1. Introduction

In today’s globalized world, multinational enterprises (MNEs) often operate through a network of subsidiaries across different countries. Among the various financial arrangements that take place within such groups, intercompany loans are a common tool for managing liquidity, financing expansion, and optimizing capital structure. However, when such loans involve an Indian entity and a foreign subsidiary or parent, they must be carefully structured to remain compliant with Indian regulatory, tax, and transfer pricing norms.

This article provides a detailed guide on how to legally and effectively structure intercompany loans between Indian and foreign subsidiaries.

2. Regulatory Framework Governing Intercompany Loans in India

A. Foreign Exchange Management Act (FEMA)

When funds are transferred across borders, FEMA governs the transaction. Loans given by an Indian company to its foreign subsidiary or vice versa are treated either as External Commercial Borrowings (ECB) or Overseas Direct Investment (ODI), depending on the nature of the transaction.

• Outbound Loans (Indian Company to Foreign Subsidiary): These are regulated under the ODI rules.

• Inbound Loans (Foreign Parent/Subsidiary to Indian Entity): These are treated as ECBs.

Key conditions include:

• Loan agreements must be reported to the Reserve Bank of India (RBI).

• There are restrictions on end-use, tenure, and interest rate.

• All transactions must be routed through Authorized Dealer (AD) banks.

B. Companies Act, 2013

Sections 185 and 186 of the Companies Act are crucial while structuring intercompany loans.

• Section 185 restricts loans to directors or entities in which directors are interested.

• Section 186 provides conditions for lending or investing beyond certain thresholds, including the requirement of board and shareholder approval.

• Interest must not be lower than the prevailing yield of a government security of similar tenure.

C. Transfer Pricing Regulations

Under Indian tax laws, any transaction between associated enterprises, including intercompany loans, must adhere to arm’s-length pricing.

Important requirements:

• The interest rate charged must be comparable to market rates.

• Comprehensive documentation and benchmarking studies must be maintained.

• Tax authorities can scrutinize these loans during audits, especially if interest-free loans are given or if repayment terms are vague.

3. Key Components of a Well-Structured Intercompany Loan

To ensure the loan structure is robust and defensible from a tax and regulatory perspective, the following components are essential:

A. Purpose of the Loan

Clearly define whether the loan is for working capital, capital expenditure, or any other specific purpose. Regulatory approval may depend on the intended use.

B. Interest Rate

The interest rate must:

• Be benchmarked to international rates like SOFR, LIBOR, or EURIBOR, depending on the currency.

• Be consistent with arm’s-length principles.

• Comply with FEMA and transfer pricing guidelines.

C. Tenure

The duration of the loan must align with regulatory limits. For ECBs, minimum average maturity periods apply based on the loan amount and sector.

D. Repayment Terms

A clear repayment schedule must be outlined. Grace periods, prepayment options, and consequences of default should also be included.

E. Security or Guarantees

Whether the loan is secured or unsecured must be specified. Any third-party guarantees should also be disclosed.

F. Governing Law and Jurisdiction

In cross-border arrangements, specify which country's law will govern the agreement and which court will have jurisdiction in the event of a dispute.

4. Taxation Aspects

A. Withholding Tax (TDS)

Interest paid by an Indian company to a foreign lender may attract withholding tax. The applicable rate depends on:

• The nature of the loan (ECB or regular debt).

• Availability of relief under a Double Taxation Avoidance Agreement (DTAA).

• If ECB conditions are met, a concessional rate may apply.

B. Deductibility of Interest

Interest expense must be at arm’s length and is only deductible if:

• The borrower can prove commercial necessity.

• Thin capitalization rules are not breached.

• The transaction complies with transfer pricing laws.

C. GST Implications

GST is not typically applicable to interest on loans. However, the GST impact on associated services like processing fees or forex charges must be examined.

5. Transfer Pricing Documentation

The loan must be supported by:

• A Transfer Pricing Study that includes benchmarking interest rates using comparables.

• Documentation of creditworthiness and business rationale.

• Evidence of actual fund flow, not just book entries.

Common transfer pricing methods used include:

• Comparable Uncontrolled Price (CUP) Method.

• Cost Plus Method (if there are value-added services involved).

6. Reporting and Compliance Requirements

Both the Indian and foreign entity must comply with reporting regulations:

In India:

• 
  File Form ECB with RBI (if inbound loan).

• Form ODI for outbound lending.

• Annual return on foreign liabilities and assets (FLA).

• Transfer Pricing disclosure in Form 3CEB under the Income Tax Act.

• Board and shareholder resolutions under the Companies Act.

Globally:

Foreign jurisdictions may require reporting under local BEPS (Base Erosion and Profit Shifting) or CbCR (Country-by-Country Reporting) frameworks.

7. Risks in Improper Structuring

Improperly structured intercompany loans can lead to:

• Tax disallowances or penalties.

• Recharacterization of debt as equity.

• Non-compliance with FEMA, leading to compounding proceedings.

• Regulatory scrutiny during audits or due diligence.

8. Alternatives to Intercompany Loans

• Equity Infusion: Simpler regulatory treatment but affects ownership.

• Convertible Debentures: Hybrid instruments with both debt and equity characteristics.

• Trade Credit Arrangements: For short-term financing.

• Royalties or Management Fees: For specific operational support.

9. Best Practices for Structuring Intercompany Loans

• Always obtain internal and legal approvals before proceeding.

• Maintain comprehensive documentation at every stage.

• Use conservative assumptions while pricing and structuring.

• Review and update intercompany loan policies regularly.

• Engage professional advisors for regulatory filings and documentation.

10. Conclusion

Structuring intercompany loans between Indian and foreign subsidiaries is a powerful financial strategy when executed properly. However, it must comply with Indian regulations under FEMA, the Companies Act, Income Tax Act (transfer pricing), and relevant foreign laws.

• Proper documentation.

• Transparent intent.

• Accurate transfer pricing.

• Timely regulatory reporting.

As regulatory authorities become increasingly vigilant, companies must prioritize compliance, documentation, and strategic structuring to make intercompany financing an efficient  and risk-free tool for international expansion.

Created & Posted by Twinkle Jha

Operations Head at TAXAJ

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