In the context of transfer pricing, an allocation key is simply a way of apportioning the recharge of centrally incurred cost across multiple beneficiaries. A typical example is head office services such as finance, accounting, tax, legal, HR, IT services etc, where the costs involved do not directly relate to a specific benefitting entity. Typical allocation keys include revenue, headcount, number of users and balance sheet totals.
When it comes to implementing a cost plus recharge policy through intercompany agreements, there are two main options regarding allocation keys:
Option 1: A ‘hard wired’ approach, where the agreement fixes the allocation keys for specific types of service for the duration of the agreement. This approach may be suitable for simpler groups.
Option 2: A ‘policy-type’ approach, where the agreement refers to general policies or principles regarding the allocation of costs, which are to be applied by one of the parties and which may be updated from time. This may be appropriate for more complex groups, where allocation keys may be adjusted during the course of a year or from year to year.
The question of how to apportion indirect costs also arises in other contexts – such as service charges for residential units within a larger development. Such service charges typically include the costs of central amenities such as a swimming pool. These costs may, for example, be apportioned between tenants pro rata to the floor area of the respective apartments or the number of bedrooms.
The service charge provisions in residential leases generally follows Option 2 as regards the legal drafting. The major difference between this domestic example and allocation keys within multinational groups, is that the method of allocating the cost of a swimming pool is unlikely to be material as regards the household budgets of individual tenants (you would hope), whereas the selection of allocation key may be material for some members of a group.
Options 1 and 2 as mentioned above are both provided for in our new ‘fast track’ document automation platform for creating intercompany agreements for business support services. You can find details of the full range of transaction types covered by this service here.