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Putting the cart before the horse?

Intercompany Agreements

20 January 2022

Last week I read a 2020 TP report produced by a Big Four firm. The group concerned provided consulting services and technology-based solutions. Here is an extract (my italics):

“The Group utilises a centre-led operating model, whereby client contracts are entered into by either the local entity or the central UK entity. The determination of where a contract is signed should reflect the economic substance relating to the contract, and the central UK entity should not be entering into contracts substantially agreed by other companies. Intercompany agreements should be in place to support the recharge and governance processes, including acting on behalf and covering the actual economic circumstances.

In the context of the Group’s operating model, where prospective clients and negotiations are undertaken in the US and Switzerland, the contracts should be executed, and negotiations documented by the local entities (US and Switzerland); thereby aligning the economic substance to that respective jurisdiction. Where negotiations and work are undertaken within the UK or in any other countries (most commonly where there is no local presence), the UK should be assigned as the contracting entity to reflect the economic substance for that contract.”

In my view, this is completely wrong. It’s putting the cart (TP) before the horse (commercial necessity). A group’s contracting model (i.e. which entities should act as contractual counterparties to customers) should be primarily dictated by commercial and regulatory considerations. Such as:

  • Whether any legal requirements mean that supplies can only be made by regulated entities in the relevant countries
  • Whether sales considerations mean that local customers may prefer to contract with local entities or ‘head office’ (or a mixture of the two)
  • The group’s strategy for ringfencing legal and commercial risks (e.g. liability risks when dealing with markets such as the US which may be perceived as litigious)
  • Potential operational efficiency gains in centralising contracts (which may pull in an opposite direction to the ringfencing of risks)
  • Customs considerations and the operation of the group’s supply chains

Yes, sometimes the considerations listed above may leave a group with a range of options. In which case, by all means use TP as a tiebreaker.

But the fundamental point is this: contractual structure, as long as it is consistent with conduct, is not separate from economic substance. It is an intrinsic part of economic substance.

Do you agree? Am I missing something? Please do get in touch and share your thoughts.

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Article by
Paul Sutton
LCN Legal Co-Founder

Free Guide: Effective Intercompany Agreements for TP Compliance