MNEs now must use discretion when including proprietary information or information on IPRs in their inter-company agreement and balance the need for completeness and protecting proprietary information.
One of the most crucial aspects addressed by the ambitious Base Erosion and Profit Shifting (BEPS) project of the Organisation for Economic Co-operation and Development (OECD) is effectively utilising the transfer-pricing regulations. While the BEPS project has touched upon several aspects and proposed multiple action items relating to transfer-pricing, the most far-reaching would be the one relating to maintenance of three-layered documentation, supporting the main pillar of transparency. Action Plan 13 of the final BEPS reports lays out a new, three-layered framework of transfer-pricing documentation containing a Local File, Master File and Country-by-Country Report (CbCR). The final guidelines require, among other things, “copies of all material inter-company agreements concluded by local entity” to be maintained as a part of the local file. The guidelines also require the master file to contain “important related party-agreements” regarding certain specific type of transactions.
Importantly, the BEPS reports emphasise on ‘contractual terms’ being a significant factor for determining comparability between a controlled transaction and uncontrolled transaction. The OECD recommends that an analysis of the contractual terms should be a part and parcel of the functional analysis. The final reports further go on to recommend that in absence of written contracts, the conduct of the parties and the economic principles that generally govern relationships between independent relationships should apply.
While all multi-national enterprises (MNEs) are meticulous about their legal contracts documenting the rights and obligations in any transaction with a third party, a significant portion of them have traditionally been not as diligent when it came to inter-company agreements. A significant portion of the MNEs may not have maintained contemporaneous inter-company contracts. The fact that inter-company contracts are never to be enforced in court of law adds to the complacency of the MNEs.
Another problem that is prevalent amongst the MNEs relating to inter-company agreements is that of the actual conduct of their related entities not being in line with the substance of the documented inter-company terms. A lot of times, inter-company agreements which are drafted and executed before the transactions begin are not updated or revised to incorporate the changes in conduct of the parties to the agreement. Some MNEs may not even have a process to ensure that the inter-company agreements which are in place are being properly adhered to. As jurisdictions around the world move towards implementation of the guidance from the Action Plan 13, the MNEs should proactively pay attention to maintenance of inter-company agreements among other important aspects.
Keeping with India’s commitment to implement the recommendations of 2015 Final Report on Action 13, the Indian tax law were amended to include providing for the maintenance of CbCR and maintenance of Master file. These amendment to the tax law were carried in 2016 by insertion of sections which provided the required the central government to prescribe the guidelines for maintenance of documentation.
On October 6, the Central Board of Direct Taxes (CBDT) released a draft notification for public comments setting out the guidelines for maintaining and furnishing of transfer-pricing documentation in the Master File and CbCR. The said notification proposes limits for the documentation requirement to apply. They prescribe the documents to be maintained. In line with the BEPS recommendation, the Indian rules require maintenance of “a list and brief description of important agreements among members of the international group related to intangibles, including cost contribution arrangements, principal research service agreements and license agreements”.
With very little time available at the disposal of the MNEs for compliance, it is important that they spend time evaluating their status. This could entail reviewing the existing inter-company agreements to ensure that they align with the actual conduct and the stated transfer-pricing policies. The MNEs would also need to make sure that the existing agreements are easily retrievable for submission to the tax authorities when called for.
Going forward, it would be imperative for every MNE to adopt processes which deal with the creation of new inter-company agreements and a periodic review of existing agreements.
The traditional processes for drafting and implementing inter-company agreements would not meet the requirements of today. For instance, MNEs must use discretion when including proprietary information or information on IPRs in their inter-company agreement and balance the need for completeness and protecting proprietary information. While drafting new inter-company agreements or updating the existing agreement, the MNE and its advisors need to bear in mind aspects relating to contemporaneousness, confidentiality, substance and consistency.
Author Partner, Dhruva Advisors LLP Views are personal