Intercompany loans without charging interest expense

Daniel Magliari's Profile

Intercompany Loans

I am working for a privately held company that has recently acquired a couple of subsidiaries internationally. 

We currently need to provide an intercompany loans to two of the subs (located in Germany and Taiwan).  The subs are wholly owned by the parent.

In loaning the funds intercompany ("parent-to-sub" or "sub-to-parent"), is it absolutely necessary to charge interest on the loans - or for simplicity, can we loan funds back-and-forth without charging interest? (while still documenting and recording the intercompany loans in the financials).

We would like to forego the requirement for charging interest expense in order to minimize the internal accounting effort since it is all internal to the corporation. 

Can we loan funds without charging interest on the loan?

Answers

Member's Profile

I think GAAP doesn't care (except for treatment of exchange gains or losses - see FASB 52 for difference in treatment of revaluation between LT and ST intercompany balances.) All inter-company so eliminated for consolidation.

Your issue is going to be tax driven. US tax could say you should be imputing income. Foreign tax could say unless you have documentation, you can't deduct interest expense. You could end up with income taxed, but deduction disallowed. Also could have the loan re-characterized as a capital contribution by tax authorities, with implications when you try to pull funds back out - repayment of capital could be subject to backup withholding, etc.

Best to discuss with your international tax advisors, they are the ones most likely to be concerned that these loans are properly documented.

To comment, and for full access, login or register
Member's Profile

FIN 48 and the uncertainty of your tax position.
Agree with the other comments.

To comment, and for full access, login or register
Member's Profile

Yes, this is primarily tax driven. Intercompany loans (rather than trade intercompany or very short term advances) from US parent to nonUS sub requires an interest rate. Note the interest rate must be an arm's length rate. Also, note that the interest may require tax withholding (reduced treaty rates may apply) which will require a US tax computation for foreign tax credit purposes.
If there is a loan from the sub to the parent make sure to check whether there is a deemed repatriation of funds under Section 956.

To comment, and for full access, login or register
Member's Profile

Daniel, you might want to take a look at Proformative's free...

"Accounting Resources Guide:"

http://www.proformative.com/resources/accounting-resources-guide

You might also check out this other discussion here on Proformative:

http://www.proformative.com/questions/best-practices-handling-inter-company-loans

Best... Sarah

To comment, and for full access, login or register
Member's Profile

We have wholly owned subsidiaries both in the states and oversees and we do not charge interest on the loans. Our auditors have never questioned it.

To comment, and for full access, login or register
Member's Profile

Mark,
I find it hard to believe that both audit and tax issues haven't been raised for you.
1) Auditors always question whether or not interest should be imputed on any and all loans, unless the activity is so transient (i.e., short-term Due To / Due From offsets) vs real loans, which always require repayment Ts & Cs. (Maybe yours waive their issues due to immateriality or otherwise,

2) Tax advisors you use don't indicate a requirement to formalize the loans, establish standard arms-length Ts & Cs, which would require interest as Allan and Zach have already commented.

To comment, and for full access, login or register
Member's Profile

when I took a 3 Mn long term ( 3 to 5 years) loan from an US company (parent co) for the 100% Indian subsidiary , I took the Indian government's (Reserve Bank of India) permission as an External Commercial borrowing with an interest of around 3% + LIBOR rate. So the bottom line is that for long term loans interest should be charged notwithstanding the accounting involved.

If you are looking at a short term of 30 to 90 days , some kind of trade advance should not be a problem without any interest. This will be ultimately set of against the running transactions. This is my personal opinion based on past experience.

To comment, and for full access, login or register
Member's Profile

I concur with Allan Kaplan, above. The issue is tax-driven.

To comment, and for full access, login or register
Member's Profile

GAAP is not the driver. It is US and Foreign Tax issue. Dooing things to make accounting easy should be the first clue that it may not be correct.

To comment, and for full access, login or register
Member's Profile

US tax law requires interest be charged to your foreign subs. This position does not depend upon whether it is an actual loan or a long term balance in an intercompany account. When you are audited, the US tax you would have paid if you charged interest will be levied by the IRS. There is no doubt. The difference at that point will be that it may no longer be deductible in the foreign sub. Most companies do seek to minimize the interest rate and this has survived audits.

To comment, and for full access, login or register