Making comparability transparent

One of the key functions of intercompany agreements is to be transparent as regards key matters such as risk allocation, compensation (pricing), and ownership of intangible assets.

What does ‘transparent’ mean in this context, and why does it matter?

Transparency requires that intercompany agreements should be easily understood by the reader, no matter who that reader is.

It matters because lack of transparency can easily lead to confusion as to how risks are actually allocated in the contract. Which may mean that the benchmarked transactions are not comparable. And the arrangements are unlikely to withstand scrutiny in a transfer pricing audit.

To give an example: if you’re pricing controlled transactions involving a so-called ‘limited risk distributor’ with a guaranteed return and therefore no significant market risk, then clearly benchmarking third-party distributors is unlikely to be meaningful. Because the transactions won’t be comparable in terms of risk profile.

In that scenario, contractual warranties given by the supplier of goods may suggest that that supplier is bearing certain risks. However, that apparent risk allocation may be neutralised by a ‘standard’ clause (or implied terms) excluding or limiting liability.

In order to be transparent, intercompany agreements should therefore:

• be as short as possible
• be written in plain language
• avoid relying on implied terms as far as possible
• avoid referring to statutory provisions of the relevant applicable law, because the effect of those provisions may not be obvious to a lay reader
• state the key terms explicitly.

These factors are part of what we look at when we carry out a 'health-check review' of a sample intercompany agreement. The review involves comparing the legal effect of the agreement with the description of the transaction in the group's transfer pricing policies. The output is a brief report, highlighting any issues regarding lack of alignment, and giving our recommendations as to corrective action required.