How Implicit Support Can Impact Intercompany Financing Arrangements: An IRS Transfer Pricing Perspective
On December 29th, 2023, the Office of Chief Counsel of the Internal Revenue Service (“IRS”) issued Memorandum AM 2023-008 that provides guidance on the impact of Implicit support or the effect of group membership on intercompany loans and related areas, including passive association.
The IRS has clarified that it is their position that it may adjust the interest rate on intragroup loans under Section 482 of the Internal Revenue Code (“Section 482”) and Treas. Reg. § 1.482-2(a) to reflect the implicit financial support a borrower receives from being part of a corporate group—even if there’s no formal guarantee in place.
Background
Prior to the Memorandum, Section 482 did not provide a statutory definition of “implicit support” in its text ,or how it would impact the determination of an arm’s length interest rate.
In the context of intragroup lending, Section 482 regulations require that the interest rate applied meets the arm’s length standard, meaning it should reflect the rate that would be charged between unrelated parties under similar circumstances. The relevant provisions are primarily found in Treas. Reg. § 1.482-2(a)(2), which mandates consideration of “all relevant factors” when determining an arm’s-length interest rate. Among the illustrative factors listed is the credit standing of the borrower.
In addition, according to Treasury Regulation § 1.482-9(l)(3)(v), for US transfer pricing purposes, no compensation is owed for any benefit that arises solely from an entity’s membership in a controlled group—that is, from so-called “passive association.” The IRS regulations recognize that group membership can passively benefit a subsidiary or affiliate. Such benefits do not warrant a separate charge, and the beneficiary does not owe compensation merely because it received a benefit by virtue of being a group member, unless there is a specific, compensable service (like a guarantee).
Even though the memorandum cannot be used or cited as a precedent, it provides the IRS position towards the interpretation of Section 482 and the impact on the determination of an arm’s length interest rate. The memo even provides an example in which describes a US subsidiary (“USSub”) that receives a loan from its foreign parent (“FP”). Although a USSub’s standalone credit rating is low, its group affiliation may boost its rating due to expected support from the FP. The IRS concludes that the appropriate interest rate is based on this enhanced rating, not the standalone one. Charging a higher rate would violate the arm’s length principle.
In other words, if a subsidiary benefits from the group’s reputation or financial strength, the IRS might expect this to be reflected in the interest rate it pays on intercompany loans during an audit.
Furthermore, the IRS’s clarified position is also aligned with Chapter X of the 2022 OECD Transfer Pricing Guidelines (“OECD Guidelines”). Based on paragraphs 10.71 to 10.80 of the OECD Guidelines, group membership is understood as a contextual factor that may influence the creditworthiness of an entity within a multinational enterprise (“MNE”) group, even in the absence of explicit guarantees. This phenomenon, known as implicit support, arises from the perception that the group may provide financial backing to its members in times of distress. Such support is not contractually mandated but is instead inferred from the group’s past behavior, strategic interests, or reputational concerns. The OECD Guidelines emphasize that this perception can affect the pricing of intragroup financial transactions, particularly in determining the appropriate credit rating of the borrowing entity.
However, the OECD Guidelines caution that implicit support should not be automatically assumed or overestimated. The likelihood of such support must be assessed based on objective evidence, including the MNE group’s historical actions and the specific circumstances of the borrower. The absence of a formal guarantee means that the borrower’s credit rating should primarily reflect its own financial position, unless there is compelling evidence that the group would intervene.
Ultimately, while group membership may influence market perceptions and borrowing conditions, it does not, in itself, constitute a service or benefit that warrants compensation under the arm’s length principle. The OECD Guidelines distinguish clearly between passive association and deliberate, compensable actions such as formal guarantees. In transfer pricing analyses, only the latter should give rise to intercompany charges, ensuring that pricing outcomes reflect genuine economic contributions rather than assumptions about group affiliation.
Why This Matters
– Interest Disallowance Risk: If the intercompany loan interest rate does not reflect the borrower’s enhanced creditworthiness due to group membership, the IRS may propose an adjustment and assess penalties.
As mentioned in the example above, from a US perspective, if a USSub pays an interest rate that is higher than it should be after considering the implicit support provided by its parent company, the interest rate may be subject to a downward adjustment to reflect the enhanced credit profile due to group membership.
Similarly, if a US taxpayer lends funds to a foreign related party, and the foreign related party has a stronger credit profile than that of the group, the interest rate charged by the US entity may be considered too low, as it does not fully reflect the group’s weaker credit profile.
Measuring the Impact of Implicit Support
Estimating the impact of implicit support on a borrower’s credit profile is a critical step in determining an arm’s length interest rate for intercompany loans. Different credit rating agencies such as Standard and Poor’s (“S&P”), Moody’s Investors Service, Inc.(“Moody’s”)[1], Fitch Ratings, Inc. (“Fitch”)[2] have developed methodologies to measure such impact.
One of the common industry practices in transfer pricing for estimating the impact of implicit support is to follow S&P’s[3] Group Rating Methodology. This approach can be summarized in the following six-step analysis, which involves determining an issuer credit rating (“ICR”):
- Identify the group’s members. This includes establishing a clear definition of “control” within the group.
- Determine the Group Credit Profile (“GCP”). While not a formal rating, the GCP reflects the overall creditworthiness of the group or subgroup.
- Assess the borrower’s role within the group. This step evaluates the borrower’s strategic importance and the likelihood of receiving group support.
- Evaluate the borrower’s Standalone Credit Profile (“SACP”), if necessary, to understand its independent creditworthiness.
- Estimate the ICR by integrating the SACP with the effects of group support—typically through upward or downward notching from the SACP or GCP.
- Apply any relevant constraints to the ICR, such as sovereign risk or transfer and convertibility limitations.
The table below summarizes how an entity’s group status can influence its potential long-term ICR[4]:
| Potential Long-Term Group Status | Brief Definition | ICR |
| Core | Integral to the group’s current identity and future strategy. The rest of the group is likely to support these entities under any foreseeable circumstance. | Generally, at GCP |
| Highly strategic | Almost integral to the group’s current identity and future strategy. The rest of the group is likely to support these subsidiaries under almost all foreseeable circumstances. | Generally, one notch below GCP. unless the SACP on that entity is equal to, or higher than, the GCP. In such a case, the potential ICR is equal to the GCP. |
| Strategically important | Less integral to the group than “highly strategic” subsidiaries. The rest of the group is likely to provide additional liquidity, capital, or risk transfer in most foreseeable circumstances. However, some factors raise doubts about the extent of group support. | Generally, three notches above SACP. This is subject to a cap of one notch below the GCP, unless the SACP is at least equal to the GCP, in which case the potential ICR is equal to the GCP. |
| Moderately strategic | Not important enough to warrant support from the rest of the group in some foreseeable circumstances. Nevertheless, there is potential for some support from the group. | Generally, one notch above SACP. This is subject to a cap of one notch below the GCP, unless the SACP is at least equal to the GCP, in which case, the potential ICR is equal to the GCP. |
| Non-strategic | No strategic importance to the group. | Generally, at SACP |
Conclusion
As transfer pricing scrutiny intensifies globally, the IRS’s position on implicit support—reflected in Memorandum AM 2023-008—signals a clear shift toward recognizing the economic realities of group membership in intercompany financing.
While implicit support does not constitute a compensable service, its influence on creditworthiness and interest rate determination cannot be ignored. For tax professionals and transfer pricing practitioners, this underscores the importance of robust documentation, realistic credit assessments, and alignment with both US regulations and OECD guidance.
Looking ahead, taxpayers should anticipate increased scrutiny around implicit support and proactively incorporate it into their intercompany pricing strategies to mitigate risk and optimize financial outcomes.
[1] Moody’s methodology for quantifying the implicit support can be found at Moody’s, Rating Non-guaranteed Subsidiaries: Credit Considerations in Assigning Subsidiary Ratings in the Absence of Legally Binding Parent Support (December 2003). See also Moody’s, The Incorporation of Joint-Default Analysis into Moody’s Corporate, Financial and Government Rating Methodologies (February 2005).
[2] Similarly to S&P and Moody’s, Fitch methodology for quantifying the implicit support can be found at Fitch Parent and Subsidiary Rating Linkage: Fitch Approach to Rating Entities Within a Corporate Group Structure (8 August 2012) for further details.
[3] S&P, General Criteria, Group Rating Methodology (July 1st ,2019).
[4] Source: S&P, General Criteria, Group Rating Methodology (July 1st ,2019). Page 4-5 (Table 1, Summary of Associating an Entity’s Group Status with a Potential Ling-Term ICR)
