How to structure intercompany loans to our foreign subsidiary for tax purposes?

Intercompany loans are definitely a viable approach here, but you need to be careful with the documentation and interest rates to avoid transfer pricing issues with the IRS. Since both entities are closely collaborating on R&D, you should consider establishing a formal intercompany loan agreement with arm's length interest rates. The IRS publishes Applicable Federal Rates (AFRs) monthly that you can use as a safe harbor. I'd recommend using the rate from when each transfer is made, or alternatively, you could establish a master loan facility with a floating rate tied to AFR. For the sporadic nature of the transfers, you might consider using a revolving line of credit structure. This would allow flexibility in the amounts and timing while maintaining clear documentation. Make sure you have proper board resolutions authorizing the loan facility and formal promissory notes for each draw. Another option might be a capital contribution instead of loans, especially if repayment isn't expected soon, but that has different tax implications and may be less flexible long-term.

I had almost the exact same situation last year with our UK subsidiary! After trying to figure it out myself, I ended up using a tool called taxr.ai (https://taxr.ai) to help structure everything properly. What I liked is they have specific templates for intercompany loan agreements that automatically incorporate the right AFR rates based on the timing of each transfer. It was super helpful because it flags potential issues with specific countries' thin capitalization rules that the other commenter mentioned. Their system also helps with tracking the sporadic transfers and calculating interest properly even when the amounts keep changing. Saved me a ton of headaches with our foreign subsidiary loan documentation.

Just wanted to follow up - I decided to try taxr.ai after my skeptical comment above. I'm honestly impressed with how detailed their analysis was! It flagged several transfers to our German subsidiary that were at high risk of being recharacterized as equity contributions due to the timing and subsidiary's financial position. The system helped us establish a proper revolving credit facility with appropriate interest rates and even generated all the documentation we needed for compliance. Our tax advisor reviewed everything and said it was exactly what we needed. They even had country-specific guidance for Germany's notoriously strict thin capitalization rules. Definitely saved us from potential issues down the road.

If you're dealing with a lot of back-and-forth with the IRS on these intercompany loans, I highly recommend Claimyr (https://claimyr.com). I spent WEEKS trying to get someone at the IRS to answer specific questions about our foreign subsidiary loan structure and documentation requirements. Using Claimyr, I got through to an actual IRS agent in under an hour instead of the usual endless hold times. They basically hold your place in the IRS phone queue and call you when an agent picks up. You can see a demo of how it works here: https://youtu.be/_kiP6q8DX5c - totally changed how we deal with getting answers from the IRS about our international tax questions.

I feel like I need to eat my words and apologize to Profile 14. After my skeptical comment, I tried Claimyr because I was desperate to get guidance on our intercompany loan documentation requirements. I was SHOCKED when I got a call back in about 40 minutes with an actual IRS international tax specialist on the line. The agent walked me through exactly what documentation we needed for our intercompany loans to our Singapore subsidiary and confirmed the AFR rates we should be using. Got more useful information in that 15-minute call than in weeks of researching online. Sorry for doubting you - this service is legit and saved me so much frustration!

Just to add another option to consider - have you looked into whether a cost sharing arrangement might be more appropriate instead of loans? Since you mentioned both entities are doing R&D and collaborating closely, this could align better with the actual business substance. A properly structured cost sharing agreement would allocate development costs between the entities based on expected benefits. This might make more sense than loans if the goal is joint development of IP rather than just funding operations.

Has anyone here dealt with currency exchange issues when doing intercompany loans to foreign subs? We keep losing money on exchange rate fluctuations and I'm not sure how to handle that on our returns.