When businesses establish entities across Southeast Asia, the early focus is usually on incorporation, banking, hiring, payroll, compliance and getting the operation running.
From our experience at Ryoss, one area is regularly left until much later, the movement of money between related companies.
It often starts innocently. A parent company funds the local entity, the local entity pays salaries and operating costs, then invoices another group company for services. Because the entities sit within the same ownership structure, management assumes the arrangement is straightforward.
That assumption can become expensive.
We have seen businesses discover, sometimes years later, that there was no formal agreement supporting the transactions, no documented basis for the amount being invoiced, inconsistent accounting treatment, or insufficient evidence to explain why money moved between entities.
These issues often become visible when accountants begin preparing audits, advisers review historical transactions, or a tax authority starts asking questions.
For smaller and medium sized businesses, the answer does not need to be unnecessarily complicated. But the arrangement does need to be deliberate, documented and commercially defensible.
Here are five things we believe every business operating related entities should have in place.
1. A Written Intercompany Agreement
If one group company is providing services to another, there should be a written agreement explaining the commercial relationship.
This might cover management support, technology, finance, administration, customer service, back office functions, intellectual property or other operating services.
The agreement should clearly explain what services are being provided, which entity is responsible for what, how fees are calculated, how often invoices are issued, payment terms, ownership of relevant assets or intellectual property, record keeping responsibilities and how the arrangement can be reviewed or changed.
One of the problems we see is businesses creating documentation after the fact.
That is much harder.
The agreement should reflect what actually happens in practice, rather than being written simply to satisfy a compliance exercise.
2. A Defensible Transfer Pricing Methodology
One of the most common questions we hear is, what percentage should our local company charge the parent?
There is no universal answer.
The important point is that the number should not simply be selected because it feels reasonable.
Related companies generally need to transact on terms that can be commercially justified. Depending on the structure, one common approach may involve the local business charging its costs plus an appropriate margin. In other circumstances, another transfer pricing methodology may be more suitable.
What matters is that management can explain why the chosen method makes sense.
If an auditor asks why a particular margin was used, the answer should be supported by a clear methodology, appropriate records and, where necessary, specialist transfer pricing advice.
We have seen businesses struggle because somebody selected a percentage several years earlier and nobody can now explain where it came from.
3. Proper Invoices and Supporting Records
Even a sensible commercial arrangement can become difficult to defend if the underlying documentation is poor.
Invoices between related entities should clearly describe what is being charged and should align with the intercompany agreement and actual activities of the businesses.
Supporting records may include cost calculations, payroll expenses, operating costs, management reports, allocation schedules, accounting records, transfer pricing calculations, contracts and evidence of payment.
The objective is simple.
If somebody unfamiliar with the business reviewed the transactions several years later, they should be able to understand what happened, why it happened and how the amount was calculated.
We have seen businesses forced to reconstruct years of historical information because this discipline was not established from the beginning.
That exercise can consume management time, accounting resources and significant professional fees.
4. Understand the Tax Position in Both Jurisdictions
Another issue we frequently encounter is businesses considering the transaction from only one side.
A payment may appear completely reasonable from the perspective of one entity while creating withholding tax, deductibility, indirect tax, foreign exchange or corporate tax issues for the other.
This is why related company transactions need to be reviewed across both jurisdictions.
The question should not simply be, can our local company issue this invoice?
The better question is, what are the legal, accounting and tax consequences for both entities when this invoice is raised and paid?
Getting appropriate advice early can prevent a commercially sensible arrangement from creating an unexpected tax problem elsewhere in the group.
5. Review the Arrangement Regularly
Intercompany arrangements should evolve with the business.
The structure that made sense with five employees may look completely different when there are fifty.
Functions move between entities, headcount increases, new services are introduced, intellectual property changes, costs increase and local operations become more sophisticated.
Yet we often see the same agreement and pricing methodology continuing year after year without review.
At least annually, management should ask whether the agreement still reflects reality, whether the pricing methodology remains appropriate, whether margins are still supportable, whether documentation is complete and whether regulatory or tax requirements have changed.
A relatively small amount of preventative work each year can avoid a much larger remediation exercise later.
What Happens When This Is Ignored?
The impact can be significant.
We have seen businesses face expensive historical reviews, accounting corrections, additional professional fees, uncertainty around deductions, difficulties supporting transactions during audits and large amounts of management time spent trying to recreate decisions that were never properly documented.
There can also be tax adjustments, penalties, interest and the risk of the same income effectively being taxed in more than one jurisdiction if the positions of the two entities are not aligned.
For a smaller business, these costs can be particularly painful because they are often entirely avoidable.
Our Advice
Intercompany agreements and transfer pricing do not need to become a major corporate exercise simply because your business operates across multiple countries.
But they should never be ignored.
At Ryoss, our experience has shown us that the businesses that manage this best usually establish the fundamentals early.
They can answer three simple questions.
- What is each entity actually providing?
- Why is this amount being charged?
- Where is the documentation supporting the arrangement?
If those answers are unclear, the best time to address the issue is now, not when an auditor or tax authority begins asking the same questions.
Ryoss helps international businesses understand the operational implications of related company arrangements and coordinates appropriate legal, accounting and transfer pricing specialists where formal advice is required.
A modest investment in getting the structure right today can prevent a far more expensive problem several years from now.
Important note: This article is provided for general information only and does not constitute legal, tax, accounting or transfer pricing advice. Requirements vary by jurisdiction and by the specific circumstances of each business. You should obtain advice from appropriately qualified legal, tax and accounting professionals before implementing or changing any intercompany arrangement.