Understanding Intercompany Billing

Episode 2, How Much Should One Company Charge Another? Welcome back to our series on intercompany billing. In the first episode, we looked at what intercompany billing is and why companies may need to charge each other for services, costs, or other transactions. But knowing that a charge needs to happen is only the first step. The next question is, how much should one company charge the other? You can't necessarily pick a number simply because it's convenient for the group. Under the arm's-length standard, the goal is to determine a price or result consistent with what unrelated parties would have agreed to under comparable circumstances.

Let's take a simple example. Imagine your parent company has employees providing ongoing administrative support to its U.S. subsidiary. The first step is understanding the actual service being provided, what work is being performed, who benefits from it, and what costs are associated with providing that service. Once you understand the transaction, you can determine an appropriate transfer pricing method. Depending on the facts, that could involve comparing the transaction with similar transactions between independent companies, applying an appropriate markup to costs, or using another method permitted under the transfer pricing rules.

For certain qualifying intercompany services, U.S. regulations also provide a services cost method. Under that method, eligible services may in certain circumstances be charged based on the total cost of providing them without a profit markup. But this is where businesses need to be careful. Not every service qualifies for cost-only treatment, and there isn't one markup percentage that automatically works for every intercompany transaction. The right approach depends on the type of transaction, the functions performed, the risks involved, and the specific facts of the businesses involved.

Another common mistake is focusing on the invoice before thinking about the underlying economics. An invoice may say “management fee” or “consulting services,” but that label alone doesn't explain why the amount was charged. The underlying transaction and pricing methodology need to support it.

So if there's one takeaway from this episode, it's this. Start with the transaction, not the invoice. Understand what was actually provided, determine how it should be priced, and then make sure the billing reflects that analysis. But setting the price is only part of the process. You also need records that show what happened and make sure those transactions are properly captured. That's what we'll cover in the final episode.

Welcome to the final episode of our intercompany billing series. We've talked about what intercompany billing is and how companies can determine what to charge. Now let's look at what happens next. How do you actually manage intercompany billing in practice?

Let's go back to our example. Our French parent company regularly provides marketing, accounting, and IT support to its U.S. subsidiary. Throughout the month, the first step is keeping track of the support being provided and the costs connected to it. Some costs may be easy to identify. For example, if an employee works specifically on a project for the U.S. company, you may be able to track the time and cost connected to that work. But other costs are shared.

Maybe both companies use the same software. Maybe the same IT team supports employees in France and the U.S. In those situations, the companies need a reasonable way to divide the cost. For example, software costs might be divided based on the number of users in each company. Employee-related services might be divided based on time spent supporting each business. This is called cost allocation. It simply means finding a reasonable way to divide a shared cost between the companies that benefit from it.

Once the amount has been calculated, one company can issue an intercompany invoice to the other, and both sides need to record it. For the company providing the service, it may be recorded as income. For the company receiving the service, it may be recorded as an expense, depending on the nature of the transaction. But the process doesn't stop with the invoice. You also want to keep the information that explains where that number came from.

That could include the intercompany invoice, the calculation behind the charge, records of the services provided, and any relevant intercompany agreements. This becomes especially important when your companies operate in different countries. For certain U.S. companies with foreign owners, transactions with related foreign companies may also have additional IRS reporting requirements, including Form 5472. That's why it's much easier to keep track of these transactions as they happen instead of trying to rebuild everything at the end of the year.

So, to keep it simple, track what's being shared, calculate the charge, create the invoice, record it on both sides, and keep the documents that explain it. Intercompany billing doesn't have to be complicated. The key is having a clear and consistent process so that as your business grows across borders, you can easily understand what each company is paying for and why. Still have questions or want to learn more about doing business in the U.S.? Head to Orbiss.com for more.