Arm's-length interest rate
Arm's-length interest rates for intercompany loans
An arm's-length interest rate is the rate an unrelated lender would have charged the borrowing entity for the same facility, on the same terms, at the same time. Establishing it requires a credit view of the borrower, a comparable search matched to the loan's terms, and documentation of every adjustment applied.
The most common weakness in intercompany loan pricing is treating the borrower as if it were the group. A subsidiary's standalone credit profile is usually weaker than the parent's, and where implicit group support is relevant it must be reasoned rather than assumed, because the size of that uplift directly changes the defensible rate.
The second weakness is comparability. A rate taken from bonds of a different tenor, currency or seniority is not evidence of anything, however precise the resulting statistics look. Matching those attributes properly, and adjusting transparently where a perfect match does not exist, is what makes the resulting range hold up under review.
How a defensible rate is actually built
The method matters as much as the number. A reviewer will follow the chain from credit assessment through comparable selection to the final range, and each link needs to be documented well enough that someone outside the process could reproduce the conclusion from the same inputs without further explanation.
Standalone credit assessment
The borrower's own financial ratios, industry position and repayment capacity establish a baseline rating using rating-agency style methodology. This is the foundation of the whole analysis, because every subsequent comparable selection depends on the rating band, and an unsupported rating undermines everything built on top of it.
Implicit support adjustment
Group membership can improve a borrower's effective credit standing without any formal guarantee. Where that applies, the uplift should be reasoned from the borrower's strategic importance to the group and evidenced, rather than applied as a blanket notch adjustment with no supporting analysis behind it at all.
Comparable search
Third-party bonds and loans are filtered to match tenor, currency, seniority and rating band. The screening criteria and rejections should be recorded, because the credibility of the range rests on showing which instruments were considered and precisely why the ones excluded were not genuinely comparable to this facility.
Range, adjustments and documentation
The output is an interquartile range and median, with documented adjustments for any remaining differences in terms, covenants or credit enhancements. The final pack sets out method, data, adjustments and conclusion, so the rate can be defended without reconstructing the analysis from scratch years later.
Checklist
Does your intercompany loan pricing hold up?
- Is the borrower rated on a standalone basis rather than at group level?
- Is any implicit support uplift reasoned and evidenced?
- Do the comparables match tenor, currency and seniority?
- Are screening criteria and rejected comparables documented?
- Have rates been refreshed since market conditions moved?
- Could someone outside the team reproduce the conclusion from the pack?
Use cases
When an arm's-length rate analysis is needed
Pricing a new intercompany loan or refinancing an existing facility
Defending interest deductions questioned in a tax audit
Supporting an advance pricing agreement or financing ruling
Refreshing legacy rates that have not moved with the market
Frequently asked
Common questions
Can we just use the parent's borrowing cost?+
Generally no. The parent's cost reflects the parent's credit profile, and a subsidiary borrowing on its own account would rarely obtain the same terms. Using the group rate without a standalone assessment is one of the most frequently challenged positions in intercompany financing, and it is usually straightforward for an authority to test.
What is implicit support and how much does it matter?+
It is the benefit a borrower derives from being part of a group that would likely support it, even without a formal guarantee. Its size depends on how strategically important the borrower is. It can shift a rating by several notches, which makes it material to the rate and worth documenting carefully.
How often should intercompany rates be refreshed?+
Rates should be set when the facility is agreed and reviewed when terms change or market conditions move materially. Where a facility is revolving or short-term, an annual refresh is typical, because carrying a rate set under very different market conditions is difficult to present as arm's length in a review.
What documentation should the analysis produce?+
A pack covering the credit assessment, the comparable search criteria and results, any adjustments applied, and the resulting range with the selected rate. It should be self-contained, so a tax authority or auditor reviewing it years later can follow the reasoning without needing the original analyst to explain it.
Benchmark a facility and see the supporting pack
Give us one intercompany facility and we will show you the credit assessment, the comparable set, and the resulting arm's-length range together with the documentation that supports it. It is the fastest way to see whether your current rates would stand up, without committing to a full benchmarking programme.