IRS Clarifies Intercompany Loan Rates, Citing Corporate Group Influence

Businesses with complex corporate structures face new IRS scrutiny over intercompany loans as the agency tightens regulations on the interest rates charged within corporate groups. The IRS’s latest legal memorandum, issued on December 19, 2023, signals a shift towards considering the financial strength of entire corporate groups when setting loan terms, potentially impacting how companies finance their operations.

Understanding the Change

For years, the pricing of intercompany loans has been a gray area, with businesses often challenged to justify the arm’s length nature of their intragroup financial transactions. The IRS’s recent memo, AM 2023-008, clarifies that if a third-party lender would factor in the company’s group membership when determining loan terms, the IRS is also entitled to do so. Under Section 482 transfer-pricing regulations, related entities are required to interact at arm’s length, meaning they should offer terms in intragroup dealings that mirror those available with an unrelated party.

Consider a scenario where a U.S. subsidiary of a foreign parent company has a better credit rating than it would have on a standalone basis. The better credit rating may be explained by its affiliation to an enterprise group and the financial backing it would likely receive from the parent in case of financial distress, which it wouldn’t have as an independent entity. In this scenario, the parent company cannot charge the subsidiary a higher interest rate based on the subsidiary’s standalone credit profile when lending funds because the subsidiary could secure a more favorable rate from an external lender, the IRS Memo explains.

The IRS Memo concludes, “That USSub’s credit rating depends in part on implicit support from Foreign Parent (and possibly other group members) does not alter this determination, and such implicit support is not separately compensable.”

Taking Proactive Steps

Taxpayers conducting intercompany financing transactions should be particularly mindful of the growing trend towards increased scrutiny in the transfer pricing space for these transactions. Being proactive in preparing robust supporting transfer pricing documentation will be the best strategy, not only to support the arm’s length nature of the interest rate agreed but also to protect businesses from potential adjustments and penalties and foster transparency and trust with the IRS.

Ask Marcum

For further assistance or to discuss your specific situation, Marcum’s transfer pricing professionals stand ready to guide you through these evolving regulations and support your business in achieving compliance.