Documentation of Transfer Pricing and Intercompany Agreements

Imagine that you are going to buy a 12-month-old car. Would you pay more if you went to buy from a licensed car dealer, or if you bought from a private individual who had been advertised in small ads? You would, of course, pay the dealer more, even though the physical goods in question, the car, may be identical in spec and condition.

The difference is partly the status of your counterparty (financial status and reputation) and partly the legal terms of the contract (such as warranties and after-sales support).

The same considerations apply to intercompany sales. Documentation of legal arrangements is not only important to support the transfer pricing position. It is also essential that the directors of each of the companies can demonstrate that they have fulfilled their legal duties as directors, regardless of the fact that they may also act as directors of other companies in the group.

Here is a sample checklist of issues that can be considered when establishing written agreements between companies for the supply or distribution of goods, and which should also support transfer pricing analysis.

Party Factors

– Financial state
– Availability of security (for example, guarantees from the parent company)
– Legal form and location

market problems

– Responsibility for local marketing costs
– Responsibility for compliance with local regulations (product and packaging)
– Responsibility to uphold IP rights/prosecute infringements
– Responsibility in providing after-sales assistance.

Security of tenure/ability to benefit from investment in the market

– Exclusivity / territory
– Prohibition of direct sales
– Duration / notice periods for termination without cause
– Ownership of client lists / requirement to hand over lists upon completion
– Obligation to pay compensation / indemnity for termination

supply problems

– Seller obliged to accept/place orders
– Vendor committed to supplying minimum volumes
– Distributor restricted from selling/purchasing competitor products
– Distributor able to purchase substitutable products elsewhere

inventory problems

– Minimum purchase volumes
– The seller maintains a local stock of products for the distributor (consignment stock)
– The distributor is required to physically adapt the product for the local market
– The seller bears the risk of loss/damage of the products in transit
– Seller forced to repurchase unsold/obsolete stock

Price/payment risks

– Guaranteed/fixed prices for a specific period (regardless of raw material costs)
– Responsibility for foreign exchange risks
– Responsibility for customer credit risks

Product Liability Risks

– Liability for design defects.
– Liability for manufacturing defects.
– Obligation to replace defective products
– Liability for third party intellectual property infringement claims
– Liability for lost profits and third-party claims
– Limitations on remedy (eg caps on claims, statute of limitations)

Approaches to documenting intercompany agreements seem to vary widely, not only between different groups, but also within the same groups.

In my experience, the most efficient approach is for one group to prepare standard terms for each type of deal (eg, R&D services, supply of goods, supply of HQ services). These standard terms are then incorporated into an abbreviated contract schedule that is signed for each agreement. This has the advantage of reducing the administrative burden involved, and also fits well with the master file/local file approach for broader transfer pricing documentation.