Tax implications of intercompany loans to foreign subsidiary

Thanks for the response. Quick question - wouldn't we also need to consider the impact of FDII and GILTI here? And would it make more sense to do a capital contribution instead of a loan structure if both entities are in R&D phase and not profitable?

FDII and GILTI are definitely relevant considerations here. GILTI (Global Intangible Low-Taxed Income) would apply to certain income from your foreign subsidiary, but since it sounds like the subsidiary isn't generating profits yet, this might not have immediate impact. However, you should plan with these provisions in mind for when profitability begins. As for capital contributions versus loans, that's a strategic decision. Loans offer more flexibility for eventual repatriation of funds without dividend treatment, but equity investments might make more sense if repayment isn't expected in the near term. Consider your long-term plans for the subsidiary and what makes most sense from both a business and tax perspective.

Does this work for smaller companies too? We have a similar situation but much smaller scale (only sending about $50k/month to our Canadian subsidiary).

I'm curious - how does this handle the required transfer pricing documentation? Our auditors have been brutal about making sure we have proper functional analyses for all our intercompany transactions.

Yes, it absolutely works for smaller companies. The pricing scales based on transaction volume, so it's actually very accessible for startups and smaller businesses. We started using it when we were only transferring about $30k monthly. Regarding transfer pricing documentation, that's actually where it really shines. The system generates a functional analysis based on questionnaires you complete about each entity's roles and responsibilities. It creates the core documentation required for transfer pricing compliance, including comparable analyses to support your chosen rates. Our auditors were impressed with the thoroughness - it definitely meets the contemporaneous documentation requirements to avoid penalties.

Wait, I don't understand. Why can't you just call the IRS directly? Why pay a third party to wait on hold?

Sounds too good to be true. You're telling me they actually got you to someone in the international division who knew what they were talking about? Last time I called the IRS about foreign income questions, I got transferred 4 times and then disconnected after waiting 2 hours.

It's because the IRS wait times are ridiculous - often 2+ hours, and that's if you're lucky enough not to get disconnected. The international tax department is especially bad. Most business owners simply can't afford to sit on hold for that long, especially when you might need to call multiple times to get the right person. I was definitely skeptical too! But after my third attempt calling directly ended with a disconnect after 90 minutes of waiting, I was desperate. They actually have specialized agents who know which IRS departments to navigate to for specific tax issues, and they only call you when an actual human is on the line. The agent I spoke with was surprisingly knowledgeable about Form 5471 filing requirements for foreign subsidiaries and cleared up our confusion immediately.

How difficult is it to document a proper cost-sharing arrangement? I've heard they're audit magnets for the IRS.

They do require substantial documentation, including a detailed agreement that specifies how costs will be shared, how the value of current and future intangibles is determined, and how benefits will be measured. You'll need to conduct a thorough analysis to determine each participant's "reasonably anticipated benefits" and allocate costs accordingly. Cost-sharing arrangements do receive scrutiny from the IRS, but they can be defensible if properly structured and documented. The key is having contemporaneous documentation that demonstrates economic substance and shows that the arrangement reflects what unrelated parties would agree to. The upfront investment in proper documentation can be significant, but it provides a much more stable framework for ongoing operations than constantly evaluating each cash transfer.

Good point. We deal with this with our German subsidiary. Do you have any practical advice for handling the currency translation? We've been using monthly averages but our auditors are questioning if we should be using spot rates for each transaction.

For currency translation on intercompany loans, you generally have flexibility in choosing your method as long as you're consistent. Monthly averages are acceptable under ASC 830, but spot rates at transaction dates can be more precise if you have the systems to track them. The key is documenting your policy and sticking to it. Since you're dealing with irregular funding amounts, I'd recommend using spot rates for each drawdown if possible - it gives you better matching of the economic reality and is harder for auditors to challenge. Just make sure your loan agreements specify which currency the obligation is denominated in and how you'll handle the translation. Also consider whether you want to designate the intercompany loan as a hedge of your net investment in the foreign subsidiary under ASC 815 - this can help manage some of the P&L volatility from forex movements.

This is really helpful - I hadn't thought about the state tax implications at all. We're incorporated in Delaware but have operations in California, so this could definitely impact us. Do you know if there are any good resources for understanding how different states treat intercompany interest? Also, at what transaction volume threshold would you typically recommend getting a formal transfer pricing study? We're probably looking at around $2-3M annually in total transfers to the foreign sub.