Six Implications of RisingInterest Rates on Your Intragroup Financing

As a direct result of inflation and central bank monetary policies, the historic rise in interest rates and stricter lending conditions are having a significant impact on businesses. This period of changing market conditions also affects intragroup financial transactions, which remain one of the most closely scrutinized areas during tax audits.
This situation calls for greater precision and individualization in the remuneration of each financial transaction—especially as higher interest rates correlate with increased financial impact in the event of tax adjustments. While each situation must be assessed on a case-by-case basis to ensure transactions comply with the arm’s length principle and to limit the risk of disputes, several key points require particular attention.

1. Potential Deterioration in Credit Risk for Certain Companies

Unfavorable economic outlook, sectoral slowdowns, and rising financial costs may increase the credit risk for some companies. Rating agencies anticipate higher default rates and downgrades for certain businesses.
Additionally, financial support provided by a group company to a struggling affiliate (even without a legally binding commitment) demonstrates the existence of implicit support within the group. Such support can influence, to varying degrees, the credit risk assessment of certain group companies.

2. Changes in Borrowing and Repayment Capacity

In some cases, to secure the debt qualification of an intragroup loan, it may be useful to demonstrate that the borrower could have obtained equivalent financing from independent lenders.
For new financing or refinancing of existing debt, the increase in financial charges—coupled with the decline in EBITDA for some companies due to inflation—may have reduced their ability to repay and service interest. In this context, a thorough analysis of the alignment between the borrower’s cash flow forecasts and the terms and conditions of the proposed intragroup loan is essential to reasonably justify its repayment capacity.

3. Evolution of Interest Rates

Interest rates on newly concluded intragroup loans must reflect current market conditions. For financings arranged before the rate hike, their terms are generally assessed as of their inception date.
However, in certain situations, French tax authorities may question whether the parties should renegotiate the applied interest rate (or even refinance intragroup debt). In this regard, tax courts have ruled that the arm’s length nature of a loan should be assessed not only at the time it is granted but also subsequently, especially if clauses allow for renegotiation under more favorable terms for one of the parties.

4. Updating Terms for Debit and Credit Positions in Cash Pooling

The end of negative interest rates and the continuous rise in rates require more frequent reviews of the remuneration terms applied to debit and credit positions of entities participating in cash pooling.
This centralized management of short-term liquidity needs and surpluses must always enable participating companies to benefit from interest rates at least as favorable as those they could obtain from independent parties.

5. Increased Use of Financial Guarantees and Their Remuneration

The slowdown in bank lending to businesses and the sharp rise in borrowing rates have led some companies to provide financial guarantees to facilitate financing for subsidiaries. These guarantees should, in principle, be remunerated at arm's length (in the form of a guarantee fee) paid by the borrower to the guarantor.
Again, the dual phenomenon of rising rates and deteriorating credit risk for the borrowing subsidiary increases the value of the financial guarantee—and thus the arm’s length guarantee fee applied.

6. Management of Risks Borne by the Lender and Its Profitability

Rising rates and economic slowdown highlight the importance of functional analysis (i.e., the functions performed, assets used, and risks actually managed and borne by each entity). For example, if the lending company borrows at a variable interest rate, its financial costs increase. If it lends at a fixed rate to other group companies (and does not use a hedging instrument against interest rate risk), the lending company may find itself in a loss-making position. The same applies if there is a mismatch between the repayment or refinancing dates of the loans it has granted and the maturity of its own debt.
This situation may raise questions from French tax authorities; therefore, risk management within the group must be carefully explained and documented.