Intra-Group Services

3ExplainExplain

Two shortcuts, and one rule for both

First, is it a service at all? A charge needs a benefit (the benefit testBenefit testThe test for whether an intra-group service can be charged at all. The OECD asks whether an independent company in the same position would pay for the activity or do it itself (para 7.6). The US asks whether it gives the recipient a reasonably identifiable increase in economic or commercial value (Treas. Reg. § 1.482-9(l)(3)).Open in the Glossary): would an independent company in the subsidiary's place pay an outsider for this, or do it itself? Payroll and IT pass. Work the parent does only as owner fails. That is a shareholder activityShareholder activityWork a parent does only because it owns its subsidiaries, such as its own shareholder meetings, stock exchange filings or raising its own capital. The subsidiaries get no benefit, so the parent cannot charge them for it.Open in the Glossary, such as its own board meetings, stock listing and investor relations. The parent bears that cost. Duplicate work the subsidiary already does for itself, and a benefit that is only remote, fail too.

The US shortcut: the services cost methodServices cost methodA US option to charge certain routine support services at cost with no mark-up. It covers services on the IRS list (Rev. Proc. 2007-13) and services whose usual mark-up is 7% or less, but not excluded work such as R&D or manufacturing, and not services that are key to the business's success (Treas. Reg. § 1.482-9(b)).Open in the Glossary. The Entrepreneur may charge its total services cost with no markup. It is elective, and it works only if all four tests are met. The service is a covered service: it is on the IRS list in Rev. Proc. 2007-13 (payroll, accounting and IT support are), or comparable firms' median markup for it is 7% or less. It is not an excluded activity, such as manufacturing, R&D, engineering, distribution or financial transactions. It passes the business judgment ruleBusiness judgment ruleA condition of the US services cost method. A service can be charged at cost only if the company reasonably concludes, in its business judgment, that the service does not contribute significantly to the group's key competitive advantages, core capabilities, or fundamental risks of success or failure (Treas. Reg. § 1.482-9(b)(5)).Open in the Glossary: it does not add much to the group's key competitive advantages, core capabilities or big risks. And the books record the costs, who got the service, how costs were allocated, and the choice to use the method. Strategic advice from senior managers often fails the business judgment rule. Then it is priced with another method, usually cost plus a benchmarked markup.

Then allocate. Shared costs are spread with an allocation keyAllocation keyA measure used to share a cost among the group companies that benefit, such as headcount, sales or number of invoices. A good key reflects how much each company uses or benefits from the service.Open in the Glossary that reflects who benefits: headcount for people services, users for IT, transactions for accounting. Use the same key for the same service every year. Switch the key above: Mexico has most of the people, so headcount gives it most of the cost. Note the gap between the two shortcuts: the US charges cost with no markup; the OECD adds 5%. Mexico, Canada and Germany each check the fee under their own rules.

Sources: Treas. Reg. § 1.482-9(b), the services cost method; § 1.482-9(k), allocating costs; § 1.482-9(l)(3), benefit and shareholder activities; Rev. Proc. 2007-13, the list of specified covered services