10 (More) Signs Your Intercompany Agreement May Be Stale
This Margin Note takes a deeper dive into intercompany agreements (ICAs) and focuses on what may be lurking within – or conspicuously missing from – key clauses. For tax teams catching their breath after compliance season, this may be an ideal moment to peek under the hood and assess whether ICAs for key related-party transactions are indeed still fit for purpose.
We have partnered with long-time collaborator Sandra Spector (Law Office of Sandra Spector Sandra Spector | LinkedIn), a veteran international tax attorney, to share her perspective on contract construction and how common gaps in an ICA may weaken both your tax and legal position. Sandra’s insights allow us to broaden the lens. She reminds us that ICAs are not merely just functional tools of the tax team, but rather, are a critical component of the operational fabric of a company.
Many tax teams know their ICAs need attention, but often don’t know where to start. We hope this guidance will either help you regain confidence in your ICAs, or muster the resolve to spend some quality time with counsel.
So, without further ado, “What’s in Your ICA?”
The following are ten ‘More’[1] signs that your ICA may be in need of some timely attention and renewal.
1. Force Majeure
Pandemics, exotic forms of terrorism, convulsive structural market changes, and fallout from potentially illegal administrative acts haven’t always been top of mind when attorneys drafted Force Majeure clauses.
Many legacy ICAs omit these provisions entirely. Those that do have them, often possess a rather pedestrian list of triggers. Even when adequately-paranoid Force Majeure clauses are present, many legacy ICAs don’t address how the contracting parties should agree to act if the clause is triggered.
What to do? For starters, a Force Majeure clause well-suited to protect contracting parties from our increasingly chaotic world may look to the triggers found in a current commercial contract. A modern Force Majeure clause can then do more than pause enforcement of the ICA. Rather, it should clarify rights to renegotiate, terminate, or (when to) adjust the parties’ obligations. The lack of such clauses may give taxing authorities a stronger basis to challenge emergency responses taken, if triggered.
2. Evergreen Clauses
An ICA that automatically renews without a prescribed review schedule can be a flashing yellow light. Evergreen clauses are not inherently bad, but they help make it easy to set the ICA aside and forget about it—which we do not recommend! Termination clauses can also be revisited to ensure the notice periods align with local rules and are commercially feasible.
3. Generic Services
When ICAs rely on overly generic functional labels (such as “G&A” or “administrative” services) without offering meaningful descriptions of the sub-activities, it is difficult to be certain if evolving business functions attributed to the category are still realistically ‘under’ an ICA or not. A variation of this is when the majority of the covered business activity falls under a catch-all ‘And Other Related Services’ clause.
If your latest transfer pricing report describes benchmarks for activities that are markedly different from what your ICA describes, this is a noteworthy deviation that should be addressed. An ICA should dovetail nicely with your annual TP documentation.
4. Undisclosed Intangibles
Legacy ICAs can often understate the role of various intangibles employed in the course performing a service or some other (non-R&D-related) activity. As technology steadily creeps into more routine facets of business and life in general, an ICA today should:
Acknowledge the use of intangible assets, including passive use thereof;
Clarify ownership of work product, data, or even new ideas that could arise (planned or incidental) resulting from all uses and efforts; and
Address the role of the IP owner and constraints on use of any intangibles.
These details are no longer solely the province of licensing or contract development agreements.
5. Counterparty Responsibilities
It should be self-evident than an ICA should clearly dictate the scope and quality of services or goods to be provided and what remedies the recipient has when such terms are not satisfied. But what is expected in return? An ICA – especially ‘limited-risk’ ICAs – should shed light on how the service recipient or supplier provides oversight, operating procedures, and their cadence of review, especially when the controlled function relates to the performance of a highly-valuable or costly activity.
6. Data Privacy
Many older ICAs fail to contain standard data privacy clauses. This is very important given how many jurisdictions now have strict data privacy regimes. Such clauses are particularly poignant not just in services contracts authorizing the provision of back-office services (i.e., HR, payment processing, or IT services, etc.), but also for marketing and distribution contracts that involve client lists, customer data collection, or payment information.
The responsibilities of both parties should be outlined in the ICAs and data privacy experts should be consulted to determine whether the allocation of risk comports with local data privacy laws. Clauses should also contain clear rules for what data will be collected, how long it will be stored, and which party is responsible in the event of a data breach.
7. At What Cost?
It is often argued that a less-specific definition of costs offers greater flexibility. Given that there is not a uniform standard for specific costs ‘always’ being eligible for ‘at cost’ reimbursement, this is understandable. Many contracts establish an accounting standard, but do they provide either principles or a definition of types of costs to be included? It is notable that these definitions generally show up in annual documentation.
While the inclusion (or exclusion) of stock-based compensation is a classic example of a specific cost that more often gets careful attention, there are others. Among them, termination & shutdown costs are probably the most common. Does an agreement address material, extraordinary items? Who bears these costs? How would a low-risk and tightly-controlled entity be responsible for – or even capable of being financially responsible for – any material, borne costs?
And speaking of risks…
8. Risk & Responsibility
A stale ICA often glosses over risk allocation, even when the term ‘Limited Risk’ is featured in the contract title. A common misperception here is that by virtue of a fixed margin or markup policy alone, a state of limited or no risk exists. In reality, existing risks persist, but a contract can create the conditions under which such risks are mitigated.
A modern ICA should explicitly delineate which party bears prominent risks, and what steps may be taken to mitigate them. For example, is either party obligated to have insurance policies or take other concrete steps to manage known risks? In addition to observations from #5 (Counterparty Responsibilities) above, this contractual risk allocation may directly impact alignment of the value and significance of the respective parties’ functions with their stated economic character.
9. Payment Terms
Does your ICA provide full payment details? More than just payment days…currency, invoicing frequency, late payment charges and the like are necessary elements. Is there a complicated netting procedure deployed by the company that should be referenced? Or, do intercompany payments fall under a very specific corporate payments regime governed in a separate document? If one party is bearing all the payment risk – as is sometimes written in annual documentation – is that reflected in the ICA? All of these are elements that should be clarified, especially as these details tend to feature prominently in transfer pricing documentation.
10. More Fallout from Administrative Acts
Given where we are in the state of current events, we would be remiss if we did not revisit the topic of tariffs. Tariffs are borne by the importer, but there may be justifications to shift the economic burden back to the supplier. What happens if all or some of those get refunded? What if this occurs in a subsequent fiscal year? Similar questions arise when considering how an entity might reasonably assess profitability of its own operations under such volatile conditions.
Without knowing how government policies will impact a given transaction, this is another case where establishing a trigger and reaction mechanism is very helpful. This rationale is also not limited to tariffs. As the likelihood for persistent tit-for-tat international trade barrier erection does not appear to be subsiding, such a mechanism could be useful to address unanticipated changes in indirect taxes, business taxes, withholding, harsh penalty regimes, etc.
And while there are many more potential signs out there, we did want to share one final ‘Bonus’ sign for your consideration.
Bonus Sign: WW3PD?
WW3PD? What would a Third Party do?
As with many things, when it is impossible to list every imaginable contingency, establishing a guiding principle is next best option. With this in mind, we borrow a concept from German transfer pricing practice – the ‘prudent and conscientious business manager’ standard – and employ this as a form of basic acid test when considering the terms of a contract? Under this formulation of the arm’s length standard, decision-making and risk-taking, etc. regarding intercompany matters should align with the interests of a prudent and conscientious business manager. Somehow, personalizing the concept makes it less abstract.
We can boil this down into a simple slogan – “What would a third-party do?” – a slogan so simple it could be worn on a wristband. Would a third-party accept this agreement? In perpetuity? For that fee or rate of return? Under those constraints? If not, why? In the absence of specific guidance, think about the contract from the perspective of both parties. If you can identify areas that might give a third party pause, find a way to economically align those terms with the rights and compensation under the contract.
Reflecting from the Margins
We hope that the above are helpful in determined whether or not your legacy ICAs are still fit for purpose. The process of regularly revisiting ICAs is a very healthy thing to do, and doing so provides an excellent opportunity for business stakeholders to align with legal and tax to chart the path forward.
At Evident Solutions, we help companies align their ICAs with operational and strategic realities—efficiently and pragmatically. In collaboration with legal counsel like Sandra Spector, we can help ensure that your contracts are part of a well-oiled tax machinery, whether it’s through a targeted review of key contracts, a light refresh, or a comprehensive re-draft (or even a first-time draft)!
[1] See also 10 Signs Your Intercompany Agreement Is Stale — Evident Solutions, LLC for another fresh perspective.
