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What Are Intercompany Loans?

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  • Written By: Mary McMahon
  • Edited By: Nancy Fann-Im
  • Last Modified Date: 07 October 2014
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Intercompany loans are loans made internally within a company to address funding needs in different departments. They can potentially create tax problems, and it is important to originate such loans with care to avoid common tax pitfalls and accounting problems. If an intercompany loan appears to be necessary, a tax accountant can provide advice on how to set up the loan and how to report it accurately on tax documentation.

The issue with intercompany loans and taxes is that while the company may consider it a loan, government agencies may view it as an equity investment. If it is an investment, it must be treated differently by the recipient, and creates a complicated tax situation. Intercompany loans must be conducted at arm's length with a clear loan agreement to demonstrate that it is a loan within the company, not a movement or investment of capital, and the borrower has an obligation to repay it at set terms.

Agreements for intercompany loans should disclose the loan amount, repayment period, and interest. If the loan does not have clear terms, this can arouse the suspicion of government agents. For accounting purposes, the borrower should consider the loan a debt obligation and account for it in its financial disclosures, while the department doing the lending should also list the loan. Borrower and lender must track the loan payments and adjust the loan agreement if it becomes necessary to change the terms because the borrower can no longer service the loan.

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Intercompany loans can be a very useful source of fast financing at agreeable terms. This can be important when lack of funds slows project development, a company does not want to access outside credit, or it is necessary to quickly move funds before a project shuts down. Companies should consult their attorneys and lawyers to develop an appropriate contract and define the loan appropriately on tax declarations.

If tax authorities suspect that a supposed intercompany loan is not what it appears to be, they can conduct an investigation. This will include an investigation of accounting paperwork, documentation associated with the loan, and business practices. The tax authorities can charge back taxes if they feel the loan should count as taxable income, and there is also a risk of penalties if evidence indicative of fraud is present. All communications about the loan should be made with the awareness that they may be investigated by the government.

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gforce1059
Post 4

I work for a company with a number of subsidiaries, including Ireland and Scotland, and we have inter-company loans, rather than being funded externally. If a subsidiary has excess funds in the bank, it is pointless for another subsidiary to get funding externally and have to pay a high interest rate.

The inter-company loan agreement could state that the loan is not subject to interest charges and therefore no interest charge for this is posted to the profit and loss account. However, for tax purposes, the interest charge must be deemed to be at arm's length and a notional interest charge / receivable has to be put through the tax computation of the relevant subsidiaries using an arms length interest rate. At least this way, the tax on the interest payable and receivable nets off at the group level and cash that would otherwise be paid for interest stays within the company.

tuffy57
Post 3

@evaretra: Companies prefer to go the loan route (especially when it is an international organisation) due to the fact a loan agreement allows for interest to be charged on the loan. This reduces the tax liability in the country of the borrowing company whilst simultaneously retaining the funds (interest) within the group. Simple treasury funding normally does not carry this interest tax benefit.

NathanG
Post 2

@everetra - As to your first question, companies have departments each with their own budgets and treasuries. I don’t think you can just transfer money from one department to another; that would create serious accounting problems.

As for the possibility of default, the article mentions adjusting the terms of the loan agreement if there are problems with repayment. I don’t think you can default in the usual sense of the term. The company will simply keep modifying the loan terms until the money has been repaid, somehow, someway.

I do agree with you, however, that the whole thing seems like an iffy proposition from the start, and would doubtless raise some eyebrows.

everetra
Post 1

This sounds like I’m borrowing from my left pocket to deposit money in my right pocket. I can see how that the very arrangement of an intra company loan would arouse suspicion from accountants and possibly government investigators.

I have two questions. Since these are loans within the company, why not simply give the department access to needed capital out of the general treasury, in other words making it a withdrawal of cash and not a loan?

Secondly, what happens if the borrower defaults? Can the company more or less default on itself?

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