Inter-Company Loan Regulations & Tax Implications for Group Companies in India

Within a corporate group, companies often provide financial support to each other. This can take the form of equity infusion or, more commonly, inter-company loans. These loans serve various purposes. They provide working capital. They fund specific projects. They also enable efficient treasury management across entities. However, these transactions are not simple internal adjustments. They are governed by stringent legal and tax regulations in India. Navigating these inter-company loan regulations & tax implications for group companies in India is crucial for compliance and avoiding costly pitfalls in 2025.

As a leading CA in Mumbai, CA Sweta Makwana & Associates specializes in corporate law, FEMA, and tax advisory for complex group structures. We ensure your inter-company transactions are compliant, transparent, and optimized.

Why Inter-Company Loans are Prevalent in Group Structures

Group companies often resort to inter-company loans for several reasons:

Optimized Resource Allocation: Efficiently channel surplus funds from cash-rich entities to those needing capital for growth or operations.
Reduced External Dependency: Minimize reliance on external lenders, which can save on interest costs and provide greater flexibility.
Project Funding: Facilitate funding for specific projects or business initiatives within the group.
Treasury Management: Centralize cash management and liquidity within the corporate umbrella.
Operational Flexibility: Provide quick access to funds without complex external borrowing procedures.

Key Regulations Governing Inter-Company Loans in India

Inter-company loans are primarily governed by two major statutes in India: the Companies Act, 2013, and the Foreign Exchange Management Act (FEMA), 1999 (if cross-border).

1. The Companies Act, 2013

This Act sets strict limits and conditions for loans and investments made by companies.

Section 186: Loans and Investments by Company: This is the most critical section. It aims to prevent companies from siphoning off funds or making imprudent loans/investments.
- Limits: A company cannot provide a loan or guarantee or acquire securities exceeding:
  - 60% of its paid-up share capital, free reserves, and securities premium account, OR
  - 100% of its free reserves and securities premium account,
  - whichever is higher.
- Special Resolution: If the loan exceeds these limits, prior approval by a Special Resolution of the shareholders is mandatory. This resolution must clearly specify the total amount up to which the Board can make such loans.
- Interest Rate: Loans must be given at an interest rate not lower than the prevailing yield of one-year, three-year, five-year, or ten-year Government Security closest to the tenor of the loan. This prevents interest-free or very low-interest loans which could be used for tax avoidance.
- No Default: A company that has defaulted in repayment of any deposits or interest thereon cannot make any loan or provide any guarantee under this section.
- Exceptions: Section 186 does provide certain exceptions, such as:
  - Loans made by a banking company or a housing finance company in their ordinary course of business.
  - Loans provided by a company whose ordinary business is to provide financial facilities.
  - Loans made to a wholly owned subsidiary company (WOS) or a joint venture company (though WOS loans are exempted from limits, other compliances like interest rate and no default still apply).
- Disclosure: Details of loans, guarantees, and investments made must be disclosed in the financial statements.
Section 185: Loans to Directors, etc.: While primarily for directors, this section can indirectly affect inter-company loans. It broadly prohibits a company from giving any loan to its directors, or to any other person in whom the director is interested. This can include certain companies where a director or their relatives hold substantial interest. This is a very restrictive section with limited exceptions.

2. Foreign Exchange Management Act (FEMA), 1999

If one of the group companies involved in the loan transaction is located outside India (e.g., an Indian parent lending to a foreign subsidiary, or a foreign parent lending to an Indian subsidiary), FEMA regulations come into play.

Overseas Direct Investment (ODI): An Indian company lending to its foreign subsidiary/joint venture falls under ODI regulations. There are specific limits and reporting requirements (e.g., Form ODI) prescribed by the RBI. The loan must be for the foreign entity’s bona fide business activities.
External Commercial Borrowings (ECB): When an Indian company borrows from its foreign parent or another foreign group entity, it typically falls under ECB regulations. These involve stringent norms regarding:
- Eligible Borrowers & Lenders: Who can borrow and who can lend.
- Permitted End-Uses: What the borrowed funds can be used for.
- Maximum Amount, Maturity Period, All-in-Cost Ceiling: Specific limits on loan quantum, repayment tenure, and effective interest rates.
- Reporting: Mandatory reporting to the RBI (e.g., Form ECB).
Current Account vs. Capital Account: Classification of the transaction (e.g., loan repayment is a capital account transaction) determines applicable regulations.

Tax Implications of Inter-Company Loans

The tax treatment of inter-company loans varies depending on whether you are the lender or the borrower, and if the transaction is domestic or cross-border.

1. For the Lender (Company Providing the Loan):

Interest Income: Any interest received by the lending company is treated as income from other sources or business income (if lending is its primary business) and is fully taxable in its hands.
TDS Obligation: The borrower is obligated to deduct Tax Deducted at Source (TDS) on the interest payment under Section 194A of the Income Tax Act, currently at 10% (if the amount exceeds the threshold).
Transfer Pricing (Section 92): Crucial for cross-border loans between “Associated Enterprises” (AEs). The interest rate charged on such loans must be at “arm’s length.” This means the rate should be what independent parties would charge in similar circumstances. If the interest rate is deemed non-arm’s length, the tax authorities can make adjustments, leading to higher taxable income for the lender or disallowance for the borrower.
Disallowance of Interest Expense (Indirect): If the lending company itself has borrowed funds (e.g., from a bank) at a certain interest rate, and then lends those funds interest-free or at a lower interest rate to a group company, the tax authorities might disallow a proportionate amount of the interest expense incurred by the lending company. This is based on the principle that the expense was not incurred wholly and exclusively for its own business.

2. For the Borrower (Company Receiving the Loan):

Interest Expense: The interest paid on the inter-company loan is generally deductible as a business expense under Section 36(1)(iii) of the Income Tax Act. This is provided the loan was taken for the purpose of the borrower’s business or profession.
TDS Obligation: The borrowing company is responsible for deducting TDS on interest payments made to the lending company under Section 194A. Failure to do so can lead to disallowance of the interest expense for the borrower.
Transfer Pricing (Section 92): For cross-border loans, the interest paid by the Indian borrower to a foreign AE must also be at arm’s length. If the interest is deemed excessive, it can be disallowed as an expense.
Deemed Dividend (Section 2(22)(e)): This is a critical anti-avoidance provision. If a closely held company (a company in which the public is not substantially interested) gives a loan or advance to:
- A shareholder who is the beneficial owner of 10% or more of the voting power, OR
- Any concern (e.g., another company, firm, HUF) in which such shareholder has a substantial interest (20% or more voting power/profit share), OR
- Any individual for the benefit of such shareholder. Then, to the extent of the accumulated profits of the lending company, the loan can be treated as a “deemed dividend” in the hands of the recipient. This has significant tax implications as dividends are taxed in the hands of the recipient. This provision can extend to inter-company loans, particularly in complex group structures with common shareholders.

Specific Scenarios and Challenges

Interest-Free Loans: While often attractive for cash flow, interest-free inter-company loans are fraught with challenges.
- Companies Act: Section 186 requires a minimum interest rate. An interest-free loan would generally violate this, unless it’s to a Wholly Owned Subsidiary (WOS).
- Tax Implications (Lender): Risk of disallowance of lender’s own interest expense (if borrowed funds are lent interest-free).
- Transfer Pricing (Cross-border): High risk of adjustment if deemed non-arm’s length.
- Deemed Dividend: An interest-free loan can be a strong trigger for deemed dividend provisions.
Loan for Non-Business Purposes: If the loan is not demonstrably for the borrower’s business purposes, the interest expense may be disallowed for the borrower.
Improper Documentation: Lack of formal loan agreements, repayment schedules, and board resolutions can lead to legal and tax disputes.
Rollover/Extension of Loans: Frequent rollovers or extensions without proper justification can attract scrutiny regarding the bona fide nature of the loan.

Best Practices for Inter-Company Loans

To ensure compliance and mitigate risks, group companies should adhere to the following best practices for inter-company loans:

Formal Loan Agreements: Document every loan with a clear agreement. It should specify the amount, interest rate, repayment schedule, tenure, and default clauses.
Charge Arm’s-Length Interest Rates: For domestic loans, ensure compliance with Section 186 rates. For cross-border loans, strictly adhere to Transfer Pricing arm’s-length principles.
Obtain Necessary Approvals: Secure all required Board Resolutions and Shareholder Special Resolutions (under Section 186).
Comply with FEMA Regulations: For cross-border loans, strictly follow RBI guidelines for ODI or ECB, including permissible end-uses and timely reporting.
Maintain Proper Documentation: Keep meticulous records of all loan transactions, interest calculations, TDS certificates, and bank statements.
Regular Review and Monitoring: Periodically review loan agreements and ensure continued compliance with all statutory provisions.
Disclosure in Financial Statements: Ensure complete and accurate disclosure of all loans and advances in the audited financial statements and annual reports.

The Indispensable Role of a CA

Navigating the intricate web of inter-company loan regulations & tax implications for group companies in India requires specialized legal and tax expertise. CA Sweta Makwana & Associates, your trusted partner for corporate compliance and financial advisory, offers comprehensive support:

Regulatory Compliance: We advise on the applicability of Sections 185 and 186 of the Companies Act, ensuring all necessary approvals and conditions are met.
FEMA Advisory: For cross-border loans, we guide you through ODI and ECB regulations, ensuring compliance with RBI guidelines and timely reporting.
Tax Structuring: We help structure inter-company loans to optimize tax implications for both the lender and the borrower, while mitigating risks like deemed dividend and disallowance of expenses.
Transfer Pricing Documentation: For international group companies, we assist in determining arm’s-length interest rates and preparing robust transfer pricing documentation.
Documentation Support: We help draft legally sound loan agreements and ensure all required corporate approvals are in place.
Audit Scrutiny Preparation: We prepare your group for potential scrutiny from tax authorities regarding inter-company transactions.
Accounting Treatment: We guide on appropriate accounting and financial reporting for inter-company loans.

Conclusion

Inter-company loans are powerful financial instruments for optimizing liquidity and resource allocation within a corporate group. However, their execution in India is governed by a strict regulatory framework under the Companies Act, FEMA, and the Income Tax Act. Non-compliance can lead to severe penalties, disallowance of expenses, or even recharacterization of transactions (e.g., as deemed dividends).

By understanding these complexities and adhering to best practices, Indian group companies can leverage inter-company loans efficiently and compliantly. Engaging an experienced CA firm is not just advisable, but essential, to ensure that your financial strategies are robust, legally sound, and tax-efficient.

For expert guidance on inter-company loan structuring, compliance, and tax implications, get in touch with CA Sweta Makwana & Associates today. We are committed to supporting your group’s financial health and strategic growth.

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For detailed provisions of the Companies Act, 2013, refer to the Ministry of Corporate Affairs (MCA) website. For FEMA regulations on overseas investments and external commercial borrowings, refer to the Reserve Bank of India (RBI) website.