The cost plus method: commonplace, but not to be underestimated

I wanted to share with you a slide that we use for internal development and training. It concerns cost plus arrangements. When I posted it on LinkedIn last week, people shared some very interesting thoughts in response.

Although cost plus service recharges are commonplace in transfer pricing, it’s actually quite an extreme position when looked at from a commercial perspective. Would you hire out your team at cost plus 5%? Or even cost plus 10%? Probably not. And if you did, you would probably want the security of a long-term arrangement. (Just one reason why contractual notice periods can be important.)

We already know that it’s essential to have appropriate agreements in place. Aspro, Inc v IRC is just one of several recent cases that made the position clear: ‘no agreement’ may mean ‘no transaction’ and ‘no deduction’. A cost plus arrangement is no exception to the rule. (You can read a rather detailed analysis of Aspro by guest blogger Harold McClure here, and some top-line thoughts from me here.)

The slide above sets out the key types of arrangement for cost plus services. Of course, variants and combinations are also possible, which will affect the legal documentation. As always, the intercompany agreements to implement these transactions should be as short as possible – but no shorter than they need to be – whilst providing legal certainty and reflecting the commercial and operational reality of the arrangements.

What are your thoughts? As always, I’d be very interested to hear your views.