Loan Considerations for Cross-Border Transactions | Podcast

In this episode of Weaver: Beyond the Numbers, Josh Finfrock discusses key considerations for companies engaging in cross-border funding transactions, including whether to use capital contributions or intercompany loans. He highlights the importance of ensuring that transactions are respected as legitimate loans rather than equity contributions, analyzing debt capacity to determine appropriate loan amounts and benchmarking interest rates to be in line with market conditions.

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Detailed Description of Loan Considerations for Cross-Border Transactions

00:00:00
Josh: Hi. I’m Josh Finfrock and I lead the transfer pricing practice at Weaver. And I’m here to talk about another transfer pricing topic today. We commonly deal with companies who are planning cross-border transactions related to funding events.

00:00:12
Josh: So, when companies are making an investment or need cash somewhere that they don’t have it, they’re commonly looking at the question of whether they contribute capital or cash into this, or whether they do something around an intercompany loan and what makes sense from a tax perspective.

00:00:31
Josh: Often, there are benefits to having some amount of intercompany debt in a cross-border tax structure, but companies need to be careful to consider all the things that the IRS would want to consider, or the other foreign government, who are keenly interested in limiting interest deductions and some of these kinds of things.

00:00:49
Josh: So, the first thing that really has to be considered is the nature of the transaction. So, between case law factors and relevant rules, we need to make sure that the transaction is going to be respected as a loan and not be really recast or considered more like an equity type contribution.

00:01:09
Josh: So that’s the first piece, and there’s some analysis that goes into that. Usually, not a bright line, but there’s a collection of factors that can go into that consideration. The next thing to really consider is the debt capacity, meaning how much would an independent party be willing to lend to this borrower in similar circumstances, right?

00:01:33
Josh: So, part of what we need to look at there is, in certain context, it may be like a loan to value if we’re buying assets in that company. But in an operating company, it may be more how do we show that this is something that we’re going to be able to repay and operate with the debt level and the interest level and all these different kinds of things.

00:01:52
Josh: So, there are a lot of different metrics that can go into supporting the notion that that is in line with market kind of conditions and then how independent borrowers are being treated by lenders.

00:02:04
Josh: And then the other piece and, usually, this is actually the first piece that I get asked about is the interest rate, which is important. This can be benchmarked.

00:02:12
Josh: We do transfer pricing analyses all the time to benchmark against the debt markets for interest rates, which involves a couple of things. You need to take the borrower and credit rate it on an independent basis and then benchmark against terms and conditions and the types of loans that are in that space to make a reasonable approach there.

00:02:33
Josh: The other thing available is safe harbor rate in the U.S., which is commonly very effective, especially for middle market companies, to utilize as long as they’re able to support the nature of the transaction as debt and they’re able to support the debt capacity amount.

00:02:49
Josh: One last thing that I like to make sure people are going to consider with this interest rate is the IRS has put out recent guidance. We’re clearly in a context where the U.S. side of this might be the borrower.

00:03:03
Josh: Their natural position is going to be one of implicit support. What is implicit support? Implicit support means that they’re going to view this U.S. subsidiary entity as integrally linked with the parent company if it’s foreign.

00:03:18
Josh: And so, if it’s a really high interest rate because the standalone subsidiary wouldn’t get a very good rate from a bank, they’re still going to question that, really, this parent company is effectively the same.

00:03:32
Josh: So, we should be borrowing in the U.S. at a lower interest rate more in line with the credit rating of the overall group, right? And so, that’s an exposure as well, especially for our U.S. subsidiary borrowers, to think about.

00:03:46
Josh: And so, in a case where a company is using a rate much higher than the AFR, it becomes more important to have that backup and support for the debt capacity, the interest rate, have thought through the implicit support arguments that the IRS might levy against a client.

00:04:04
Josh: So, when we’re looking at that with our clients, we want to make sure we’re preparing them for what the IRS might be wanting to ask, and these can also come up at the state tax level as well for the separate filing states.

00:04:16
Josh: And any of these transactions, whether it’s a loan into or out of the U.S., have a counterparty, another country’s jurisdiction as the borrower or the lender. And those countries are going to have similar types of considerations and scrutiny going on intercompany loan arrangements.

00:04:36
Josh: So, it needs to be looked at from both sides and considered. So that’s our topic for today.

00:04:41
Josh: Thanks for joining us and look for another topic soon. Thanks. Bye.

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