When deciding on intra-group financing, it is important to take into account not only the prospects for the commercial development of the borrowing company and its current financial stability.
There are several common intragroup funding options :
- The loan from the parent company (including from a foreign-related party)
- Credit from other group members (including physical ” cash pool “)
- Contribution to property (an increase in the net assets of subsidiaries due to a contribution to the charter capital, transfer of property, property or non-property rights, as well as release from debt).
- A loan from an independent bank under a guarantee or guaranteed by a foreign-related company (indirect intra-group financing option).
The loan from the parent company
Of course, the receipt of funds from the parent company, which, as a rule, has more liquidity and a lower cost of raising capital, promises great benefits for the borrowing company. In most cases, a subsidiary can count on a loan at a rate significantly lower than in commercial banks (or even on a loan at 0%).
The greatest tax risks arise from companies that raise funds in the form of a loan from a foreign-related party. Such financing schemes attract the maximum attention of the tax authorities and are perceived as controlled debt. Tax authorities initially see such transactions as a way to withdraw profits and avoid taxation from the foreign parent company.
Therefore, often interest on a loan, which should normally be deducted from the tax base and taxed at a rate of 20% to 0% (if Russia has an agreement on the absence of double taxation with the recipient country), can be re-qualified by the tax authority as dividends that are not deducted from the base when calculating income tax and are taxed at a rate of 5% to 15%.
The reclassification of loan payments from interest to dividends is legally based on the rules of “ thin capitalization ”: this requires that the court declares such debt controlled and that the amount of loans from the lender is three times the size of the borrower’s net assets. If these two conditions are met, all payments on the loan (or part of them) will be subject to additional taxes on dividends (if the loan is provided by a foreign owner, if the loan is provided by a World related company, a dividend tax is not withheld). Also, all these interest payments will be removed from taxable profit for the respective periods, as a result of which additional tax will be charged on the borrowing company.
In general, in order to charge additional taxes on the transaction, it is enough for the court to recognize the debt as controlled.
What debt is considered controllable?
This is an outstanding debt to a foreign interdependent legal entity, or to other persons acting as a surety, guarantor or otherwise ensuring the performance of this debt obligation. In general, the criteria for defining controlled debt are rather vague. In most cases, the courts in the World Federation side with the tax authorities. Therefore, all transactions to raise financing from the parent company must have a solid business case to defend their position in court.
Credit from other group members
The tax authorities can charge additional taxes and penalties through the court on all credit agreements, not only between directly affiliated companies, but also any interdependent companies. These risks apply not only to classic intragroup loan agreements, but also to all agreements within the framework of the cash pooling mechanism .
In order to have a strong position in the event that the additional tax assessment has to be challenged in court, the company must prepare as follows:
- Provideas much detail as possible for all loan agreements between the group companies (to the same extent as agreements with any third-party lenders, for example, banks). In the loan agreement, it is necessary to indicate the interest rate and the procedure for determining it, the timing of the loan repayment, the procedure for obtaining tranches (loan payments) and the lender’s liability in case of default. Thus, it is necessary to ensure that the loan agreement complies with the terms of urgency, repayment and payment.
- Establish the size of the interest rate on the loan based on the principle of transfer pricing( transfer pricing ). Those. the amount of interest rates on intragroup loans should correspond to the market level, but should not exceed the level of the interest rate that an independent bank is ready to offer to the borrower. The intra-group loan rate can be determined, for example, based on the key rate of the Central Bank or the indicative LIBOR rate adjusted by a fixed interest.
- If the financial position of an intragroup borrower changes significantly, it is necessary to initiate a renegotiation of the financing terms. If a decision is made to restructure a debt, then it must be economically justified and set out in writing.
- Group treasurersand finance professionals preparing a fundraising transaction, providing advisory and coordination services, should receive market compensation for this work.
- When concluding cross-border transactions(including physical cash pooling transactions ), all the requirements of the World currency legislation should be observed: issue a transaction passport and ensure that the requirements for repatriation of loans issued to foreign residents are met.
With less risk, a company can obtain an interest-free loan from another company in the group if all parties to the transaction are World companies. In this case, the loan payments will not reduce the taxable base. Therefore, with this financing option, the tax authority will have fewer reasons to believe that the transaction was made in order to lower taxes or withdraw capital from the World Federation.
Contribution to property
If the borrowing company is unable to service the interest-bearing debt, it is also possible to finance the business within the group through contributions to the authorized capital or property of the company. At the same time, a contribution to property, in contrast to an interest-free loan, increases the value of the net assets (NP) of the borrowing company.
The advantage of this option is that transactions on the transfer of certain property objects (for example, intellectual rights), as well as a contribution to the authorized capital of the company, are not taxed either on the side of the recipient or on the side of the depositor. In addition, the depositor can withdraw the invested property without paying taxes. However, one should be aware of the legal risks that could arise if such a withdrawal would precede the bankruptcy of the company being funded.
Debt forgiveness is sometimes encountered as a contribution to property – for example, when offsetting counterclaims. However, even with such transactions, significant tax risks often arise. In particular, the courts in the World Federation consider such offsets and forgiveness as receiving income in non-cash form and decide to charge additional tax. This does not take into account the arguments of the defense about the lack of income due to the fact that there was no actual transfer of funds to the current account.
Loan from an independent bank guaranteed by a foreign parent company
The indirect intra-group financing method is obtaining a loan from an independent bank against a surety or guarantee of a foreign related company. Often foreign parent companies have access to cheap financing, which they can share with their foreign subsidiaries through a mechanism for providing guarantees or guarantees for bank loans (as a rule, this is done through international banking structures in which the parent company has open lines of credit).
However, if a foreign person agrees to fulfill a debt obligation on a loan with a bank and is interdependent with respect to the borrowing company, then the tax authorities will probably not agree with the deduction of interest on such a loan from the tax base. According to World jurisprudence, a loan to an independent foreign bank secured by a letter of guarantee from another independent foreign bank is regarded as a controlled debt if the letter of guarantee was issued under the condition of its counter guarantee from the foreign shareholder.
Thus, many of the economic benefits of intragroup financing are offset by the presence of significant tax risks that must be taken into account in time and minimized at the stage of planning the transaction.