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Is it preferable to finance a trading subsidiary through a loan from the parent company or a capital contribution?

We are an international start-up and funding was obtained by the parent company. In order to finance the trading subsidiary, would it be best to transfer the funds from the parent company in the form of a loan (repayable on demand with no interest) or a capital contribution? I understand there are both tax and legal implications but was wondering what "best practice" is considered to be?

Answers

Topic Expert
Scott MacDonald
Title: President/Owner
Company: AlphaMac Resources, Inc.
(President/Owner, AlphaMac Resources, Inc.) |

The "best practice" is to limit the amount of taxes you pay. If there are foreign subsidiaries involved you have other things to consider. Since I don't know the tax jurisdictions you are involved with, it is impossible to give you and answer. Consult your a qualified tax accountant or tax lawyer to help you understand how to minimize taxes.

Topic Expert
Simon Westbrook
Title: CFO
Company: Aargo Inc.
( CFO, Aargo Inc.) |

Jurisdictions are important, especially if overseas.

But the principles to understand are as follows.

Intercompany relationships are not arms length. If the receiving party is not paying interest at a true commercial rate given the risk, volume, and time, then the receiving party's tax jurisdiction is likely to attribute the benefit of such below par interest as taxable income to the receiver.

If you fund the Company by equity, the investment is committed and may be hard to recover when the receiver becomes profitable, other than by way of dividends which will be taxed. Some countries are especially hard to recover cash from due to tax, FX, labor protection and bureaucracy issues.

You might also consider your Investor's position if you lend or invest his money to an overseas subsidiary

Anonymous
(Finance Director) |

I am responding as the original poster...At the moment we do not pay taxes as both the subsidiary and entity over all are loss-making. Both the holding company and subsidiary in question are in the UK. I was told that dividends to a holding company are tax free. However, the subsidiary must be profitable in order to issue dividends to the holding company. It seems that the major advantage with a loan is for legal reasons; with a loan, the money can be repaid on demand if the company decides to dissolve the subsidiary for any reason (it seems this would be unlikely). In terms of tax, since both the subsidiary and holding company are loss making, if the holding company were to have taxable interest income then we would be paying more taxes overall so that is why at the moment a loan is disadvantageous for tax reasons.

Pedro Rodrigues
Title: Group Deputy CFO
Company: Delfingen Group
(Group Deputy CFO, Delfingen Group) |

I totally agree with Simon.
If you have sufficient knowledge of your activity and you think you will generate future cash flow, it is better to do it as a loan, this way you are sure to get your money back.
Just don't forget that some countries (India, Brazil, China, ...) have some restrictions for the implementation of the loan and extra paperwork in the case you can not pay in time (justification to the National Bank, new schedule, etc...).

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