VILIPO MUCHINA MUNTHALI
Contributor
Intra-group services are a critical aspect of multinational enterprise (MNE) operations, facilitating the efficient management and coordination of activities across multiple jurisdictions.
These services often involve significant costs and are subject to transfer pricing scrutiny. In fact, during most transfer pricing audits, intra-group services and associated fees draw the most attention from tax auditors globally.
This article (in two parts) provides an in-depth analysis of the concept of intra-group services, focusing on the regulatory framework, arm’s length pricing, challenges and compliance strategies.
Malawi’s transfer pricing legislation, which is aligned with international standards, form the backdrop for this discussion.
The concept of intra-group services
Intra-group services refer to activities performed by one member of an MNE group for the benefit of another member of the same group. Such services range from centralised management functions to specialised technical assistance and shared support services such as human resources and information technology (IT).
The provision of these services may arise from two possible scenarios as follows: Where the services are performed by a member of a group to meet an identified need of one or more specific members of the group and where a member undertakes activities that relate to more than one member of the group or to the group as a whole.
In the first scenario, it is relatively straightforward to determine whether a service has been provided or not. However, in the second scenario, a more complex analysis is necessary.
Both the domestic law and the Organisation for Economic Cooperation and Development (OECD) guidelines outline the principles for determining whether intra-group services have been rendered and the appropriate charge for these services.
Determining whether intra-group services have been rendered
The benefit test
The benefit test is the cornerstone of determining whether a service has been rendered. It evaluates whether the service provides a measurable benefit to the recipient.
For example, if a parent company provides IT support to a subsidiary, the test assesses whether the subsidiary derived economic value from the service.
Under the arm’s-length principle, a service is deemed to have been rendered if and only if the activity provides the recipient group member with economic value that might conceivably enhance its commercial position and if an independent enterprise in similar circumstances would be willing to pay for the same service if conducted by another independent entity or would have performed that service in-house for itself.
However, if the independent enterprise would not have been willing to pay or perform for itself, the activity would not be considered as an intragroup service. The costs for such activities are non-chargeable.
Shareholder activities
An activity performed by a group member solely in its capacity as a shareholder is not considered as an intra-group service and therefore cannot be charged to group members. Therefore, costs associated with activities such as shareholder meetings, issuing of shares or reporting requirements of the parent company are non-chargeable.
Duplicative services
An activity undertaken by one group member is not considered as an intra-group service if it merely duplicates a service which is already performed by another group member for itself or if the service is rendered by a third party.
Services that duplicate activities are non-chargeable unless there is evidence of added value. However, such services might be considered as chargeable to recipients if valid business reasons exist such as situations where: The duplication is temporary e.g. where an MNE group is reorganising to centralise its management functions; an activity is undertaken to reduce the risk of a wrong business decision (getting a second legal opinion on a subject); activities are different, additional, or complementary to the activities performed in-house and activity is undertaken to fulfil a regulatory requirement especially in regulated sectors such as financial services.
Incidental services
This refers to services performed by one group member such as a shareholder for a particular group member or a set of group members, but incidentally also provides a benefit to other group members.
The incidental benefits arising from such activities do not constitute intra-group services. For example, no service would be received where an associated enterprise by virtue of its affiliation alone (i.e., due to its passive association) has a credit-rating higher than it would if it were unaffiliated.
However, an intra-group service would usually exist if the higher credit rating was due to a guarantee by another group member.
Centralised services
These are activities that are centralised in the parent company or a group service centre but are made available to the group as a whole. Such activities will be considered as intra-group services as they are the type that even independent enterprises would have been willing to pay for or to perform for themselves.
Generally, such activities may include planning, budgetary control, financial advice, accounting, auditing, legal, operations, IT services, treasury activities, marketing, human resources, customer service and call centres, among many others.
On-call services
Intra-group on-call services apply in situations where an associated enterprise agrees to be on hand to provide services such as financial, managerial, technical, legal or tax advice to members of the group at any time.
An intra-group service would exist to the extent that it would be reasonable to expect an independent enterprise in comparable circumstances to incur “standby” charges to ensure availability of the services when the need for them arises.
For example, an independent enterprise would be willing to pay an annual “retainer” fee to a legal firm to ensure entitlement to legal advice and representation.
However, it is unlikely that an independent enterprise would incur stand-by charges where the potential need for the service was remote; or where the advantage of having services on-call was negligible; or where the on-call services could be obtained promptly and readily from other sources without the need for stand-by arrangements.
Conclusion
Intra-group services play a vital role in the operations of MNEs but are subject to intense transfer pricing scrutiny. In Malawi, the application of transfer pricing rules to intra-group services requires careful consideration of the local regulations and economic conditions.
As tax authorities intensify their focus on transfer pricing, MNEs must adopt proactive strategies to navigate the complexities of intra-group services.
In part two of this article to come out next Thursday, we shall discuss how to determine arm’s length remuneration for intra-group services. Stay tuned!
*Vilipo Muchina Munthali is managing consultant at Swift Resources, an international tax and transfer pricing consulting firm that specialises in developing, implementing and defending transfer pricing policies
