Intra-group services refer to the provision of services by one company within a group to another. These services can include a wide range of functions, such as administrative, accounting, legal, and payroll services. Given that intra-group services can be used to shift profits between group companies, tax authorities worldwide are paying increasing attention to the transfer pricing of such services.
The US Treasury and IRS have issued the final intercompany service regulations under Section 482, which provide guidance on determining the arm’s length price for intra-group services. These regulations replace the temporary regulations issued in July 2006, with minor changes made for clarification purposes. The US regulations provide for several methods for determining the arm’s length price, which are generally consistent with the methods outlined in the OECD Guidelines. However, there is one specified method, known as the services cost method (SCM), which companies can elect to use in respect of their intercompany service charges.
Under the SCM, companies can apportion the costs of certain specified routine services, such as payroll, administration, accounting, and legal services, without a mark-up. The full equity cost, including the cost of the employees’ equity-based remuneration, must be included in the “total services costs” that are apportioned among the recipients of the services. The SCM can only be applied to routine services, and the company providing the services must meet certain conditions before the method can be applied. The company providing the services must apply the “business judgment rule” to ensure that the services provided do not make a significant contribution to the competitive advantage, core capabilities, or the fundamental risk of success or failure of the group as a whole.
The SCM method is not applicable to certain excluded services, including manufacturing, production, insurance, R&D, or financial services (including guarantees). In addition to the “specified covered services,” there is another category of services that can be included under the SCM, which is “low margin covered services.” These are services for which the median comparable arm’s length mark-up is 7% or lower. The mark-up must be supported by a benchmarking analysis that could be challenged by the tax authorities.
Shared Services Arrangement (SSA) is another mechanism for allocating costs from shared or centralized services. A taxpayer may allocate arm’s length charges for services ineligible for the SCM that benefit a number of members of the group. However, in this case, the flexible SCM rules for establishing joint benefits and choosing the allocation key are not applicable. Instead, an analysis under the general transfer pricing rules is necessary.
The US service regulations suggest using the Profit Split (PS) method for transactions that include significant non-routine contributions. A non-routine contribution is one where the return cannot be referenced to market benchmarks (and not necessarily involving intangibles). The Residual Profit Split (RPS) method could be used where there are multiple group companies making significant non-routine contributions, excluding transactions where only one party is making non-routine contributions.
Shareholder activities, or “stewardship” activities, are not intended to provide a benefit to the related party. An activity is a shareholder activity if the “sole effect” of the activity is to protect the renderer’s capital investment and/or to facilitate legal or reporting requirements. The standards remain strict, and the IRS considers that shareholder activities could include activities that are not true shareholder activities and could even contain substantial activities that are non-shareholder activities.
In conclusion, intra-group services have become increasingly important, and taxpayers must ensure that their transfer pricing is in line with the regulatory requirements of each jurisdiction. The US regulations provide guidance on determining the arm’s length price for intra-group services and offer several methods, including the SCM, for determining the price.