Intercompany Loans under Scrutiny: IRS May Consider Implicit Support in Loan Pricing

Intercompany loans are a key part of cash management for multinational companies, but they are also an area of increased Internal Revenue Service (IRS) scrutiny. This is particularly the case around the issue of how a company’s membership in a group of multinational companies influences interest rates and the related deduction for interest expense. The IRS indicated in a memorandum that it may consider the possibility of financial support from a subsidiary’s foreign parent, commonly referred to as “implicit support,” when assessing the required “arm’s length” interest rate for intercompany loans.

Intercompany Loans and IRS Scrutiny

Parent companies of multinational groups often make loans to subsidiaries as part of their cash management process. These companies must support the position that the transaction is bona fide debt, including that it has a business purpose and that the terms are similar to “arm’s length” transactions between unrelated parties. In doing so, companies must consider realistic alternatives to support the determination that an independent lender and borrower would enter a loan transaction with similar considerations for borrowing capacity, interest rate, and other terms and conditions.

As part of its efforts to prevent tax evasion, the IRS often scrutinizes these transactions and adjusts the income, deductions, credits, or allowances of group members. Under Internal Revenue Code (IRC) Section 482 and the related regulations, the IRS may adjust the interest rate in an intercompany loan to reflect membership in a multinational group if an unrelated lender would consider a borrower’s group membership in establishing financing terms for the borrower and third-party financing is realistically available.

The scenario in which a foreign parent makes a loan to its U.S. subsidiary but does not explicitly guarantee that it will provide financial support for the loan further complicates the issue. In Advice Memorandum 2023-008, the IRS Chief Counsel considered this scenario and concluded that group membership does affect the interest rate charged between related entities even without an explicit guarantee of support.

Determining the Arm’s Length Interest Rate

In determining the arm’s length interest rate, Section 482 states that “[a]ll relevant factors shall be considered, including … the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans between unrelated parties.” Because a commercial lender would charge interest based on the borrower’s credit rating, the borrower’s role, level of integration within the group, and implicit support from affiliates are factors that inform the borrower’s rating.

The IRS considers all of these factors in its assessment and may adjust interest rates in loans between related subsidiaries of a corporate group to comply with the arm’s length standard. The IRS can base this adjustment on an agency credit rating of the borrower, on a similar analysis, such as a “shadow rating,” or on terms available to the controlled borrower from commercial third-party lenders. According to the memorandum, this includes adjusting the interest rate in an intercompany loan to reflect group membership and implicit support from the group.

While intercompany loan transactions can provide an efficient cash management tool, chief financial officers of multinational groups should consider potential scrutiny from taxing authorities when evaluating, executing, and documenting intercompany financing activities, including the possibility of financial support from a subsidiary’s foreign parent.

For more information on how the IRS could scrutinize intercompany loans, contact us. We’re here to help.

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