Evidence on Demand: Auditing the Contracts Between Your Group's Own Companies

An intercompany arrangement rarely fails because it was badly conceived. It fails because nobody wrote it down. A parent provides finance to a subsidiary and records it in a ledger narrative; a trading company uses a brand owned by a dormant sibling and settles the matter with an annual adjusting entry; a shared services centre recharges its costs on a percentage that everyone regards as broadly fair. The commercial logic is sound. The evidence, regrettably, often is not.

The difficulty is one of timing. During ordinary trading, an unwritten arrangement causes no friction. It becomes a problem at precisely the moment the group can least afford delay: when HMRC asks how a charge was determined, when the auditor requests support for a related-party balance, or when a buyer's due diligence team begins asking who owns what.

A structured review, conducted calmly and in advance, is considerably cheaper than an improvised one conducted under pressure. What follows is a practical method, framed as six questions a board can put to any intra-group arrangement.

Why informal arrangements persist

Informality is usually a symptom of success rather than neglect. Groups grow by acquisition and by accretion; each new entity arrives with its own bank account, its own ledger and its own set of habits. The people who arranged the original terms often knew each other well, and a conversation was sufficient. Documentation felt like an unnecessary formality between colleagues.

The result is a portfolio of arrangements held together by institutional memory. That memory is durable while the individuals remain. It becomes considerably less reliable after a retirement, a restructuring or a change of finance director — and it is at that point that the group discovers how much of its position rests on recollection.

The six-point review

1. Purpose: what is this payment actually for?

Begin with substance, not form. For each material flow between group companies, ask what economic or commercial function it performs. Is the parent genuinely providing strategic, financial or administrative services that the subsidiary would otherwise need to buy elsewhere? Is the loan funding a specific asset, or is it simply the residue of a group treasury arrangement? Is the licence fee payment for a brand that carries real value, or a mechanism for moving profit between tax jurisdictions?

A clear, one-sentence answer is the test. If the board cannot articulate the purpose without reference to accounting treatment, the arrangement requires closer thought.

2. Pricing: is the number defensible rather than merely convenient?

Most UK groups are within the scope of the transfer pricing rules where they transact across borders, and the domestic position on intra-group charges deserves equal attention. The question is not whether the price is optimal, but whether it can be explained to an informed outsider.

Ask how the figure was derived, when it was last reviewed, and what would happen if the underlying activity doubled or halved. Cost-plus arrangements with a documented mark-up are straightforward to support. Round-sum charges justified as 'what we have always done' are not. Where a charge has been static for several years, check that the activity it reflects has not materially changed.

3. Documentation: a single page is better than none

A common misconception is that documentation must be elaborate. In practice, a short agreement — or even a signed memorandum of terms — that records the parties, the service, the basis of charge, the payment terms and the review date will resolve the great majority of queries.

The standard to aim for is proportionality: more substantial arrangements justify more substantial documents, and a cross-border licence of core intellectual property warrants proper legal drafting. A modest internal recharge does not. What matters is that the record exists at the time, or close to it, rather than being reconstructed years later.

4. Approvals: who said yes, and were they entitled to?

The Companies Act 2006 imposes particular requirements on transactions between a company and its directors, and related-party disclosures must be considered in the accounts. Smaller groups sometimes overlook that a decision taken by a parent board is not automatically a decision of the subsidiary's board, even where the individuals are the same.

Review the minutes. Confirm that each entity's decision-making body considered the arrangement, that any conflicted director abstained where required, and that the delegated authority matched the value involved. Where a group relies on a general treasury or shared-services mandate, check that the mandate is written and current.

5. Termination: how does it end, and what survives?

An arrangement with no exit is a liability waiting to be discovered. Consider notice periods, the treatment of outstanding balances on termination, the fate of intellectual property once a licence ends, and whether transitional support is required. Where a loan has no stated repayment terms, the group should understand how it would be called and whether the borrower could realistically meet the demand.

6. Record-keeping: could a stranger reconstruct it?

The final test is the most practical. If an adviser with no prior knowledge of the group were given access to the relevant files, could they reconstruct the arrangement — its purpose, its pricing, its approvals and its history — without speaking to anyone? If the answer depends on a particular individual being available, the record is insufficient.

A plain-English test: formalise or simplify

Not every arrangement deserves a contract. A useful rule of thumb is to weigh two factors: value and ambiguity.

Where the annual value is material, the arrangement crosses borders, it touches intellectual property, or it could plausibly be challenged by a tax authority or a buyer, formalise it. Where the value is modest, the basis is obvious, the treatment is consistent year to year, and the only real gap is that nobody has written it down, a short memorandum of terms will usually suffice.

There is a third option worth considering more often: simplify. Some groups carry dozens of small recharges that exist only because a historic cost centre was never closed. Consolidating or eliminating them reduces administrative burden, removes audit queries and makes the remaining arrangements easier to explain. A board that tidies its intercompany map often finds the documentation task becomes far smaller than first feared.

Sequencing the work

Start with a schedule of all material intra-group flows and balances, drawn from the ledgers rather than from memory. Rank them by value and by risk, then work through the six points for the highest-ranked items first. Record the review itself, including the decisions taken and the reasons behind them — that minute may prove as valuable as any agreement it produces.

The objective is not a perfect archive. It is a position the board can defend with confidence, at short notice, in whatever forum the question arises.