Nine preliminary questions when considering intercompany loan agreements

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

Many thanks to everyone who gave us positive feedback about our recent thoughts on intercompany debt. I've been thinking about that subject a lot recently, as I'm in the process of updating our book 'Intercompany Agreements for Transfer Pricing Compliance – A Practical Guide’, and over the last few days I've been working on the chapter on loans and indebtedness between associated enterprises in a multinational group.

It includes a section called 'Preliminary considerations: initial questions regarding the fact pattern', and I thought you might like to see a summary of that here. It lists nine fundamental areas that should be considered before preparing or reviewing an intercompany loan agreement or associated document. 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.)

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? For example, regulated entities within the financial services sector may be subject to specific requirements as regards regulatory capital.

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.)

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.

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.

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.

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?

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?

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.