In the field of international taxation, intra-group financing (IGF) has become one of the most widely used financing mechanisms by multinationals, but also one of the most closely monitored by tax authorities. These seemingly simple transactions involve multiple dimensions: from determining the interest rate to the capital structure of the borrowing company, including risk assessment and the availability of comparables in the market.
The tax focus is explained by the fact that, in most jurisdictions, interest is deductible for the borrowing entity, unlike dividends. This differential creates a natural incentive for business groups to structure financing schemes that, without adequate economic support, may favor the transfer of profits to countries with more favorable tax regimes. As a result, intra-group loans represent an area of potential aggressive tax planning and, at the same time, a high risk of transfer pricing adjustments.
Why do tax authorities pay special attention?
Intra-group financing, involving related entities rather than independent parties, opens up ample room for transfer pricing issues. Unlike a transaction with third parties, where conditions are determined by market supply and demand, in intragroup loans it is the group itself that defines the financial terms. This raises legitimate questions about whether these conditions truly reflect what would have been agreed between independent parties.
As a result, tax authorities closely analyze these transactions to identify possible distortions that could erode the local tax base. Among the main risks that are often observed are:
- Artificial or excessive indebtedness: Companies could unduly increase internal debt levels to increase interest deductions, reducing the group’s consolidated tax base.
- Reclassification of loans as capital: If the instrument does not meet the characteristics of a genuine debt contract—defined term, interest payments, explicit contractual clauses, guarantees, or other supporting factors—it could be reclassified as a capital contribution, especially if there is no evidence of economic consideration.
- Inappropriate interest rate: Choosing a rate that is too low (or inappropriate) and does not reflect the risk, term, currency, or market conditions may result in adjustments by the tax authorities.
Key elements for structuring an IGF in accordance with the arm’s-length principle
In order for an intragroup loan to be upheld by the tax authorities, it is advisable to include the following elements:
- Validate a reasonable debt/equity ratio: The borrower must have a level of debt that is reasonable in comparison with what an independent third party would accept in similar circumstances, paying attention to leverage ratios in the sector.
- Arm’s-length determination of the interest rate: The schedule of interest and principal payments, penalties for default, and conditions for possible renegotiations must be stipulated, in addition to reflecting standard market terms and conditions.
- Determination of the arm’s-length interest rate: The interest rate applied must be comparable to the market: either through comparable independent transactions (CUP) or through analysis of debt spreads adjusted for credit risk, term, currency, or collateral structure.
- Document each assumption in the analysis: Adjustments, selected comparables, functional differences, risk analysis, market conditions, internal interviews, etc., must be supported by robust documentation.
- Periodically review the conditions: Given the volatility of macroeconomic factors (interest rates, country risk, changes in credit), it is prudent to establish clauses that allow for adjustments or reevaluations of the instrument.
It is important to emphasize that, for the correct determination of interest rates and loan conditions, the tax authorities not only assess the functional analysis, but also the risk involved in the transaction. This includes aspects such as the borrower’s credit profile, the guarantees offered, the currency of the transaction, and the market conditions in which the group’s activities take place.
Additional practical considerations
- In situations where interest-free loans are granted, it is necessary to assess whether these are truly loans or whether they are disguised capital contributions.
- Borrowers must demonstrate independent financial capacity and solvency to assume the debt, without relying solely on the group to meet payments.
- In the event of an audit, the taxpayer must be prepared to explain what economic facts justify the transaction and why that comparison was identified as the most appropriate.
Conclusion
Intragroup loans are a legitimate corporate financing instrument, but given their exposure to the tax authorities, they require careful design from a transfer pricing perspective. Best practices consist of structuring instruments with real substance, comparable rates, complete documentation, and a consistent market vision. This not only mitigates risks but also reinforces the consistency of the group’s operations in the face of potential tax challenges.
Specialized support in transfer pricing
The correct structuring and documentation of intra-group loans is essential to avoid tax contingencies and ensure compliance with international standards. Having the support of specialists makes the difference between a solid transaction and a potential tax dispute.
TPC Group offers comprehensive advice on transfer pricing and international taxation, helping companies design, evaluate, and support their intragroup financing policies in accordance with best practices and current regulations.
Source: The Sun