In transfer pricing practice, the intercompany agreement occupies a paradoxical position: many companies treat it as if it were, on its own, sufficient proof that a transaction between related parties is valid, while others relegate it to an administrative formality with little technical relevance to the transfer pricing analysis. Neither of these positions is correct. The intercompany agreement is a necessary but not sufficient component of Transfer Pricing documentation, and its true value depends on how well it reflects—and is reflected by—the transaction actually carried out.
What should a well-drafted intercompany agreement establish?
A solid intercompany agreement must precisely identify the parties involved, clearly describe the purpose of the transaction—whether it is the sale of goods, the provision of a service, the licensing of an intangible asset, or the granting of financing—and explicitly establish the allocation of functions, assets, and risks among the parties. This allocation is not a minor detail: it is, in fact, the starting point that is then compared against the actual transaction to determine whether the agreed-upon remuneration is consistent with the arm’s-length principle.
Why does the contract, on its own, not support a transaction?
The OECD Transfer Pricing Guidelines (Chapter I) are explicit on a point that is central to understanding the limitations of this document: the contractual allocation of a risk is recognized for Transfer Pricing purposes only if the party to which that risk is allocated exercises effective control over it and has the financial capacity to assume it. In other words, a contract that stipulates that the parent company assumes market risk, while in practice it is the subsidiary that negotiates terms, absorbs losses, and makes relevant business decisions, does not protect the transaction from challenge by the tax authority. The actual conduct of the parties takes precedence over what is written on paper.
The Opposite Mistake: Underestimating Its Role as a Reference Document
The opposite extreme also creates risk. A group that operates for years without formal intercompany agreements—or with generic agreements that do not reflect the specific details of each relationship—loses a valuable tool: the agreement is what allows for the terms under which each transaction is expected to operate—price or pricing methodology, payment terms, duration, adjustment mechanisms—to be established in advance and consistently. Without that framework, it becomes more difficult to demonstrate that the transaction followed a coherent commercial rationale from the outset, rather than having been retroactively adjusted to justify a specific tax outcome.
The Relationship Between the Contract and the Rest of the Transfer Pricing Documentation
The true value of the intercompany contract becomes apparent when read in conjunction with the rest of the group’s documentation: the transfer pricing study must be able to verify that the contractually agreed-upon terms are consistent with the functional analysis, that the pricing methodology described in the contract matches the one actually applied, and that any relevant changes to the transaction over time—such as a modification in the functions performed—were reflected in an update to the contract, and not merely in the Local File prepared at the end of the fiscal year.
What should a multinational group review regarding its intercompany contracts?
Keeping intercompany contracts up to date, aligned with actual operations, and consistent with the functional analysis of the Transfer Pricing Local File is not a task that should be limited to the initial signing of the document. Changes in the business model, the group’s structure, or the functions actually performed by each entity should be reflected in a revision of the corresponding contract, preventing that document from becoming an outdated snapshot of a relationship that, in practice, has already evolved.
At TPC Group, we help multinational groups review the consistency between their intercompany agreements, their functional analysis, and their Transfer Pricing documentation to ensure that each of these elements tells the same story in the event of a tax audit.
Sources:
Chapter 1