How intercompany recharges affect transfer pricing for firms

It is normal for multinational companies to centralise some functions by having a few staff to perform or procure some services or goods on behalf of the whole group. Subsequently, the costs incurred by the central entity is recharged to the respective beneficiary entities in the group. This is known as intercompany recharging.

Generally, intercompany recharging is a business model to reduce costs. For example, centralised procurement of goods results in better pricing and payment terms given larger bulk purchases.

However, intercompany recharges can also arise where one company in the group assists its related party in settling operational expenses such as salary expenses, inventory purchases, insurance covers, and recharge the benefiting party at cost without mark-up, thereby creating a receivable from such entity.

Either way, intercompany recharging is a hot topic in the transfer pricing landscape and whether such recharging is necessitated by centralization of functions within the group or through intragroup financing to support operational costs. Therefore, a critical question to ask is, at what point does intercompany recharging becomes a transfer pricing issue?

Well, where the recharging results from centralisation of functions, transfer pricing issues hinge around three main areas:

• whether the said intragroup services have, indeed, been rendered;

• whether the provision of such services has conferred an economic benefit or commercial value to the business that enhances its commercial position; and,

• whether the recharged costs conform to the arm’s length test.

Failure to demonstrate any of the above facts may result in corrective adjustments by the Revenue Authority, including disallowing the recharged costs for income tax purposes.

Therefore, it is important to ensure intragroup recharges are aligned with the domestic transfer pricing rules and guidelines.

If recharging results from intragroup financing of operating costs, then a comprehensive look into the circumstances of the recharge of expenses would need to be done to determine if there is a transfer pricing exposure.

Matters such as the timing for the payment of the receivable created through recharged expenses would also need to be assessed.

It is highly unlikely for third party entities to settle expenses on behalf of each other, but this is inarguably a benefit of companies being related as they can take advantage of such practises to simplify ways of doing business.

However, due to the opportunity cost of holding money, it is arguable that related or unrelated companies would allow for their funds to be held by other companies for long periods of time.

It is this fact that brings the transfer pricing issue to the recharging of expenses at cost, between related parties.

Since in an arm’s length transaction, compensation would be required by the party initially settling the expenses on behalf of the other, especially when the repayment of the recharge remains outstanding for long periods of time.

This may portray that there may be an element of intercompany financing attached to it.

You have probably heard of the famous statement that “transfer pricing is not an exact science”.

This stands to be true in this matter as subjectivity arises in determining at what point is a repayment of the recharges considered to have been “long outstanding”, such that deeming it an intercompany financing would be appropriate.

Whilst this matter poses a challenge to the law makers on how to provide guidance that better illustrates ways of adhering to the arm’s length principle, in the different forms of financing that would be reflective of the complex ways of doing business in the current fast paced world, it is also important for taxpayers to be aware and minimise their exposure as much as possible.