Part 4: Proper setup of Intercompany financing: Key considerations

This contribution is the fourth and final article in a series on how companies combine centralized financing with a decentralized management system. In the first article, we explained what we mean by “centralized financing” and why many companies make use of it. In the second and third articles, we discussed the “decentralized management model,” the pitfalls of this model when combined with centralized financing, and the four requirements to avoid or manage these pitfalls. In this final article, we focus on setting up an intercompany financing structure under a centralized group financing arrangement.

Key points addressed in this article include:

Which entity(ies) should serve as the central borrower(s)?
What types of intercompany funding exist?
What should be considered when documenting intercompany financing?
How should pricing for intercompany financing be determined?

1. Which entity(ies) should serve as the central borrower(s)?

Ideally, a single entity is set up whose sole purpose is to borrow and on-lend financing within the group—often referred to as an in-house bank. This entity then acts as the only central borrower under the group financing arrangement. This structure is commonly seen in very large multinationals.

In practice, however, multiple borrowers are often involved. Typically, this includes the top holding company and, in some cases, certain sub-holdings (for example, regional or business-unit sub-holdings). The top and sub-holdings draw financing from the bank(s) under the group facility and then lend it internally.

2. What types of intercompany funding exist?

There are several ways to structure intercompany financing. The most straightforward method is to provide a fixed-term loan (term loan) from the holding company that borrows externally to the entity that requires funding. This loan has a fixed term, and the borrowing entity repays the intercompany loan either over the term or at the end of the term. The downside is that the loan amount is not flexible. This can be addressed by establishing an interest-bearing intercompany current account.

With an intercompany current account, the borrowing entity can flexibly draw or repay funds from the lending entity. It is important to set a limit that determines the maximum amount the entity can borrow (see also our previous article). Another key consideration is that systems must be set up to properly record the intercompany current account relationship (in Excel, the ERP system, or a treasury management system). Intercompany current accounts also arise in the context of a (zero-balancing) cash pool set up at a bank. The bank account of the operating company is either swept or topped up daily, creating current account balances with the master account holder (often the top or a sub-holding).

Typically, fixed intercompany loans are used to finance fixed assets (e.g., investments in real estate, machinery, or acquisitions), while intercompany current account relationships are used to finance working capital and other assets with a shorter-term funding requirement.

3. What should be considered when documenting intercompany financing?

Proper documentation of intercompany financing is essential. Clear documentation ensures that agreements are transparent for both internal stakeholders (to prevent disputes between different operating companies) and external stakeholders (including tax authorities).

Documentation should include agreements on term, collateral, internal limits, and any financial covenants applicable to the internal financing structure. Legal agreements must be concluded between the lending and borrowing entities. For entities in different countries, it is crucial to account for local (tax) laws, which may differ between jurisdictions. Documentation should be tailored accordingly.

4. How should pricing for intercompany financing be determined?

In recent years, there has been increased focus on the pricing of intercompany transactions in organizations operating across multiple countries. Various global regulations (including BEPS) have been developed to prevent multinationals from exploiting different tax regimes to significantly reduce the group’s overall tax burden.

In 2022, the OECD published the latest version of the Transfer Pricing Guidelines (TPG). The TPG serve as a global standard for determining the pricing of cross-border transactions (including loans) within multinationals. The TPG emphasize that intercompany financing transactions should be priced as if the loan were provided by an independent lender or bank. This means that the applied interest rate and terms must be “at arm’s length.”

When determining an arm’s length interest rate, factors such as the borrower’s creditworthiness, term, currency, collateral, and market conditions at the time of financing must be considered. The OECD stresses the importance of a thorough analysis of credit risk and the financial position of the borrowing entity. In practice, transfer pricing models are often used, based on credit rating analyses combined with external benchmarks (market interest rates and spreads) to determine an appropriate interest rate.

Additionally, the functions, assets, and risks borne by the group companies involved also play a role. For example, a treasury center actively managing liquidity and market risks may warrant higher compensation than a passive pass-through structure. The TPG also highlight the importance of assessing guarantees or implicit group support, which may influence the risk premium on interest rates.

Summary

This article provides practical guidance for designing an intercompany financing structure. First, it is necessary to determine which entity(ies) will act as the central borrower(s), often the top holding and, in some cases, a few sub-holdings. Next, the types of financing to be used should be defined, such as fixed loans or intercompany current accounts. Finally, both the documentation and pricing of the intercompany financing structure should be carefully established in advance to prevent internal and external disputes.