Member question: “We are in the process of reevaluating our intercompany (IC) loan rate-setting policy. I’m trying to benchmark to understand how this is managed at other companies. What is your company’s approach to setting rates on any intercompany lending agreements?
- “I know reference rates are in flux with the Libor transition but I am specifically trying to understand, from a transfer pricing standpoint, if you set rates with a standard mark-up or based on the entity’s creditworthiness similar to a bank.”
Peer answer: “For long-term IC loans, our internal funding team works with tax to determine an appropriate arm’s-length spread over benchmark.
- “That process has varied over the years, but typically involves either getting some local bank indicative loan rates for comparison or doing other local market research on comparable companies’ public debt issuance and/or credit indicators.
- “This would all be documented and retained as supporting evidence of the arms-length rate.
“For revolving (short-term) IC loans, we may use comfort letters and/or parent guarantees to backstop the subsidiary IC debt.
- “This has allowed us (in most cases) to have a fixed credit spread for our short-term IC loan portfolio. Obviously, that type of approach would need to be well established with tax.
“With the upcoming Libor replacement, there is an expectation that the credit component backed into Libor will need to be reflected in the updated rates plus the spread we use.
- “These details are still being worked out by our Libor replacement team.”
Using SOFR for IC. The Alternative Reference Rates Committee (ARRC) recently released recommendations for IC loans based on the Secured Overnight Financing Rate (SOFR). ARRC’s announcement does not specifically address transfer pricing.