Should default interest terms be included in intercompany agreements?

As you may know, every Monday we send out an e-newsletter with insights, guidance and views on the legal implementation of transfer pricing for multinational groups. (If you don’t subscribe to it, just scroll to the bottom of this page and fill in the box.) Earlier this month I wrote about the choice between bilateral and multilateral agreements. This prompted one of our subscribers to write in with some very interesting questions concerning default interest. I’ll paraphrase them:

1. Should intercompany agreements include the terms for default interest, and if so are any particular terms preferable, eg a fixed or flexible period of time?

2. Because it is standard practice to calculate comparability adjustments in accounts receivable and payable, how can you apply that in ICAs while avoiding any deductibility problems (as default interest payments are normally not deductible)?

In response, I would say that most of our clients (and their TP advisers) take the view that agreements should provide for default interest, because that’s clearly a feature of arm’s length arrangements. Some include provisions that the interest should only kick in if the relevant period is overdue (i.e. there is a ‘grace period’). A number of smaller clients prefer not to provide for default interest, on the basis that it is an unnecessary complication, and the likely amounts are such that the tax risks are low.

I was also struck by the fact that these questions relate to an issue we discussed in another newsletter exactly a year ago, about contractual provisions on frequency of invoicing. (We’d generally wouldn’t regard those as being particularly important, although it is said that tax authorities may challenge an annual payment frequency on the grounds that independent third parties may be unwilling to agree to such terms.) That newsletter attracted more responses than any other we’ve ever written – so many in fact that we assembled them all in a blog, which you can read here.

As always, I’d be fascinated to hear your thoughts on any and all of this, so do feel free to get in touch.