Transfer Pricing for Biotech and Deeptech R&D Cost Sharing: Practical Guide

Understanding Transfer Pricing for R&D Cost Sharing

Your biotech or deeptech startup has teams on both sides of the Atlantic, with researchers in a UK lab and a data science team in the US. You have raised a round of funding, and that capital needs to support both operations. The immediate challenge is simple: how do you get money from the entity that holds the cash to the entity incurring R&D payroll and expenses? While it might start as an intercompany transfer, tax authorities in both countries will eventually demand a more formal structure. Learning how to document R&D cost sharing between biotech companies isn't just a tax compliance exercise; it is about creating a clear, defensible logic for how your global company funds its innovation, protecting you from future adjustments and penalties.

This guide provides a practical framework for setting up and maintaining a compliant R&D cost sharing arrangement, specifically for early-stage companies navigating both US and UK tax environments.

Foundational Concepts: The Arm's-Length Standard

At its core, sharing R&D costs between related companies in different countries is a transfer pricing issue. The goal is to ensure each entity is compensated fairly for its contribution, just as it would be if it were dealing with an unrelated company. This is governed by a core concept: "The guiding principle for sharing costs is the 'arm's-length' standard," according to the OECD Transfer Pricing Guidelines. Essentially, the terms of your internal arrangement should mirror what two independent companies would agree to in a similar situation.

To formalize this, companies use specific intercompany agreements for research. While the underlying concepts are nearly identical because "US and UK transfer pricing regulations are both based on OECD principles," the terminology differs. In the United States, "The official term is Cost Sharing Agreement (CSA) in the US" (26 C.F.R. § 1.482-7). For those operating under OECD guidelines, which includes the United Kingdom, "The official term is Cost Contribution Arrangement (CCA) in the UK/OECD" (OECD). For simplicity, we will use the terms interchangeably, but it is important to use the correct one in your legal documents.

Why does this matter for a startup? Tax authorities like the IRS in the US and HMRC in the UK want to prevent companies from shifting profits to lower-tax jurisdictions by manipulating costs. By establishing a clear agreement, you demonstrate that your cross-border research funding is based on genuine R&D activity, or 'economic substance,' not tax avoidance. This protects each country's tax base and ensures profits are taxed where the value is created.

Part 1: How to Value Contributions and Split Shared Development Expenses

For an early-stage biotech with uncertain future revenue, the primary pain point is valuing each entity's contribution. How can you justify a cost split when the value of the intangible assets being developed is unknown? The reality for most startups at this stage is more pragmatic: tax authorities are less concerned with perfecting the valuation of future royalties and more focused on whether you have a logical, consistently applied method for your R&D cost allocation.

Choosing the Right Allocation Key

What founders find actually works is building a method on cost allocation keys, which are simple, objective metrics that reflect where the work is being done. The most common and defensible keys for R&D-heavy companies are based on personnel. These are effective because they directly link costs to the people performing the research. Common choices include:

• R&D Headcount: The number of full-time equivalent R&D employees in each location. This is simple, easy to track, and highly defensible for early-stage companies.
• R&D Payroll Costs: The total salary, bonus, and associated payroll tax costs for R&D staff in each entity. This can be more precise if there are significant salary differences between locations.

A scenario we repeatedly see is a straightforward headcount allocation. Consider a deeptech startup, 'QuantumLeap,' developing a new computational platform. They have a team of 12 people dedicated to this project and a total shared R&D cost pool of $1.5 million for the year.

• Eight engineers are based in the London entity (UK).
• Four machine learning specialists are in the Delaware entity (US).

Using a headcount-based key, the UK entity would bear 8/12 (66.7%) of the total shared development expenses, or $1 million. The US entity would cover the remaining 4/12 (33.3%), or $500,000. This split is reasonable and defensible because it is based on the location of the R&D activity, providing the economic substance needed to satisfy the arm's-length standard.

Defining the R&D Cost Pool

Just as important as the allocation key is clearly defining which expenses are included in the shared pool. Your agreement must specify the categories of costs to be shared. These costs should relate directly to the R&D activities defined in the scope of the agreement. A typical R&D cost pool includes:

• Direct Payroll: Salaries, bonuses, and benefits for employees directly engaged in R&D.
• Contractor and Consulting Fees: Payments to third-party individuals or firms for specialized research services.
• Materials and Supplies: Costs for lab equipment, chemicals, consumables, and other materials used in research.
• Software and IT: Licenses for specialized software, cloud computing costs, and other IT expenses directly supporting R&D.
• A portion of Overheads: A reasonable allocation of facility costs like rent and utilities for the space occupied by the R&D team.

Part 2: Drafting a Single Agreement for the US and UK

Given the alignment between US and UK regulations, you do not need two separate, complex agreements. A single, well-drafted CSA or CCA can satisfy both the IRS and HMRC, helping you avoid double taxation and penalties. The key is ensuring the document contains the essential elements that both authorities look for in intercompany agreements for research. Your agreement should be a clear, concise document that outlines the arrangement. It does not need to be a hundred pages long, but it must include these core components.

1. The Participants

Clearly identify the full legal names of the entities involved (e.g., your UK Limited company and your US Delaware C-Corp). This establishes the parties to the agreement and ensures there is no ambiguity about which parts of your corporate structure are sharing costs.

2. The Scope of R&D Activities

Define the specific R&D activities covered by the agreement. Is it for a single drug candidate, a research platform, or all R&D activities of the company? A narrow scope might be easier to manage initially, while a broad scope may be more efficient as you scale. The definition should be clear enough for an outside party to understand what is included and excluded.

3. Contributions and Cost Allocation

State how costs will be pooled and which expenses are included, referencing the cost categories discussed earlier. Crucially, you must specify the allocation key being used (e.g., R&D headcount) and provide a brief justification for why it is a reasonable measure of each entity’s contribution to the shared innovation effort.

4. Ownership of Intangibles

The agreement must state how the resulting intellectual property (IP) will be owned. This is a critical point for biotech and deeptech investors and tax authorities. Typically, the participants will have joint ownership or rights to exploit the IP in their respective territories. For example, the US entity might hold the rights for North America, while the UK entity holds them for Europe and the rest of the world. This arrangement must be commercially rational and clearly documented.

5. Terms and Adjustments

Include the start date, duration, and conditions for adjusting the cost-sharing percentages. The agreement should anticipate change. What happens if you double the size of your UK team or open a new research lab? Define a process for reviewing and adjusting the allocation key, for example, on an annual basis or after a significant change in circumstances like a major financing round.

Your agreement should be a living document that grows with the company. For a Seed-stage company, this might be a 2-3 page agreement. As you grow and raise a Series A, you can add more detail and formalize the methodology further.

Part 3: Building an 'Audit-Ready' Documentation Package

Creating audit-ready documentation for your R&D cost sharing is less about having a single perfect document and more about maintaining a body of evidence. This practice is known as keeping contemporaneous documentation, which are records created in the normal course of business, not years later in a panic. This evidence proves that your agreement isn't just a piece of paper but an active part of your financial operations.

Your documentation package should consist of four key components.

1. The Signed CSA/CCA Agreement

This is the formal legal document signed by both entities, as detailed in the previous section. It serves as the foundation for the entire arrangement and outlines the intent and mechanics of your cost sharing policy.

2. The Cost Pool Calculation

This is typically a spreadsheet maintained quarterly or annually. It should list all the shared R&D expenses from your accounting system, sum them to create the total cost pool, and apply the allocation key to calculate each entity's share. This calculation operationalizes the terms of the legal agreement.

3. Source Financial Data from Your Accounting System

The numbers in your calculation spreadsheet must tie directly back to your accounting records. This is why it is important to tag R&D expenses consistently from day one. In accounting software like QuickBooks, you can use "Classes" to tag transactions. In a system like Xero, common in the UK, you would use "Tracking Categories." These tagged expense reports become the supporting evidence for your cost pool calculation.

4. Proof of Intercompany Settlement

You must show that the money actually moved according to the agreement. This means generating an intercompany invoice based on the cost-sharing calculation and providing proof of the wire transfer or bank payment. This closes the loop and demonstrates the agreement has real economic substance, transforming it from a theoretical plan into a documented business practice.

At this stage, those running finance usually face the challenge of consistency. The key is to make this process a routine part of your quarterly or annual financial review. By systemizing the process of tagging, calculating, invoicing, and paying, you build a robust and defensible record over time.

A Staged Approach to R&D Cost Sharing Compliance

For biotech and deeptech startups, the approach to documenting R&D cost sharing should evolve with your company's stage. The requirements for a five-person team are different from those for a 50-person organization preparing for a major financing round.

Pre-Seed and Seed Stage

At the earliest stages, a simple intercompany agreement outlining the intent to share costs based on a clear metric like headcount is often sufficient. The priority is meticulous R&D cost tracking in your accounting software, whether it is QuickBooks or Xero. Your goal is to establish a logical foundation from the beginning that you can build upon as you grow.

Series A and Beyond

The "Key inflection point for formal CSA is Series A financing round." At this point, investors, their due diligence teams, and your board will expect a more robust agreement. The simple logic remains, but it needs to be formalized in a comprehensive CSA/CCA document. This is the time to refine your cost allocation key, clearly define the cost pool, and ensure the quarterly documentation process is routine and reliable. Proper transfer pricing for your multinational R&D partnerships becomes a marker of operational maturity.

The most important lesson is that for early-stage companies, tax authorities and auditors focus on the logic and the process. They want to see that you had a reasonable, arm's-length plan and that you documented your actions contemporaneously. Perfect valuation of highly uncertain R&D is not the expectation. Instead, consistent execution and clear records are your strongest defense. By implementing a simple system early, you build a scalable foundation for tax compliance and operational excellence.

Frequently Asked Questions

Q: Do we need a complex valuation for our R&D intellectual property at the seed stage?

A: No. At the seed stage, tax authorities do not expect a perfect valuation of highly uncertain IP. They focus on whether you have a logical, consistently applied method for allocating actual R&D costs based on factors like headcount or payroll. The process and documentation are more important than a speculative valuation.

Q: What is the biggest mistake startups make with intercompany R&D cost sharing?

A: The most common mistake is failing to document the arrangement formally with a signed agreement. Simply moving money between entities without a supporting CSA or CCA leaves the company exposed to significant transfer pricing adjustments and penalties from tax authorities in both the US and UK during an audit.

Q: Can we just call the payments an "intercompany loan" instead of creating a CSA?

A: While possible, this is generally not advisable for funding ongoing R&D. A loan implies an expectation of repayment with interest, which may not fit the economics of early-stage research. A cost sharing agreement correctly characterizes the transaction as a joint investment in innovation and is the proper transfer pricing model.

Q: How often should we update our R&D cost sharing calculation?

A: For most early-stage companies, performing the calculation and settlement on a quarterly or annual basis is sufficient. The key is to be consistent. Your agreement should also specify that the allocation key itself will be reviewed annually or when a significant change occurs, such as a large hiring round in one location.