9 Key Questions for Intercompany Loan Agreements

How to scope out intercompany agreements that deal with loans and indebtedness

Intercompany debt remains one of the more complex and scrutinised areas of transfer pricing compliance – especially when it comes to loans and financial arrangements between associated enterprises within multinational groups.

This article outlines nine essential areas to assess before preparing or reviewing an intercompany loan agreement. These questions are designed to help practitioners ensure that documentation is not only legally sound, but also aligned with tax and regulatory requirements, and capable of withstanding scrutiny from tax authorities and regulators.

They are:

1. Participating entities and structure of debt

Is the intention to document a single loan, a series of loans between the same lender and borrower, or multiple loans between different parties? (If you can standardise the legal form and commercial terms of intercompany debt across the group, it will be easier to maintain the relevant documentation). Consider whether the arrangement involves group companies, two companies, two group companies, or subsidiaries, as intercompany loans facilitate financing and fund transfers within a corporate group.

2. New debt vs existing debt

Have the relevant loans already been advanced, or have the debt obligations already arisen? If so, what are the existing terms of the debt, and what documentation already exists? The purpose and commercial rationale for changing the terms of existing debt will need to be clarified and documented.

3. Regulatory considerations

Are any of the relevant entities subject to particular regulatory requirements or other legal restrictions which affect loan capital or use of cash? For example, regulated entities within the financial services sector may be subject to specific requirements as regards regulatory capital. It is also important to consider all applicable regulations, regulatory compliance, and the need to ensure compliance with tax laws and transfer pricing guidelines.

4. Solvency considerations

Are any of the participating entities subject to solvency concerns? Examples may include entities with negative net assets or negative reserves. (Such situations may give rise to additional accounting issues and enhanced personal liability risks for director). The impact of the loan transaction on assets and tax liabilities should also be assessed.

5. Third party creditors and security interests

What third party creditors does the borrower have (or is it likely to have), and are those creditors likely to be secured? Such arrangements will affect the lender’s and the borrower’s risk, and may also provide a constraint as regards the form and substance of the intercompany arrangements which may be put in place. When comparing external borrowing and external loans to intercompany loans, note that external loans often come with high interest rates, stricter terms, and less flexibility, while intercompany loans can offer lower interest rates and are generally more cost effective as internal financing options.

6. Other legal constraints

Are there any other legal constraints which may restrict the ability of any of the entities to participate in the arrangements? This includes constraints which affect the lender’s ability to lend, or the borrower’s ability to borrow. Examples may include covenants given in the context of third party loan facilities or government grants received. Consideration should also be given to equity financing and equity as alternative funding options for companies.

7. Security

Is it appropriate for security to be provided by or on behalf of the borrower? This may be in the form of a charge over assets or a guarantee provided by an entity other than the borrower. The presence or absence of such security can be a key comparability factor, and a key part of the economic analysis of the arrangement. Unsecured loans, which do not require collateral, differ from secured loans in terms of risk and documentation requirements.

8. Legal form of the debt

Are any non-transfer pricing considerations likely to apply which may require the debt to be documented in a particular legal form? Intra group loan agreements and contracts should be clearly defined and documented to align with arm’s length principles and independent parties’ standards. Key terms such as interest, maturity, and covenants should be explicitly defined in the intra group loan agreement.

9. Purpose and commercial rationale

What is the purpose of the loan (or the proposed modification to existing arrangements), and why does the form and substance of the transaction make sense from the individual perspectives of each participating entity? Intercompany loans can be tailored to the specific needs of each company or subsidiary, supporting cash flow management and providing flexibility. The purpose may include funding operations, supporting expansion, or optimizing the use of funds and money within the group. Tax benefits, tax efficiency, and the impact on taxable income should also be considered.

This last question is arguably the most important, from both a legal and a transfer pricing perspective. It relates to many other issues, including the business strategy to be followed by the borrower; from the lender’s perspective, the risks relating to the loan and assumptions as regards the cashflows and assets; and, from the borrower’s perspective, its ability to service the debt and meet its obligations as regards payment of the principal repayment obligations. Intercompany loans are generally structured to reflect the terms that would be agreed between independent parties, with proper consideration of all relevant factors, including the impact on the company’s tax position, tax implications, tax liabilities, and overall financing strategy. Aligning intercompany loans with the corporate group’s financing strategy, including the use of funds, money, assets, and comparisons with external financing and external loans, is essential.