One entity legally owns the IP. Another employs the people who developed it, made the strategic decisions and controlled the risks. The royalty flows to the first. The value was created in the second. This is one of the most common misalignments TPA encounters — and one of the most difficult to defend when a tax authority starts asking questions.
Three realities, one story
Transfer pricing sits at the intersection of three perspectives that tell the same story.
Financial reality is where the money goes: which entity earns revenue, incurs costs, receives royalties and ultimately earns the profit or bears the loss.
Legal reality is what has been formally agreed: intercompany agreements, ownership structures, contractual rights and obligations.
Economic reality is what actually happens in practice: who performs the functions, makes decisions, controls risks and creates value.
When these are aligned, they tell the same story. When they are not, the inconsistency creates exposure, not necessarily because the structure is wrong, but because it cannot be defended.
Why misalignment is more common than it appears
It usually emerges gradually. A business restructures. A function moves jurisdiction. Decision-making shifts. The intercompany agreements are not updated, and the financial flows continue as before. By the time a tax authority raises a question, the gap between what the contracts say and what the business does may have been widening for years.
“A structure cannot work only on paper. The contracts, financial results and actual conduct of the business need to support each other.” – Semra Altintas, TPA Associate
What companies commonly get wrong
Treating documentation as the solution rather than the output. If the three realities are inconsistent, a more detailed Local File records the inconsistency more thoroughly. It does not resolve it.
Assuming legal ownership determines where profit should sit. Under the OECD guidelines, the entity that legally owns an asset is not automatically entitled to the full return. The return should reflect the functions performed, risks controlled and assets used, wherever those actually sit in the group.
Looking at the three realities separately. Financial analysis, legal review and operational understanding are often handled by different teams at different times. The misalignment becomes visible only when someone puts all three layers together.
How TPA approaches it
The introduction of a formal regime places renewed focus on the appropriateness and defensibility of existing intercompany pricing positions.
TPA begins with the business, not the documentation. That means speaking with the relevant people in the organisation to understand how it operates in practice: who does what, who makes decisions and where risks are controlled.
The financial flows and legal arrangements are then reviewed alongside that operational picture. Putting the three layers together shows whether the economic activity, contractual arrangements and financial outcomes are consistent, and where they are not.
Where a gap exists, TPA can help adjust the transfer pricing model, entity remuneration or intercompany agreements, supported by economic analysis and benchmarking. The goal is a structure that is commercially realistic, financially appropriate and properly documented.
“At TPA, we help clients make sure that what happens in the business, what happens financially and what is written legally all tell the same story.”
Five things worth reviewing now
- Do your intercompany agreements reflect how the business currently operates?
- Does the entity receiving royalty income employ the people performing the relevant functions?
- Are your financial flows consistent with your functional analysis?
- Has your transfer pricing model been reviewed since your last significant business change?
- Can you explain the connection between your legal structure, financial outcomes and operational reality in plain terms?
To discuss how TPA reviews alignment between financial, legal and economic reality in your group, speak to a TPA professional.
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