2.4.1 Contractual terms of the transaction

A transaction is the consequence or expression of the commercial or financial relations between the parties. Where a transaction has been formalized by the associated persons through written contractual agreements, those agreements provide the starting point for delineating the transaction between them and how the responsibilities, risks, and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract.

The terms of a transaction may also be found in communications between the parties other than a written contract. The written contracts alone are unlikely to provide all the information necessary to perform a transfer pricing analysis. As such, further information will be required by taking into consideration evidence of the commercial or financial relations provided by the economically relevant characteristics in the other four categories (see paragraph 2.2.5). Taken together, the analysis of economically relevant characteristics in all five categories provides evidence of the actual conduct of the associated persons. The following example illustrates the concept of clarifying and supplementing the written contractual terms based on the identification of the actual commercial or financial relations.

Company P is the parent company of an MNE Group situated in Country P. Company S, situated in Country S, is a wholly-owned subsidiary of Company P and acts as an agent for Company P's branded products in Country S market. The agency contract between Company P and Company S is silent about any marketing and advertising activities in Country S that the parties should perform. Analysis of other economically relevant characteristics and in particular the functions performed, determines that Company S launched an intensive media campaign in Country S in order to develop brand awareness. This campaign represents a significant investment for Company S.

From the example above, the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated persons. Therefore, the actual transaction that should be delineated for purposes of the transfer pricing analysis is as per the conduct of the parties.

In transactions between independent parties, the divergence of interests between the parties ensures that contractual terms concluded reflect the interests of both parties and will ordinarily seek to hold each other to the terms of the contract. The contractual terms will be ignored or modified if it is not in the interests of both parties. However, the same divergence of interests may not exist in the case of associated persons, or any such divergences may be managed in ways facilitated by the control relationship and not solely or mainly through contractual agreements.

Therefore, it is important to examine whether the arrangements reflected in the actual conduct of the parties substantially conform to the terms of any written contract, or whether the associated persons' actual conduct indicates that the contractual terms have not been followed, or do not reflect a complete picture of the transactions, or have been incorrectly characterized or labelled by the persons, or are a sham.

Where there are material differences between contractual terms and the conduct of the associated persons in their relations with one another, such as the functions they actually perform, the assets they actually use, and the risks they actually assume, considered in the context of the contractual terms, IRBM has the right, based on the factual substance, to accurately delineate the actual transaction.