The Basics of Inter Company Agreements
Inter Company Agreement’s Terms
An inter company agreement is an agreement that is made between one or more affiliated companies, such as members of a corporate group. The agreement may be between a parent company and a subsidiary, sister companies, or any other type of affiliated company. An inter company agreement is generally created for tax reasons, such as limiting transfer taxes, in the context of a merger or acquisition, or for other business purposes, such as tax-saving or tax avoidance reasons.
Inter company agreements are often tailored to the specific transaction or type of business that the companies are engaged in. While there are a number of important inter company agreement terms that should be addressed in order to protect both the company organizational forms and individual legal interests of the affiliated companies . At its core, an inter company agreement must make clear the terms of the business relationship between the affiliated companies, and what the respective rights, obligations, duties and liabilities of each party are in the context of the agreement. For example, an agreement related to the purchase or sale of goods, services or other assets or liabilities must address intercompany payments, as well as how revenues, expenses, and profits are to be reported for accounting purposes.
An inter company agreement should not be treated as merely a form document, but rather as a legal contract governing the relationship between the affiliated companies. A well written inter company agreement should address the following terms:
Different Forms of Inter Company Agreements
Within the sphere of inter company agreements, there are several types. Generally speaking, one type of agreement is for the provision of services ("Service Agreement") or alternatively can be for the supply of goods ("Supply Agreement"). The purpose of a Service Agreement is to assist a parent company in carrying out its business activities by providing it with certain services from a subsidiary of the group, where the parent company does not have capacity or resources to carry out such activities itself. Typical examples of this include accounting, information technology and data processing, legal, audit, insurance and secretarial services. Of course, the parent company can potentially outsource these activities to third parties, but it may be more efficient to have another group company carrying out these activities. The terms of the Service Agreement would inherently therefore be different to those of a Supply Agreement.
The terms of a Supply Agreement would include the price payable for the goods supplied. Depending on the nature of the goods, this may also be subject to certain regulatory requirements, notably within the pharmaceuticals and medical devices / life sciences space. As with the Service Agreement, the Supply Agreement would set out the terms and conditions that the parties wish to govern their relationship.
Core Features of an Inter Company Agreement
At a minimum, the agreement should include the scope of services as well as the terms and conditions under which the services will be supplied. It should describe the nature of the relationship between the parties. For example, if certain services will be offered to independent third parties, these should be defined in the agreement so that the intercompany business transactions are not viewed in a vacuum when reviewed by tax authorities.
The agreement should also cover the pricing models to be used, including the time and material method, fixed price method, or cost-plus methods. If the intercompany agreement allows for the procurement of certain tangible items from a member of the group, the pricing of those items should also be included.
The agreement should cover any confidentiality clauses, including intellectual property rights and other restrictions on disclosure and use of confidential information. It should also address intellectual property ownership issues, including whether any particular technology or software is proprietary. This assumes that the taxpayers have not run afoul of the applicable rules in transferring or licensing proprietary interests that would now require significant disclosures.
Finally, the agreement should discuss any issues relating to export controls, including compliance with export classification of restricted technology.
Legal and Regulatory Issues
Inter company agreements must comply with legal and regulatory requirements at both the local and international level. The primary legal framework governing inter company agreements encompasses corporate, tax, employment, intellectual property, and trade secret laws. At a regulatory level, there are requirements specific to the jurisdiction in which the parties are based or operate, which may have a content requirement for the agreements or require that the agreement be registered with a local office or authority. In addition, international laws may apply to the agreement upon the cross border nature of the interactions between the parties. At this point, it is advisable to seek specific advice on the applicable requirements.
Advantages of Inter Company Agreements
Inter company agreements typically result in cost savings for businesses which can be applied to other business needs and imperatives. Through these agreements, businesses can optimize costs and expenses where tax and legal requirements allow. They can also obtain much needed flexibility in the allocation of resources and assets, and have more efficiently distributed their employees, funds, and time, for example, between different subsidiaries, parents and affiliates. In furtherance of this last point, it is generally recognized that corporate or business groups achieve certain economy of scale due to a reduction in operational redundancies when through various inter company agreements, such as PPA Agreements, IP License Agreements, Service Agreements and others, they avoid duplicating functions, resources, investments and legal and related agreements among and between one another. Where costs are reduced through the application of inter company agreements , businesses can then redirect their resources to other business areas such as expansion (in terms of geographic reach or marketing and sales distribution), innovation (for example through research & development or an enhanced focus on emerging markets), and the amelioration of other priorities or targets such as customer, client and market satisfaction. The benefit to customers, clients, sub-distributors and others is that often resulting from inter company agreements is a more solidified and strengthened compliance, legal and regulatory infrastructure, the return, promotion and maintenance of resulting cost efficiencies, and in some cases, the concentration (when, for example, the inter company agreement does not involve distribution) of significant legal and regulatory expertise in the hands of a limited number of entities or subsidiary companies.
Common Issues and Strategies
Companies that simply draft the agreements and then file them away on a shelf end-up with a lot of agreements, but without corresponding business practices or processes. These agreements then become stale over time and out of compliance with government regulations. And, the agreement becomes ineffective to meet the company’s business needs. The agreement will eventually lead to frustration and resentment, and, in some cases, fines for non-compliance.
One best practice is to maintain a critical index or spreadsheet of all inter company agreements. Any changes to the substance or form of the agreement should be tracked through a revision process that requires a formal review and approval by relevant representatives of the companies. Some examples of items that may trigger a revision to an existing agreement include: Another best practice is to ensure that there are policies and procedures throughout the company that are integrated with the inter company agreements. Examples of useful policies and procedures include: In this way, any inter company agreements are living documents that are effective in meeting the business needs of the company.
Creating and Negotiating an Inter Company Agreement
In the negotiation process, certain issues should be addressed as part of establishing the terms of the inter company relationship including whether the parties are to enter into a contract, the scope and subject matter of the inter company relationship, structuring the arrangement, determining a price, and identifying performance obligations. Below are some key areas to discuss in negotiating the inter company agreement. The parties should determine whether the inter company relationship: (i) is to be governed by the law of a particular jurisdiction, (ii) any language translation issues should be addressed, (iii) a set period of time will be established for the inter company relationship to function, and (iv) when changes occur at one or all of the parties, how the inter company relationship is to be handled. The parties should also consider whether the agreement will be for a fixed term or if it is to automatically renew on a continuous basis. If the parties agree that the relationship is to be governed by the law of a specific jurisdiction, confidentiality and note-taking issues are also best discussed at this stage of the negotiation. It is generally agreed that the terms of the inter company relationship are to encompass the scope and type of services that companies are going to exchange with one another, the method to which the services will be exchanged, evaluation concerning whether a written agreement is to be used, and whether exchange of services will take place on a regular or irregular basis. The parties must also discuss whether the services provided involve sales (such as marketing activities), cost filling (such as cost predictions for the year ahead), transaction accounting (such as credit analysis, sales audits and payment collection) or specific operations (such as research and development or maintenance). The parties must also consider how the agreement should be structured. For example, companies may wish that the agreement is structured to set forth specific details in relation to the inter company relationship, such as stating how the service is to be provided to preserve records to substantiate the service to be offered. Additionally, the parties may want the agreement to state how liability and risk are managed in relation to the inter company relationship. The parties must also determine how the pricing of the services will be determined. For example, the parties may agree to have information provided through a data bank, and as a result, each party will be responsible in providing and maintaining such data. Additionally, the parties may agree that certain functions are to be performed at certain points in the future in exchange for costs made, targets achieved or research results released. The parties must also reach a mutual agreement as to how the service should be provided. For example, under certain circumstances, the parties may agree that one party will pay another a fixed fee both for past and future services, or that the fee will be based on costs incurred by the supplier. Other considerations when establishing price may include: specific delivery or cost multiplicities; whether the provision of services is to be complementary; and, the parties having a rights and obligations to maintain and published forms for the inter company relationship. Finally, the parties should discuss concerns relating to performance obligations, such as whether the agreement obligates the parties to have certain functions carried on between their two companies. For example, the parties should discuss whether the Agreement has a requirement that either party must regularly revise planned exchange of services or if the agreement terminates after a specific period of time.
The Role of Technology in Inter Company Agreements
The formation and management of intercompany agreements have traditionally required a significant degree of manual effort. From the development of contract language to the maintenance of various versions to the tracking of renewals and other changes, many processes have been labor-intensive and repetitive, requiring human oversight for even small or inadvertent errors. It is the rare business that has not experienced a missed renewal deadline or an outdated business term in some internal document or contract. However, technological advancements are remediating many of the issues associated with intercompany agreements by increasing the efficiency, accuracy, and oversight of many of the steps required to form, renew, and manage these corporate documents.
As noted earlier, many businesses continue to handle the intercompany contracting process on spreadsheets or in disparate internal electronic files. This can lead to a multiplicity of versions of different agreements in different forms, making it challenging to identify the terms of the actual agreement between various parties. While this process has been manageable in the past, businesses that are expanding internationally, creating new subsidiaries, and seeking cost reductions are often faced with the necessity to contract with a larger number of parties and to do so in a more timely and accurate fashion . Technology has addressed this need through the development of digital enterprise dashboards. These automated systems allow users to access all intercompany agreements for many related entities from a single file or through one internet portal. For example, a business may have several foreign subsidiaries that are part of the same group of sub-groups which must provide a specific service to the business. These sub-groups can have their own inter company agreements or can share one. The enterprise dashboard provides the ability to track all agreements among the many foreign subsidiaries (where several of these subsidiaries may be within one jurisdiction, while others span numerous countries). Maintenance of and changes to these agreements can be handled with increased efficiency through the use of these systems.
The pace of business is faster than ever, and businesses often experience delays in getting contracts signed or renewed because of the time required to send agreements back and forth among various parties. Advances in technology have also addressed this challenge through multi-party electronic signature services and the use of secure, encrypted, and limited-access internet portals / intranets to allow third parties to view agreements, sign agreements, and obtain copies, all without necessitating physical access to business premises.