Imagine that you are going to buy a 12-month-old car. Would you pay more if you bought from a licensed car dealer, or if you bought from an individual who had advertised in the small ads? Of course, you would pay more to the dealer, even though the physical goods in question, the car, may be identical in specifications 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 whether they can also act as directors of other group companies.
Here is a sample checklist of issues that can be considered when establishing written intercompany agreements for the supply or distribution of goods, and which should also support transfer pricing analysis.
Factors Relating to Parties
– 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 defend IP rights/prosecute infringements
– Responsibility in the provision of 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 turn in lists upon completion
– Obligation to pay compensation / severance pay for termination
supply problems
– Seller forced to accept/make orders
– Seller 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)
– 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 specified period (regardless of raw material costs)
– Responsibility for 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
– Responsibility for lost profits and third party claims
– Limitations on the remedy (for example, caps on claims, limitation periods)
Approaches to documenting intercompany agreements appear to vary widely, not only between different groups, but also within groups themselves.
In my experience, the most efficient approach is for a group to prepare standard terms for each type of agreement (eg, R&D services, supply of goods, supply of HQ services). These standard conditions are then incorporated into an abbreviated contract schedule that is signed for each deal. This has the advantage of reducing the administrative burden involved, and also fits well with the master file/local file approach for more extensive transfer pricing documentation.