TRANSFER PRICING & INTRA GROUP SERVICES

Almost every Multinational Enterprises Group (MNEG) must arrange for a wide scope of services to be provided and availed to the entities in its organization. Examples of these are commercial, administrative, financial, technical and legal services.

These services might also include management, coordination and control functions applicable within the whole group.

The cost of providing such services may be borne by the parent company; by a dedicated member entity such as a ‘group services center’ or by any other member of the group.

When realizing about the need of service, an independent company usually considers two options: (i) if the service needed should be hired from an external source; or (ii) if it can be done in-house.

The same exercise should be made by a group company in the way that the services can be performed in-house or received from a fellow member group company.

In light of the above, it is more likely than not that services like accounting and legal advice are hired from an external party; when services like central auditing, financing advice or staff training are performed internally.

In some cases, intragroup services arrangements are linked to arrangements for the transfer of property of tangible or intangible goods, or the license for the latters. Some other times, there are cases where know-how is obtained resulting from a services agreement. This cases are particularly complex when attempting to determine where the exact border lies between the transferring and licensing of property, on the one hand, and the transfer of a service on the other.

MAIN ISSUES

There two main issues in the transfer pricing analysis for intragroup services:

(i)                  Have intra group services been rendered?

Under the arm’s length principle, the answer to the above question depends on whether the activity provides a respective group member with economic or commercial value to enhance its commercial position.

This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed itself in-house.

If the activity is not one for which the independent enterprise would have been willing to pay or performed in-house, then the activity would ordinarily should be considered as an intra-group service under the arm’s length principle.

When a service is provided by a group member to meet identified need of one or more specific fellow group members, it is relatively straightforward to determine if an intragroup services has been provided. Commonly yes, because it is something that an independent enterprise would have hired from an independent party or would have provided for itself in-house.

A more complex analysis is required when a group member (usually the parent company or a regional holding company) performs an activity solely based on its ownership interest in one or more other group companies, i.e. in its capacity as shareholder.

This type of activity should give basis to justify any charges to the recipient companies and it may be referred to “shareholder activity” (which is different from the so called “stewardship activity” which is a broader term that would also include the provision of services like the ones provided by a coordination centre).

The following are examples of shareholder activity that should give rise to any charge to the recipient enterprise:

-          Costs of activities relating the juridical structure of the parent company itself, such as meetings of the shareholders of the parent; issuance of shares in the parent company and costs of the supervisory board;

-          Costs relating to reporting requirements of the parent company including the consolidation of reports; and

-          Costs of raising funds for the acquisition of its participation in the recipient company.

In contrast, if for example, a parent company raises funds on behalf of other group member enterprise which uses these funds to acquire a new company, then the parent company would be entitled to charge as it will be considered to be providing a service (e.g. broker or funds raiser).

Another type of these shareholder activity are the costs of managerial and control (monitoring) activities related to the management and protection of the investment such as participations.

Another issue regarding intra group services that is worth to comment on is the concept of “services on call”. This type of services require that the services provider dedicates and keep available specific resources (e.g. employees, equipment, etc.)  in order to be on a standby mode so that the potential recipient of the service can get the provision of said services on a faster manner. An intra-group service would be deemed to exist if to the extent that it would be reasonable to expect an independent enterprise in comparable circumstances to incur in some “stand-by” charges to ensure the availability of the services when the need for them materializes.

(ii)                How can the companies determine an arm’s length charge for said services?

Once determined that there has been an intragroup service rendered, it is necessary to verify that the consideration or price charged for said services was set in accordance to the principle of arm’s length.

This mean that the charge for the intragroup service should have been that which would have been made an accepted by independent enterprises in comparable circumstances.

To identify the amount (if any) that was charged to the recipient of the service, the tax authority will need to identify what arrangements (if any) have actually been put in place between the associated enterprises to facilitate the charge made for the provision of the service between them.

There are certain cases where the multinational enterprises group uses the “direct charge method. This method is where the associated enterprises are charged for specific services, in those cases where the arrangements can be easily identified.

Direct charge method can certainly and clearly be used where there are specific services provided by a group member whose core business is providing these services to independent parties as well.

But direct charge method is not always feasible to apply and MNEG have to incur in alternative methods when dealing with services provided by a parent company or group member service centre.

In these cases, the practice of MNEG for charging for intragroup services is often to make arrangements that are either (i) readily identifiable but not based on a direct-charge method; or (ii) not readily identifiable and either incorporated into the charge for other transfers allocated amongst group members in same basis or, in some cases, not allocated amongst group members at all.

When calculating the arm’s length consideration the matter should be considered from both the perspective of the services provider and the services recipient.

In this respect, relevant considerations include the value of the service for the recipient and how much comparable independent enterprise would be prepared to pay for that service in comparable circumstances as well as the costs incurred by the services provider, considering that a services provider will most likely provide the service for a consideration higher than its cost, so that it can make a profit out of it.

The method to be used to determine the arm’s length price should be one that has the support of the OECD thorough it transfer pricing guidelines, such as the CUP (Comparable Uncontrolled Price) or the Cost Plus Method.

It may be required the elaboration of a functional analysis of then various members of the group in order to establish the relationship between the relevant services and the relationship between the relevant services and the member’s activities and performance.

In addition, it may be necessary to consider not only the impact (immediate impact) of a service, but also its long-term effect, bearing in mind that some costs will never actually produce benefits that were reasonably expected when they were incurred into.

Determining the method will depend on if the charge is such as it results in a profit for the service provider. As said before, in an arm’s length deal, an independent provider would normally seek to charge for services in a way as to generate profit rather than providing the services merely at cost.

The economic alternatives available to the recipient of the services also need to be considered.

In addition, sometimes the market value of intra-group services is not greater than the costs incurred by the provider. This could happen when the services are not within the ordinary scope of activities of the provider, but they are still offered incidentally as a convenience for the MNEG.