Inter corporate loan agreements and all that you need to know

Inter-Corporate Loans, the lifeline for most group businesses.

These keep the businesses greased and include loan, guarantee or security given by one company to another company as defined under Companies Act of 2013 of the group.

These have protocol requirements centered around compliance like, Board Approval, adequate audit disclosures and filing requirements.

WHAT IS INTER COPORATE LOAN?

A company could grant repayable loans and guarantees or acquire securities and make investments in a different company of the Group with the consent of the board or shareholders. It is an inter-company arrangement, but since the companies are separate legal entities, the legal requirements remain the same.

There is a restriction on the maximum amount of the inter-corporate loan that can be given, like a

  • 60% of the company’s paid-up share capital, free reserves, security premium account or
  • 100% of free reserves and security premium account whichever is more.

A company cannot give an inter-corporate loan at a rate of interest lower than the prevailing yield of one, three, five or ten years of government security closest to the loan term.

If a company defaults in paying the interest amount, it is barred from making any inter-corporate loan, guarantee, and security. This restriction remains till the default is cleared by the company.

BENEFITS OF INTER-CORPORATE LOANS

Inter-company loans are used within the Group to:

  • save on the spreads earned by banks;
  • diversify the business of the group entities through an investment mechanism
  • improve the face of financials of the borrowing entity
  • discourage external commercial borrowings and encourages domestic borrowings within the group itself.
  • save on the foreign exchange gains or losses
  • support the entity’s operations in a group that has lower cash resources

COMPANIES ACT AND COMPANY LOANS

The Companies Act, under section 186 allows companies to give loans and guarantees, acquire securities or make investments as per the provisions of this section.

This does not apply to:

  • A banking company, housing finance company or an insurance company in its normal business operations.
  • A company established to provide infrastructure facilities or finance industrial enterprises.
  • A registered NBFC, which concentrates primarily on acquiring securities.

If any company contravenes the provision under this section, it will be liable for the penalty of maximum of INR 5 lakhs and every officer who is in default will be liable to penalty of maximum INR 1 lakh along with imprisonment of 2 to 3 years.

THE AGREEMENT AND ITS TERMS

Prior to execution of the Agreement disclosure has to be made for Issuance of Inter-Corporate Loan. The company must disclose the following to its members in the financial statement: 

  • Full particulars of the loans granted. 
  • Full particulars of the investments made. 
  • Full particulars of the security and guarantee provided.
  • Purpose for which the loan, guarantee or security is proposed to be utilised by the recipient.

Following are some of the important clauses that must be a part of inter corporate loan agreement:

  1. The loan – The loan amount must be mentioned and the terms on which it is made. Specifics of how the borrower would use the proceeds of the loan.
  2. Representations and warranties of borrower – The representations and statements are relied on by the lender, these require the repayment commitments and default remedies, which essentially determine the grant.
  3. Pending cases – Borrower must confirm no litigation pending against the company
  4. Taxes – This mentions that borrower has filed all required tax returns and paid and discharged all assessments, and governmental charges.
  5. Covenants of borrower – The borrower must preserve and maintain its corporate existence, rights and material franchises and must follow all applicable laws and orders in all material respects.
  6. Books and records – The borrower shall keep proper accounts and shall cause each of its subsidiaries to keep proper books of records with full and correct entries of all financial transactions.
  7. Events of default – This clause clarifies the events of default.
  8. Notices – It provides clarity regarding notices and other means of communication.

CONCLUSION

Inter-company loans are an efficient way to satisfies company’s capital needs and business requirements, in the short term and the long term.

Normally, intercompany loan agreements are made to avoid bank spreads. To evaluate the outcome of the arrangement, few things are concerning such as savings due to avoidance of bank spreads and the administrative costs involved in the arrangement. If the former exceeds the latter, the agreement is profitable. However, if the latter exceeds the first, it’s a whole different scenario.

Even if these loans are treated as assets and liabilities in the respective entities, these balances must be eliminated during group consolidation of accounts. To conclude, they are primarily provided for short-term finance, hence, settlements in the same time frame makes it easier.

This is only for informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.
Sources: taxreturnwala.com, taxguru.in, wallstreetmojo.com, ipleaders.in,

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