Document And Maintain Inter-company Transfer Pricing Agreement
All tax professionals should ensure that the inter-company agreements for transfer pricing are documented and maintained correctly. The primary reason for this is that transfer pricing is probably the most significant and yet most complex areas of tax risk. This affects multinational groups as any transfer pricing dispute can be extremely damaging both in financial as well as in reputational aspects.
Another reason to consider it to be the most significant is that transfer pricing is very closely connected with different contractual terms and legal structures as is in many different areas of tax. Almost in all cases, the intra-group transactions are usually conducted on these. That means any group that does not have an appropriately drafted and signed inter-company agreements in place will be on the back foot. It will effect during the discussions held with local tax authorities regarding their transfer pricing compliance.
Different areas of importance
The importance of having a regularly updated inter-company transfer pricing agreement in place cannot be overlooked no matter how costly or complex a process it may seem. Failing to will have serious consequences much to the extent of declaring a false economy. It is required for different purposes such as:
- Different compelling tax reasons
- Being a tool for supervisory compliance of ICAs
- Compliance tool for the new General Data Protection Regulation
- Ring-fencing all assets and liabilities from any risks
- Improving corporate governance of companies through the group
- Reducing personal liability risks for all directors
- Supporting external and internal audit of a group of entities and
- Ensuring intellectual property rights are monetized and enforced appropriately.
Therefore, while putting together the inter-company agreement of transfer pricing, all tax advisers must follow a specific process to ensure it is clear and error free.
Things to keep in mind
According to the set rule, the top transfer pricing firms in India must keep in mind a few points for creating, documenting and maintaining inter-company agreements.
- If it is found that the system for such creation is not yet established on a cross-functional and holistic basis, then there is a fair bit of risk of creating conflicting sets of documentation in different functions within the group. The needs of all shareholders will not be taken into account during the creation and maintenance of the inter-company agreement.
- It is important to attain the desired governance and achieve the transfer pricing benefits. Only robust and legal documentation for the intra-group supplies will ensure that. Therefore, the inter-company agreement must be consistent with the group’s transfer pricing policies regarding intra-group supply. It must include the nature and terms of the supply, allocation of risks as well as the pricing factor of the supply.
- Apart from that, it must be consistent with the reality aspect of the supply documenting how all arrangements are managed and operated in practice. If these are not practiced properly, then any reporting provision or complicated change control imported from a commercial contract at an arms’ length will do nothing good to enhance the transfer pricing position of the group.
- The terms of the inter-company transfer pricing agreement is another factor to consider. The beneficial and legal ownership of any commercial reality and related assets for any intra-group transactions must be consistent as well. It should be clear not to create any confusion or result in any misleading accounting entries.
Rather than promoting transfer pricing aim and other commercial objectives of the group the legal agreements must focus on the arrangement that will be properly approved by the directors of each participating company. The focus should be primarily on promoting the interest of the company than anything else.
The problem areas
There may be a few problematic proposed arrangements such as:
- Arrangements involving a particular entity that may be incurring ongoing losses or being exposed to other liabilities
- Cash flow demands such as the obligation to repay the loan on demand or indemnities for product liability that the entity may not have enough financial resources to meet any
- Giving away assets or value especially to a parent undertaking.
All these considerations must be addressed while making the economic and functional analysis necessary for transfer pricing.
Must be legally binding
Finally, inter-company agreements must be legally binding and capable of distinguishing the key terms of the arrangement. It must be descriptive about what is being supplied, the price at which it is provided and much more. This will make sure that all those provisions are objectively ascertainable from it as per the terms of the agreement.
What a lot of inter-company agreements do not have the price stated or even set using some vague references to the net profits or the comparable turnover of the subsidiary. This type of agreements will surely raise a lot of issues with regards to the legal certainty as well as from the perspective of transfer pricing.
There are also a few common mistakes that must be avoided while documenting inter-company agreements for transfer pricing. These are:
- Making the agreement too complicated
- Not matching the ownership with the flow of intellectual property
- Not reflecting or focusing on the group structures adequately
- Failing to guard against inapt termination provisions and
- Overlooking the significance of making proper provisions for the allocation of the cost if there are several service recipients.
Therefore, when you deal with intercompany agreements, you must make sure that it complies with and supports the transfer pricing strategy. It must be legal, robust, and most importantly tailored for the business and easy to use. make your business financially strong make your business financially strong
Seema Mehra is a Chartered Accountant at Ashok Maheshwary & Associates, top accounting companies in India that provide a statutory audit in India in a convenient manner. She is a professional writer and loves to share Financial related topics.