How To Safeguard Corporate Cross-Border Loans

When it comes to bank lending, the hot topic today is alternative finance for small businesses. But some of the largest corporations have some of the most complex lending habits, and according to a recent JD Supra editorial by Hodgson Russ LLP’s Victoria Saxon, conglomerates should take a close look at their lending practices to assure they are borrowing and lending safely and legally.

According to Saxon, companies can partake in lending activities in various ways. For example, they can move funds through a corporate group to fund a takeover or to provide working capital for an affiliate.

But corporations can run into trouble when it comes to recording these transactions. Businesses often record these intercompany loans as book-entry advances, Saxon said, and not document it until later. This could bring rise to serious tax consequences, especially if funds are being moved internationally.

U.S. tax law could categorize the lending as equity, for example, so businesses should document the funds as a loan with clear terms established — including fixed payment dates and interest rates.

“Thin cap” rules in the nation also require that loans to a subsidiary in the U.S. may be treated as equity if the subsidiary is too “thinly capitalized.” What’s more, there is no legal, mathematical formula to establish whether a subsidiary is too highly leveraged, Saxon warned.

Improperly documenting an intercompany loan, the author added, also runs the risk of being recharacterized as equity in the instance of bankruptcy of the borrower, meaning the lender will run into trouble with any future repayments made to a parent company by the borrowing subsidiary.

Saxon outlined a list of best practices corporations should use when lending within its own entity, including documenting whether funds will be considered a loan and whether repayment obligations will be secured by collateral. She also suggests establishing a fixed maturity rate, interest rate and other aspects of the loan agreement.

Doing so, Saxon argued, will not necessarily guarantee that a loan is safeguarded, but it will provide evidence that the funds were characterized as a loan if it is ever challenged.