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An intercompany loan is a financial arrangement between two or more related companies. These loans are often used to manage cash flow, finance operations, or transfer funds within a corporate group.
Intercompany loans are a common tool in corporate finance for several reasons:
Cash flow management - to optimise cash flow within a group, funds can be transferred from surplus companies to those in need.
Tax efficiency - depending on the specific tax jurisdictions involved, intercompany loans can be structured to minimise tax liabilities.
Financing operations - to finance specific projects or operations, companies can borrow from their affiliates.
Flexibility and speed - can be tailored to specific needs and circumstances, potentially with lower interest rates than external borrowing, quicker to arrange and reduced cost.
Tax efficiency - potential for tax benefits, such as interest deductions.
Under UK law, it's crucial for intercompany loans to be conducted on an arm's length basis. This means that the terms and conditions of the loan should be comparable to those that would be agreed between independent parties. Risks can include :-
Insolvency risk - if a company becomes insolvent, creditors may challenge non-arm's length transactions. Allegations may be made that they were unfair or preferential and a liquidator may seek to claw back funds transferred under non-arm's length transactions.
Breach of director duties - directors have a duty to act in the best interests of the company. Non-arm's length transactions could be seen as a breach of this duty.
Intercompany loans can have significant tax implications.
To mitigate risk it's important to be able to demonstrate sound underlying reasons for the loan arrangement, consider appropriate interest payment provisions, loan security, and warranties, covenants and default clauses in the loan agreement.
Negotiation - the terms of the loan agreement with the borrower.
Due diligence - conduct due diligence on the borrower's financial health and creditworthiness.
Drafting the loan agreement and any security documents - a comprehensive arm's length loan agreement that addresses all relevant legal and commercial issues.
Tax advice - consult with tax advisors to ensure compliance with tax laws and regulations in all relevant jurisdictions.
Regulatory compliance - adhere to any relevant regulatory requirements.
Completion - complete the loan transaction, including the disbursement of funds and execution of the loan agreement.
Interest provisions - standard commercial loans generally incorporate market-based rates, complex interest calculations, default interest and fixed interest payment dates. Intercompany loans often have lower rates (but must be arm's length) a simpler interest structure, may omit or have minimal default interest and more flexible payment timing.
Repayment terms - usually more flexible than external loans, possibly with on-demand features and early repayment without penalties and potentially contingent repayment tied to group cash flows.
Representations and warranties - typically lighter than external loans with less emphasis on financial condition.
Fewer financial covenants - may cross-reference group facility covenants.
Events of default - usually more limited than external loans,possibly excluding insolvency-related events
Security - often unsecured and if secured, possibly via a group security structure and with structural subordination
By leveraging our expertise and experience, we can help you navigate the complexities of intercompany loans and protect your business interests.
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If you would like to speak with a member of the team you can contact us on:
Partner - Corporate law
