Intercompany agreements (ICAs) are a key piece of transfer pricing compliance—they’re part of local file requirements. That’s one good reason to keep them on hand. Here’s another: the contracts, which document various transactions, usually a sale or a transfer of goods and services between two related parties, can be instrumental in defending intergroup business practices during transfer pricing audits.

However, because ICAs only show their value in times of trouble, multinational companies often create them—and then file them away and forget all about them.

How can you ensure that intercompany agreements will provide an MNE protection in the event of an examination?

To find out, we called upon two intercompany-agreement experts: Paul Sutton, co-founder of the London-based law firm LCN Legal, and LCN Associate Director Leiza Bladd-Symms, are masters at creating intercompany agreements—in fact, Sutton, a corporate lawyer for more than 25 years, authored “Intercompany Agreements for Transfer Pricing Compliance – A Practical Guide” (2019, Law Brief Publishing, Minehead, Somerset, UK).

Here’s how to make sure these contracts work to your advantage.

Common Mistakes Surrounding ICAs

The first rule of thumb in terms of intercompany agreements is to make sure it accurately represents the way the group does business. To be tax-audit ready, a multinational company needs to have an accurate, short-and-sweet ICA in place. “If an agreement doesn’t match the way that the group actually operates in practice, then it’s not going to carry much weight at all and it’s going to be unhelpful,” says Sutton.

For an ICA to do its job effectively, it needs to be read by multiple stakeholders. “And it’s hard enough getting anyone to read anything, let alone 50 pages of legal verbiage,” Sutton adds.

Not only should an agreement be consistent with actual business operations, but it also has to reflect your transfer pricing policy. An MNE must ensure the contracts are consistent with the group’s transfer pricing policy in terms of the allocation of risks and functions–and consistent with the group’s other legal needs.

Those include asset protection, IP protection, and the client’s legal governance of its entire structure.

MNEs may try to adapt third-party agreements to an intergroup situations, which is a mistake. “That can’t work,” Sutton explains. “Those types of agreements contain things like notifications and change-control procedures. But those just don’t work and are not relevant in an intergroup context.”

Similarly, he says, those type of agreements would generally not have the kind of terminology and risk allocation that’s referred to in relevant master files and other TP policies. The frequent result? A “complete mismatch” between the transfer pricing policy corporate tax teams think they have and what legal teams actually produce.

Sutton has seen all kinds of mistakes, including no-brainers like missing a signature (yes, really). Agreements that are out of date can pose problems, too. “The OECD Transfer Pricing Guidelines are really clear: You can’t backdate the allocation of contractual risk. Just like you can’t bet on a horserace after the winner has been announced,” says Sutton.

Sometimes key terms are missing, which allows tax authorities to make liability assessments, and agreements may be difficult to understand due to poor language. You’d be surprised at how many MNEs put intercompany agreements in the “too-difficult-box” and just never get around to them.

The Consequences of Not Having ICAs in Place

The biggest risk of not having appropriate ICAs in place is that the transaction will be characterized by the relevant tax authorities, explains Bladd-Symms. “Then obviously following that there’s an imposition of tax adjustments potentially or fines and penalties.”

When creating intercompany agreements, MNEs must clearly represent how risks are allocated inside the group, or the tax authority will look at the circumstances and the facts as it sees them and infer the position without a reference to the contracts.

“That’s probably the biggest risk,” Bladd-Symms says. “Also, in certain jurisdictions corporate groups are fined simply for failing to produce the signed ICA when they’re asked to do so.”

An MNE would be wise to initiate a central policy for preparing ICAs. Without a holistic approach, says Sutton, you create cottage industries. “In other words, tax produces agreements for their own purposes.

Maybe the IP protection team produces their own agreements, a VAT, and so on.” It’s not just about creating something for tax, it’s about creating something that genuinely meets the needs of all the relevant stakeholders in the group.

The real value of an ICA? When something goes wrong. “It comes back to, why are you doing this in the first place?” Sutton says. “You’re trying to create an arrangement which would withstand scrutiny.

So, it’s only really tested when something goes wrong.” In other words, when an MNE is subject to a tax challenge or tax audit. It’s insurance—you hope you never need to use it, but it’s there if you do.

“Really, you’re creating this document or a set of documentation in the hope that you’ll never need to use it but knowing that it would withstand scrutiny if it’s looked at,” Sutton says.

ICAs Require Maintenance

Once the ICA is signed and filed, it’s important to implement an ongoing monitoring process. You’ll want to assign responsibility in your organization to maintain the ICA’s compliance.

It’s incumbent on MNEs to periodically revisit their ICAs, Bladd-Symms says, and ensure that they’re accurately reflecting the substantive transaction they’re intended to document. “The main key is just to ensure that you don’t sort of sign your ICAs, put them away, and then say the job is done.”

Want to learn more about intercompany agreements? Listen to our podcast discussion on The Fiona Show: Episode 13: Intercompany Agreements and What You Need to Know Now.

Sidebar: What do ICAs Cover?

A broad range of business and financial transactions related to transfer pricing are covered by ICAs, including:

• Intellectual property (IP) agreements
• Limited-risk distribution agreements
• Loan arrangements
• Back-office service agreements
• R&D services
• Marketing services
• Cost sharing
• Cash pooling
• IT services and support