What are ‘waterfall’ clauses in intercompany agreements?

Amounts payable between related parties in accordance with transfer pricing policies sometimes need to be broken down into different elements.

This may be because those different elements are treated differently for non-TP purposes - such as withholding tax, customs duties or sales taxes.

A ‘waterfall clause’ is one way of doing this. The clause sets out the sequence of steps for calculating and allocating the different elements involved.

(It’s similar to the ‘waterfall’ of payments in a fund partnership when allocating profits as between the fund managers, the carried interest partners and the investors.)

For example, payments by an intra-group franchisee to the related party franchisor may include:

* fees for procurement services

* royalties for the use of IP

* compensation for strategic management services

As with any intercompany agreement, the different elements need to be expressed with legal certainty, and in a way that the group is capable of operating in practice.