Imagine that you are going to buy a 12-month-old car. Would you pay more if you were to buy from a licensed car dealer or if you were to buy from an individual who had been advertised in the small ads? Of course, you would pay the dealer more, although the physical goods in question (the car) may be identical in specs and condition.
The difference is partly the status of your counterpart (financial status and reputation) and partly the legal terms of the contract (such as warranties and after-sales support).
The same considerations apply to sales between related companies. Documenting legal agreements is not only important to support transfer pricing position. It is also essential that the directors of each of the companies demonstrate that they have fulfilled their legal obligations as directors, regardless of whether they may also act as directors of other group companies.
Here is an example of a checklist of issues that can be considered when establishing written agreements between companies for the supply or distribution of goods, and that should also support transfer pricing analysis.
Factors related to the parts
– 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 intellectual property rights / prosecute infringements
– Responsibility to provide 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 customer lists / requirement to deliver lists in case of termination
– Obligation to pay compensation / indemnification in the event of termination
Supply problems
– Seller obliged to accept / place orders
– Seller committed to supplying minimum volumes
– Restricted distributor to sell / purchase competitive products
– Distributor capable of purchasing replaceable products elsewhere.
Inventory issues
– Minimum purchase volumes
– The seller maintains local stocks of products for the distributor (consignment stocks)
– Distributor required to physically adapt the product to the local market.
– The seller assumes the risk of loss / damage of the products in transit.
– Seller forced to buy back unsold / obsolete stock
Price / payment risks
– Guaranteed / fixed prices for a specific period (regardless of raw material costs)
– Liability for currency risks
– Responsibility for the credit risks of the clients
Product liability risks
– Responsibility for design defects
– Liability for manufacturing defects
– Obligation to replace defective products
– Responsibility for claims of intellectual property infringement of third parties
– Liability for lost profits and third party claims
– Limitations on resources (for example, limits on claims, limitation periods)
Approaches to documenting business-to-business 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 conditions for each type of arrangement (eg R&D services, supply of goods, supply of headquarters services). These standard conditions are then incorporated into a short contract schedule that is signed for each agreement. This has the advantage of reducing the administrative burden involved, and also fits well with the local file / master file approach for more extensive transfer pricing documentation.