Intercompany funding refers to money transferred within a corporate group, often as a loan. In India, this triggers transfer pricing, FEMA and withholding tax obligations that need careful handling. Early planning helps avoid disputes down the line.
Lending money in India involves answering to three regulators at once. The Income Tax Department wants the interest rate benchmarked at arm’s length. The Reserve Bank of India wants the loan to be classified and reported correctly under its foreign exchange rules. The Ministry of Corporate Affairs wants the related party approval on record. A loan can satisfy one of the requirements but can still fail to meet the guidelines of other two regulators.
This is why intercompany funding to India is considered one of the most heavily audited categories in Indian transfer pricing. An interest rate set without a proper benchmark, a loan agreement drafted after the money has already moved, or a transfer pricing return filed as an afterthought can trigger penalties. A professional business consultant can help avoid such scrutiny. But for a foreign business operating in India, it is crucial to have basic understanding of what intercompany funding is and how it is taxed, documented and regulated.
What is Intercompany Funding?
Intercompany funds are the money that is transferred between the two entities that are in the same corporate group. The most common relations between the entities are of parent and subsidiary or two sister companies operating under the same ownership. They can take money in the form of a loan, a company contribution, a cash pool deposit, or a guarantee fees. What separates intercompany fund from an ordinary bank loan is the relationship between the two entities. Because of this relationship, Indian tax law keeps a close eye on the pricing of the transaction since a group could manipulate the profit by setting up interest rate as per their convenience.
What Are the Main Types of Intercompany Transactions?
The transaction between related entity can be classified into several categories based on distinct tax, transfer pricing and FEMA consequences. These categories include:
- Shareholder Loans: Loans that are directly provided to the subsidiary by the parent company and priced with reference to arm’s length interest. This loan is the most common route opted by the company, it is also the most frequently challenged during audits.
- External Commercial Borrowings (ECBs): ECBs are the regulated form of foreign currency or rupee borrowings. It is governed by the RBI. These borrowings are often more tax efficient on withholding than a shareholder loan.
- Equity Infusion: It is treated as a capital rather than debt. There are no interest and no transfer pricing exposure on the funding itself. Returns only come through dividends later.
- Cash Pooling: In this, group of entities pool surplus and deficit cash and position through a central treasury entity rather than managing it independently. The interest terms applied within the pool may attract transfer pricing scrutiny.
- Corporate Guarantees: This is where the parent guarantees third party borrowing rather than lending directly. No funds move between parent company and subsidiary. But, because the guarantee carries commercial value, it attracts fee that must be benchmarked.
- Trade Credit or Unusually Long terms: This refers to extended payment terms on trade transactions that go well beyond normal commercial practice. In some cases, tax authorities may treat these arrangements as a form of financing rather than a regular trade transaction and apply the relevant tax rules accordingly.
Why Intercompany Funding Receives Close Tax Scrutiny in India?
Interest is one of the cleanest channels for shifting profits across borders as it allows to price aggressively without a proper paper trail. A subsidiary paying higher interest to its parent reduces taxable profit in India while increasing income in a jurisdiction that may tax it more lightly. An interest free loan may also raise concern. Tax authorities may argue that the lender should have charged interest in line with the market conditions. Transfer pricing officers often review intercompany loans, guarantees and cash pooling arrangements on audit, even if the amount is relatively a lower number.
What Are the Transfer Pricing Rules for Intercompany Loans?
India’s transfer pricing rule requires every international transaction between the related entities to be priced at arm’s length. Arm’s length is the price that even an unrelated parties would have agreed to. It has been placed to ensure that the interest rate on a loan cannot just be picked for convenience among two related parties. Any Transfer pricing loan to Indian Subsidiary in India therefore must be priced at arm’s length and supported by appropriate documentation.
The framework historically sat in Section 92 to 92F of the Income Tax Act,1961. Two supporting rules – Rule 10B (methods) and Rule 10D (Documentation) add more details to this framework. Rule 10B explained how to work out the right price between entities. Rule 10D explained what paperwork is required to prove the relationship between entities. Section 92B specifically defines the term “international transaction” to include any kind of capital funding. It covers loans, deferred payments, and any other form of debt. The intercompany loan is automatically covered by all these rules no matter how big or small the amount is.
Income Tax Act, 2025 came into force in April 2026. With this, the old section 92 to 92F have been renumbered as new sections 161 to 173. Some changes include:
- The accountant’s report is now under Section 172. It was previously Section 92E, filed as Form 3CEB.
- The documentation requirements are now under Section 171. This was previously Section 92D.
Other than these, nothing about the actual rules has changed.
How is Interest on Intercompany Loan Determined?
For an independent lender, there is nothing to worry about. The rate depends only on the borrower’s real credit profile, currency, tenure, security and purpose for which they are applying loan for.
There is no standard interest rate for determining the interest on intercompany loan in India. A subsidiary with weaker financials or a longer repayment period is likely to pay higher rate. A short-term loan backed by strong cash flows can have a lower interest rate.
Tax authorities often reject a group’s chosen rate if the market comparison used does not reflect the borrower’s real risk. This happens if the comparison is not based on the businesses with similar financial strength or if the support of the parent company is overlooked.
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Get a Free Consultation ↗Which Transfer Pricing Method is Used to Benchmark Intercompany Loan Interest?
The arm’s length principle sits at the core of transfer pricing. According to Arm’s length, principle related party transactions must be priced as if the parties were unrelated, as if both the sides negotiated independently. Applied to loan, this means asking under what circumstances will the two unrelated parties would have settled on for the same amount, currency, tenure and risk profile.
The most used method for determining an arm’s length interest rate is the Comparable Uncontrolled Price (CPU) method. It compares the intercompany rate to bond yields, bank loan pricing, or credit spreads. These comparisons use borrowers of similar standings. A credit rating, whether agency assigned or derived internally determines which comparable instruments are relevant.
Domestic Loan vs Foreign Currency Loan
A rupee loan is usually benchmarked against Indian market rates. That means government securities yields, corporate bond spreads, or bank rates for comparable credit quality.
A foreign currency loan works differently. It’s benchmarked against international reference rates instead. Common examples are SOFR (the Secured Overnight Financing Rate that replaced LIBOR) or EURIBOR. A lender adds an extra interest margin to the benchmark rate.
The choice of loan currency affects transfer pricing analysis, FEMA compliance and withholding tax obligations. Because of this, the decision should be made after getting inputs from tax, treasury, and legal teams.
What is the Difference Between a Shareholder Loan and an External Commercial Borrowings?
A shareholder loan is a direct loan from the parent company priced and documented as an intercompany transaction, without necessarily meeting RBI’s conditions for external borrowing.
An ECB is a regulated category of foreign currency or rupee borrowing from a recognised non-resident lender, which must satisfy RBI conditions on eligible borrowers, tenure, end-use and cost of borrowing.
Since February 2026, following the Foreign Exchange Management (Borrowing and Lending) (First Amendment) Regulations, 2026, RBI has standardised the minimum average maturity at three years for most ECBs. They have also replaced the earlier all-in-cost ceiling with a requirement that cost of borrowing simply reflects prevailing market conditions. This gives more pricing flexibility but does not remove the separate transfer pricing requirement that the rate still be at arm’s length.
| Feature | Shareholder Loan | Bank Loan | ECB | Equity Funding |
|---|---|---|---|---|
| Repayment | Flexible, per agreement | Fixed schedule, lender-enforced | Fixed tenure, minimum 3-year average maturity | No repayment; return via dividend |
| Interest | Must be arm’s length; TP tested | Market-set by lender | Cost of borrowing must reflect market terms | None |
| Transfer Pricing | Fully applicable under Section 92B | Not applicable (third party) | Applicable if lender is an associated enterprise | Not applicable |
| Documentation | Loan agreement, benchmarking report, Form 3CEB | Bank sanction letter, security documents | RBI Form ECB, loan agreement | Share subscription agreement, FC-GPR filing |
| FEMA | ECB rules apply if from non-resident related party | No FEMA implication (domestic) | Fully regulated | Reported under FDI rules |
| Tax Implications | Withholding tax on interest paid | Interest deductible, no cross-border withholding | May qualify for concessional withholding under Section 194LC | No interest deduction; dividend taxed on distribution |
What Documentation is Required for Intercompany Loans?
Proper documentation separates a defensible loan from an audit liability. At minimum, retain the following for every material intercompany loan:
| Document | Purpose |
|---|---|
| Loan Agreement | Sets out principal, tenure, interest and covenants; signed before funds move |
| Board Resolution | Records related party transaction approval under the Companies Act, 2013 |
| Benchmarking Report | Demonstrates the rate against comparable market data |
| Transfer Pricing Study (Local File) | Functional and economic analysis supporting the method chosen |
| Interest Calculation Workings | Shows how the rate was applied period by period |
| Repayment Schedule | Evidences genuine debt, not disguised equity |
| Form 3CEB | Chartered accountant’s report under Section 92E (now Section 172) |
| Master File | Mandatory where consolidated group revenue exceeds ₹500 crore and transaction thresholds are met |
| Local File | India-specific documentation under Rule 10D |
| Supporting Correspondence | Emails and approvals evidencing genuine commercial intent |
Benchmark Interest Rates
Benchmarking means testing an intercompany rate against real market data to see if it holds up as arm’s length pricing. For rupee loans, this means comparing the rate to bond yields and bank lending rates for borrowers of similar credit quality.
For loans involving foreign currency, the route is relatively easier. Under the Safe Harbour Rules in Rule 10TD, a foreign currency intra-group loan is treated as arm’s length automatically, as long as the rate is not less than a reference rate plus margin.
The reference rate is SOFR for US dollar loans and EURIBOR for euro loans. The margin or extra interest rate depends on the borrower’s credit rating, ranging from around 150 basis points for the strongest ratings up to 600 basis points for the weakest.
Safe Harbour lets a taxpayer accept a prescribed margin without further dispute, in exchange of giving up the right to argue for a lower rate.
What is FEMA and How Does It Regulates Intercompany Funding in India?
FEMA, the Foreign Exchange Management Act, 1999, controls how money moves across India’s borders. This sits separately from the Income Tax Act, which only deals with pricing. As a result, related party funding in India must comply not only with transfer pricing requirements but also with FEMA and RBI regulations.
If a shareholder loan is meant to qualify as an ECB, it has to meet RBI’s conditions on eligible lenders, minimum average maturity and permitted end-use. If it fails these conditions, it can’t just fall back on being treated as an ordinary related party loan. FEMA doesn’t have a general catch-all for intercompany loans outside the ECB framework, so a structure either qualifies or it doesn’t.
This is why some groups run into trouble only after the funds have already moved, once they realise the structure doesn’t actually qualify. At that point, the only way forward is regularisation through RBI’s compounding process.
It’s also worth noting that RBI rewrote its ECB regulations through amendments effective 16 February 2026. These broadened who can lend and borrow, simplified maturity requirements, and replaced the old fixed all-in-cost ceiling with a market-linked cost of borrowing standard instead.
Withholding Tax on Intercompany Interest
Withholding tax is applied under section 195 when an Indian subsidiary pays interest to its non-resident parent. The default rate is 20 percent plus surcharge and cess. The interest rate drips to 10 to 15 percent if a Double Taxation Avoidance Agreement applies, provided that the lender submits a valid Tax Residency Certification and Form 10F.
Interest on ECBs or approved foreign currency borrowings is covered under Section 393(2) of the Income Tax Act, 2025. It can attract a concessional rate as low as 5 percent, subject to timing and form conditions. This makes the ECB route more tax efficient on withholding rather than an ordinary shareholder loan, especially for long term financing.
How Do India’s Thin Capitalisation Rules Affect Intercompany Funding
Thin capitalisation happens when a company is funded disproportionately through debt rather than equity. It extracts profits as deductible interest rather than taxed dividends. India addresses this through Section 94B, introduced by the Finance Act,2017 in line with the OECD* BEPS* guidelines.
When an Indian company pays interest exceeding INR 1 crore in a year to a non-resident associate enterprise, the deduction is capped at 30 percent of EBITDA* or the actual interest paid, whichever is lower. Whatever get disallowed can be carried forward for up to eight assessment years, through the same 30 percent ceiling, which applies every year. Banks and insurance companies are excluded from this rule.
One thing worth noting is that Section 94B operates independently of the arm’s length test. As a result, a correctly priced loan can still face partial disallowance if overall debt is too high relative to earnings.
*BEPS- Base Erosion and Profit Sharing
*OECD – Organisation for Economic Co-operation and Development
*EBITDA- Earning before Interest, Taxes, Depreciation, and Amortisation
How Do OECD Transfer Pricing Guidelines Apply to Intercompany Financing
The OECD Transfer Pricing Guidelines form the backbone of India’s framework. Since February 2020, these guidelines include a dedicated Chapter X on financial transactions, covering intra-group loans, cash pooling, guarantees and captive insurance. These guidelines have become increasingly relevant for intercompany financing for India Subsidiary structures.
This guidance also formalised the idea of implicit support. A subsidiary’s credit standing is often stronger than its standalone financials suggest, simply because the market assumes the parent would step in if trouble arose. This should be reflected in the credit rating used for benchmarking, without any separate payment for it.
Both India’s Section 94B rule and its Safe Harbour Rules for loans trace back to this OECD work under the wider BEPS project. Indian authorities cite it regularly in assessments involving cross-border financing.
Conclusion
Intercompany funding in India is difficult because there are various rules that apply at once. As per Transfer pricing rule, the interest rate must be justified. FEMA wants the structure to be classified correctly. The Companies Act wants the approval on record. A loan can be compliant on one front but can still be exposed on other. This is why many groups run into trouble despite having a sensible commercial arrangement.
Avoiding such trouble is not complicated, but it does require certain level of discipline. Deciding the funding route cautiously, benchmarking the rate before it is set, and keeping the paperwork moving in step with money rather than behind it. A well-documented loan rarely attracts trouble. Get in touch with professionals at Stratrich who can help you understand the complexities and provide you with guidance for a hassle-free intercompany funding.
Frequently Asked Questions (FAQs)
No, Interest is not mandatory on intercompany loans. Two related companies can agree to lend money without charging interest. But in practice, this is risky. Tax officers often question interest-free loans between related parties, arguing that a real lender would never give money for free. If they accept this argument, they can add a notional interest amount to the lender’s taxable income, even though no interest was actually paid.
It is based on what an independent lender would have charged the same borrower, considering things like credit rating, currency, loan tenure and security. There is no fixed number that works for every loan. The most common method compares the loan to bond yields, bank rates or lending rates given to similar borrowers. For foreign currency loans, there is also a simpler option called Safe Harbour Rules, which lets a company use SOFR or EURIBOR plus a fixed margin instead of doing a full comparison.
Yes, Interest-free loans are challenged quiet often. Tax officers usually see interest-free loans between related companies as unusual. During an audit, they can treat the loan as if it carried interest and add that amount to taxable income, even if no interest was actually paid. This is one of the most common issues raised in this type of review.
Generally for eight years from the end of the relevant assessment year. This is because tax assessments can be reopened within that period. So, loan agreements, benchmarking reports and approvals should be kept safely for that long, not just for the year the loan was taken.
