisdictions such as the Cayman Islands, Mauritius, Jersey, Guernsey and the Isle of Man
- Ringfencing assets from legal risks
In order to be effective, ICAs must be:
- Aligned with the allocation of functions, risks and rewards described in transfer pricing policies
- Legally binding
- Correctly signed and dated on behalf of all the participating entities
- Kept updated on a regular basis, so that they continue to provide an appropriate legal framework for the group’s TP policies, corporate structure and operations as they evolve
- Appropriately archived, so that they can be accessed quickly when required
Failure to achieve one or more of those things will therefore make the ICAs ineffective.
It is also important to remember that intercompany agreements should not merely be consistent with the group’s transfer pricing policies. They should also be consistent with its regulatory objectives and the practicalities of its day-to-day operations.
For more on this, you might also like to read the answer to “What general principles should be followed when preparing and implementing ICAs?” on the FAQs page.
Implementing appropriate ICAs is not a one-off project.
Over time, a group’s composition can change (for example by acquisition, organic growth or reorganisation). Many other things can also evolve: business models, functions, ranges of products and services, value drivers and market conditions. If intragroup supplies change in any way, the group may need to change its ICAs or create new ones. Changes in tax legislation may also require the group to update its transfer pricing compliance strategy.
All of this needs to be monitored on an ongoing basis.
A typical process for maintaining intercompany agreements follows five key stages. It is important that those five stages are repeated periodically (typically once or twice a year). All the previous work is wasted if, when ICAs have to be used, they are out-of-date and therefore useless.
Many of our clients choose our ‘fully managed’ service, in which LCN maintains and manages a group’s portfolio of intercompany agreements on an outsourced basis, so that they are kept current, centrally archived, and available at short notice to respond to TP or tax audits. We think of it as the equivalent of having your car fully serviced on a regular basis: rather than waiting for faults to occur and then fixing them, getting frequent expert checks means that potential risks are identified before they cause a serious problem.