While intercompany loans are often a relevant solution, the choices made during their structuring require particular attention. French tax authorities scrutinize these arrangements to ensure that the terms applied genuinely reflect market conditions. They demand a high degree of precision in the justifications provided, especially regarding the interest rate applied between related parties. Disputes over the appropriateness of the terms and conditions, or the approach used to determine the interest rate, can lead to value-destructive and complex tax controversies.
Beyond the functional analysis of the lender and borrower, four key points must be examined when setting up an intragroup loan.
1. Justifying the Borrower’s Debt Capacity
In some jurisdictions, to secure the debt qualification of the intragroup loan (particularly for borrowers with high credit risk), it may be necessary to demonstrate that the borrower could have obtained equivalent financing from independent lenders.
This involves:● Reviewing the borrower’s balance sheet and cash flow forecasts to assess whether, over the loan’s term, the borrower could reasonably service the interest and fees, and repay the principal; and/or● Comparing the borrower’s financial ratios (e.g., net debt/EBITDA and EBITDA/interest)—after accounting for the intragroup loan—with those of companies obtaining financing from independent lenders. The goal is to show that the borrower’s ratios are comparable to or better than those of similar borrowers in the market.
This approach helps secure the debt nature of the intragroup loan.
2. Defining the Loan’s Terms and Conditions
When structuring an intragroup loan, special attention must be paid to the choice of terms and conditions. French tax authorities examine not only the interest rate but also the appropriateness of the applicable terms.
It is recommended to consider the following imperatives:● Align the loan’s terms and conditions with the borrower’s financing needs and financial capacity;● Ensure that the terms and conditions are at least as favorable as those the borrower could have obtained from independent lenders for similar financing; and● Assess the impact of the terms and conditions on the interest rate, including its potential evolution over the life of the loan.
3. Assessing the Borrower’s and Intragroup Loan’s Credit Risk
Assessing the borrower’s credit risk, through the determination of its credit rating, is the cornerstone of securing the remuneration of an intragroup loan. A credit rating reflects an opinion on the borrower’s overall solvency and involves analyzing the company’s operational and financial risk profile.
When the borrower has not been rated by a credit rating agency, two main approaches are possible:● Conduct an analysis using appropriate methodologies for the borrower’s industry—known as shadow credit rating—such as those published by Moody’s or S&P Global Ratings; or● Use rating software that, based on financial data, calculates metrics such as probability of default, expected loss given default, etc., and translates these into an equivalent credit rating. This approach is accepted by the French courts.
The credit rating of a group company must also consider, where applicable, the effects of implicit support—that is, the likelihood that the company would receive support from its group in times of difficulty (despite the absence of a legally binding commitment), enabling it to meet its financial obligations. Each rating agency assesses the potential for implicit support using its own methodology. If such support exists, it typically results in an uplift of the preliminary (stand-alone) rating by a certain number of notches, leading to the company’s final credit rating.
Additionally, the intragroup loan itself must be rated to account for its specific characteristics, such as seniority and the presence of any collateral. This issue rating serves as the basis for determining an arm's length interest rate.
4. Determining the Intragroup Loan’s Interest Rate
Based on the first three points, it is now possible to determine an arm’s length interest rate. This rate should primarily be defined by reference to comparable financings entered into between independent companies, such as financing obtained by the borrower or a group company (internal comparable) and/or financings exclusively between independent companies (external comparables).
Given the size of credit markets, it is often possible to identify comparable financings—e.g., loans or bond issuances—and obtain a credit margin or margin range reflecting the characteristics of the intragroup loan.
In practice, the goal is to strike a balance between:● Rigorously considering the determined credit rating and the terms and conditions of the intragroup loan;● The availability of data; and● The reliability of comparability adjustments that may be required if there are differences between the intragroup loan and the selected comparables.
This process results in an interest rate range that the company can confidently apply to the intragroup loan and, if necessary, defend in the event of French tax authorities inquiries.