The challenge for joint ventures and intra-group transactions
Author: Beltrán Sánchez. Transfer Pricing Director at Bové Montero y Asociados
Reality is richer than any analysis: it is impossible to measure capacities such as intelligence or sound management in a negotiation
It is increasingly common for Spanish companies to opt for joint ventures in order to finance projects, share risks, or gain access to new areas of business that require talent and expertise which are scarce in the market. In this new economic reality, companies face tough negotiations to establish the form of the operations the prices of transactions that one or both parties will carry out within these ventures.
Beyond the complexities involved in analysing one party’s transactions with the joint venture, based on the transfer pricing methods set out in the Spanish Corporate Income Tax Act and the OECD’s transfer pricing guidelines, the difficulty arises in the creation of “islands” or exceptions to the group transfer pricing policies. It is unlikely that agreements made with third parties will be concluded on the same terms and at the same prices as previous transactions within one of these groups, and this fact can give rise to an internal comparable which is inconsistent with the general transfer pricing policy.
Many multinational groups today run highly integrated businesses that generate an overall profit, which can nevertheless be difficult to understand on an individual basis: the local companies contribute various kinds of benefits to the overall business, but considered separately they would be much less profitable or even loss-making.
This situation stems from the group’s use of global resources, access to technology, improved commercial offerings, bargaining power as a group, economies of scale, and aggregation of sales volumes. A single company from such a group, acting individually, would not have access to these resources and would also be forced to increase its operating costs without the support of its parent company.
In many cases, the conclusion we must draw from a detailed analysis of the functional profile of the group companies and the joint venture is that the differences are significant enough to render them incomparable, and therefore the two transfer pricing policies should not influence one another. On the other hand, there may be multinational groups whose businesses are not integrated to such a degree, and thus they may have a higher level of comparability with the business of the joint ventures.
The intra-group transactions of the latter kind of entity will usually have less of an impact on their financial performance, as they make their own key business decisions, have independent control over their main drivers, and are therefore less economically and functionally dependent on their groups.
In practice, this tends to mean that these companies may receive some support from their groups in the form of services, financing, and perhaps some other business-related elements, but, as mentioned above, these transactions have less of an impact on their bottom line. In an ideal, theoretical world, having concluded that the two businesses are comparable, the terms of these entities’ transactions should match those of the joint ventures. However, reality tends to be far richer in terms of detail and circumstance than the results of any analysis, and it is impossible to measure certain capacities such as intelligence or sound management in the midst of a negotiation.
While a possible alternative would be to change the internal transfer pricing policy to match the terms agreed with its partner in the joint venture, this solution is not only contrary to market practice (no third party with an existing contract would accept a subsequent renegotiation) but can be further complicated if, rather than a single joint venture, the group has four or five partners with whom it conducts joint business.
Some opportunists may even analyse the terms with all joint ventures, decide which is the most advantageous for their own interests, and try to show that this is the most comparable with the intra-group transactions.
In any event, if the group transfer pricing policy complies with OECD standards, is consistent with the arm’s length principle, and, in addition, the companies are properly managed, we can assume that in the long run they should all lie within arm’s length ranges, despite their differences.
One final point: when discussing transfer pricing, we should always talk in terms of arm’s length ranges as opposed to prices, as there is no such thing as a unique arm’s length price. This should mean that, even if there are different transfer pricing policies within a group, they could all be arm’s length, as long as they have been analysed, comply with the conditions of the arm’s length principle, and fall within the range of what independent third parties would have agreed.
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