Guide to intercompany agreements: Types, benefits, and best practices

Internal transactions become more common as your business grows. However, these internal transactions can create serious legal, tax, and audit risks without the right documentation.

That’s where Intercompany agreements come in. These agreements formalize how your entities work together, helping you stay compliant with tax regulations and avoid costly disputes. They’re especially important when it comes to transfer pricing, where tax authorities expect clear, defensible documentation.

We cover why your business needs intercompany agreements, the four main types, key components, and best practices to follow when drafting them.

What is an intercompany agreement?

An intercompany agreement is a contract between two or more legally related entities within your company. These agreements set binding terms between parent companies, subsidiaries, sister companies, and other affiliates.

Intercompany agreements are legally enforceable under both local and international laws, despite being between related parties. They can cover everything from the sale of goods to the licensing of intellectual property. The terms of your agreement should align with applicable legal regulations and accurately represent the economic relationship between the parties.

Intercompany agreements vs. third-party contracts

Intercompany agreements are contracts between entities under common ownership, while third-party contracts are between independent, unrelated businesses.

Intercompany agreements face more regulatory scrutiny, especially from tax authorities looking for evidence that transactions follow the arm’s length principle, meaning transactions are priced as if the entities are unrelated. These agreements also carry stricter documentation requirements and higher internal governance and compliance standards.

Why do you need intercompany agreements?

Your business needs intercompany agreements to comply with regulations, particularly global transfer pricing laws. These agreements prove your related-party transactions follow the arm's length principle and meet tax documentation standards.

Intercompany agreements clarify your operational responsibilities between entities, preventing misunderstandings and ensuring continuity, even when leadership changes.

For financial reporting, these agreements document transaction terms and values. This helps auditors understand elimination entries and confirms your consolidated financial statements accurately reflect your company's position.

Types of intercompany agreements and examples

You need different types of intercompany agreements depending on your transactions. The right agreement depends on your transaction type, the relationship between your entities, and your regulatory environment.

Service agreements

Service agreements cover services provided between your related entities. These often include shared functions like IT support, HR, accounting, or management services.

Example: If you run a retail business, your parent company might provide centralized marketing services to all subsidiaries, with costs allocated based on each subsidiary's sales volume.

Licensing agreements

Licensing agreements let one of your entities use intellectual property owned by another. This can include patents, trademarks, copyrights, or proprietary technology.

Example: A technology company might license software from your parent company (where you develop the IP) to your regional subsidiaries, with royalties based on revenue.

Cost-sharing agreements

Cost-sharing agreements help you allocate expenses for joint activities among participating entities based on expected benefits. You might use these for research and development (R&D), marketing campaigns, or infrastructure investments.

Example: If you have a manufacturing group, you might share R&D costs among subsidiaries based on projected sales.

Financing agreements

Intercompany loan agreements help you move funds efficiently between your entities, optimizing cash flow management and reducing external borrowing costs. These arrangements let your cash-rich entities support those needing capital without the costs and complexity of external financing.

Example: Your parent company might provide working capital loans to a new subsidiary, or your financing hub might manage group-wide liquidity by redistributing excess cash.

Key components of an intercompany agreement

Every effective intercompany agreement should include a few essential elements:

Benefits of intercompany agreements

Well-crafted intercompany agreements do more than just formalize internal transactions; they create a solid foundation for your business operations. Here are the key benefits they provide:

• Regulatory compliance: Intercompany agreements provide documented evidence your transactions follow appropriate standards, reducing your risk of tax audits and penalties. This is especially important as tax authorities focus more on cross-border transactions.
• Operational efficiency: By establishing clear guidelines for group interactions, these agreements prevent misunderstandings and internal disputes. This clarity is valuable during reorganizations or when new personnel join.
• Accurate financial reporting: Comprehensive agreements make it easier to consolidate your financial statements and eliminate intercompany balances. Your auditors can quickly verify accounting treatment during reviews.
• Strategic resource allocation: Intercompany agreements help you structure internal transactions to optimize tax positions, manage cash flow, and allocate resources efficiently across your group
• Stronger corporate governance: Formal documentation clarifies roles and responsibilities. This helps your board and management fulfill their fiduciary duties and ensures transactions serve legitimate business purposes.

5 best practices for drafting intercompany agreements

1. Conduct a needs assessment

Start by identifying all intercompany transactions that require formal documentation. Work with your business units to understand the nature, volume, and frequency of transactions and which regulatory requirements apply based on jurisdictions and transaction types. This assessment forms the foundation for developing agreements that match your actual business activities.

2. Consult with stakeholders

Engage key stakeholders from tax, legal, finance, and operations. Each group brings a unique perspective, from transfer pricing considerations to accounting implications.

3. Draft the agreement

Use clear, precise language to describe the transaction and relationship. Make sure to include all essential components identified during your needs assessment, and align terms with your transfer pricing policies. Avoid ambiguous language that could be misinterpreted by tax authorities or courts.

4. Conduct an internal review

Submit your draft for review by legal, tax, and finance specialists. During review, address any concerns, especially about transfer pricing methodology and documentation. Also, confirm the agreement aligns with your actual business operations and is practical to implement.

5. Obtain final approval

Finally, secure approval from authorized decision-makers according to your company governance procedures. Make sure signatories from each entity properly execute the agreement and that documentation clearly outlines the approval process.

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FAQs

How often should intercompany agreements be updated?

Review your intercompany agreements annually. Update them whenever there are significant changes in your business operations, such as a change in your business structure or revisions to your transfer pricing policies.

What are the risks of intercompany transactions?

Intercompany transactions carry risks such as non-compliance with tax regulations, including transfer pricing rules, which can lead to audits or tax penalties. Poor documentation or inconsistent terms may also trigger legal disputes or complicate financial reporting. You can help mitigate these risks by ensuring accurate, well-drafted agreements.

Can tax authorities challenge intercompany agreements?

Tax authorities can and often do challenge intercompany agreements, especially regarding transfer pricing. Your agreements must be well-documented, economically sound, and consistently followed in practice.

Do intercompany transactions need invoices?

Intercompany transactions generally require invoices to provide a clear audit trail and demonstrate compliance with tax and transfer pricing regulations.