Substantiating the arm’s length nature of inter-company loans and guarantees

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The business nature of loans between group companies can be demonstrated by drawing up transfer pricing documents. Substantiation can be obtained by determining the credit rating and calculating the corresponding rate of interest.

Arm’s length nature of the loans

Inter-company loans are only fully recognised as such where the business nature of the loan can be demonstrated. Where a loan is non-arm’s length (default risk too high), the write-down losses are not tax deductible. Substantiation of the arm’s length nature of the loan can be demonstrated by stating the creditworthiness of the party receiving the loan.

Credit rating

The creditworthiness can be calculated by a professional credit ratings agency (Standard & Poors, Fitch, Moody’s). At a substantially lower cost an approximation of the credit rating can also be obtained with a programme specially designed for this purpose, and this is where Baker Tilly Berk can help you. 

The following information is needed for calculating the results:

  • The annual accounts prior to the date that the loan was made.
  • The loan contract including the principle sum, duration and anticipated rate of interest.
  • The projection drawn up prior to the date that the loan was made.

Interest rate

The rate of interest can be set based on the credit rating.

Guarantees

With guarantees between affiliated group companies, the question arises of whether a guarantee fee must be paid to the company giving the guarantee. The credit rating of the company receiving the guarantee is also important when answering this question.

Certainty about the outcome of discussions with the tax authorities can never be given. Proper documentation for the substantiation of arm’s length loans will give you a head start. We can help you determine the credit rating of a company and/or the interest rate level that should be applied. For more information please contact your consultant.

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