What it means
When large businesses or growing groups of companies operate, cash is rarely spread evenly. One subsidiary might have surplus cash sitting in its bank account, while another newly opened sister company desperately needs funds for inventory or equipment.
Rather than paying expensive external bank fees and jumping through hoops for commercial credit, the parent company can arrange an intercompany loan. This keeps borrowing costs inside the corporate family and allows money to flow quickly to where it is most needed.
From an accounting perspective, these loans require careful tracking. Even though the money moves between related entities, it cannot simply be treated as a gift or written off.
The lending company records an asset, known as a loan receivable, because the borrower owes them that money. The borrowing company records a liability, known as a loan payable, because they must pay it back.
When the parent company prepares consolidated financial statements for the whole group, these internal loans completely disappear, because you cannot owe money to yourself on a group level. Tax authorities and regulators pay close attention to intercompany loans.
Because the lender and borrower are related, companies might be tempted to set fake interest rates, such as zero percent, to shift profits to lower-tax regions. To prevent this, tax laws require businesses to charge an arm-length interest rate, meaning the rate must match what an independent bank would charge for the same risk.
Documenting these loans properly protects the business during audits and keeps the finance team compliant with local laws.
In practice
Real-world examples.
Example
TechVentures UK lends fifty thousand pounds to its newly launched manufacturing subsidiary to buy machinery, charging a standard five percent annual interest rate to keep tax auditors satisfied.
Example
A retail chain with ten shops uses an intercompany loan to move surplus cash from a highly profitable London store to cover a temporary cash flow shortfall at a struggling Manchester branch.
Example
A holding company provides a two hundred thousand dollar loan to its overseas software development affiliate, ensuring the branch can pay local staff wages while waiting for client payments.
Think of it
“Think of an intercompany loan like a parent lending money from their personal savings account to their adult child who is buying a car. The money stays within the family, but there is still a formal agreement that the child will pay it back with a small amount of interest.
Formula
Calculation
Interest Expense equals Principal Loan Amount multiplied by Annual Interest Rate. For example, if Subsidiary A borrows ten thousand pounds from the parent company at an annual interest rate of four percent, the annual interest calculation is ten thousand multiplied by 0.04, which equals four hundred pounds of interest paid annually.Case study
Seen in the real world.
BrightSky Group operates a chain of organic cafes and a central bakery. The bakery business had a strong quarter, accumulating thirty thousand pounds in surplus cash. Meanwhile, a new cafe in Bristol required urgent funds to complete kitchen renovations before opening for the summer season.
Instead of approaching a high street bank, BrightSky arranged an intercompany loan. The bakery lent thirty thousand pounds to the Bristol cafe entity, formalised by a simple promissory note specifying a three percent annual interest rate and a two-year repayment schedule.
This arrangement avoided bank application fees and secured the funds within forty-eight hours. The bakery earned a modest return on its idle cash, while the Bristol cafe secured affordable financing. At year-end, when BrightSky Group consolidated its accounts, this internal loan and its matching interest payments were eliminated, presenting a true picture of the group's external financial position.
Watch out
Common mistakes.
- Treating the loan as free money and failing to document formal repayment terms.
- Setting zero interest rates, which triggers penalties from tax authorities.
- Forgetting to eliminate these internal loans when preparing group financial statements.
Questions
People also ask.
Do intercompany loans show up on consolidated financial statements?
No. When you combine the accounts of the parent and subsidiary into group statements, intercompany loans and interest cancel each other out.
Must intercompany loans always include interest?
Yes, tax authorities generally require an arm-length interest rate to prevent profit shifting between related companies.
What happens if the borrowing company cannot repay the loan?
The lender may need to write off the loan, which can trigger complex tax consequences and accounting adjustments for both companies.
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