Fed’s Rate Cut Implications for Intercompany Loans

On Sept. 17, the Fed announced a 25-basis point cut to the federal funds rate. In its statement at the announcement, the Federal Open Market Committee indicated that there is recognition that while inflation also has edged up, the risk of rising unemployment was more critical to address, thus the decision to cut interest rates.

When the Fed cuts the federal funds rate, short-term benchmarks such as the secured overnight financing rate (SOFR) and commercial bank lending rates, as well as yields on corporate bonds and commercial paper, typically will decline. Additionally, global credit markets tend to adjust in tandem. For most borrowers, the Fed’s action represents welcome relief in the form of cheaper financing. For multinational groups with extensive intercompany lending arrangements, however, the implications are more complex. Transfer pricing rules require that intercompany loans reflect prevailing market conditions. A shift in interest rates can quickly make previously established arm’s-length arrangements vulnerable to challenge.

Transfer pricing regulatory framework

The applicable rules for intercompany lending arrangements are grounded in Treasury Regulation Section 1.482-2(a), which requires that the interest rate on intercompany loans be equivalent to what an unrelated lender would have charged in comparable circumstances. The regulation highlights a range of relevant factors that must be taken into account when executing intercompany loan transactions: the loan’s principal amount, its maturity, the presence of collateral, the borrower’s creditworthiness, and the prevailing market interest rates at the lender’s situs. The arm’s-length standard is inherently dynamic, as changes in market conditions must be reflected in what is considered arm’s length.

At the same time, the IRC establishes applicable federal rates (AFRs) under Section 1274(d). Treasury Regulation Section 1.482-2(a)(2)(iii)(B) allows taxpayers to reference the AFRs to determine the interest rate on intercompany loans if they meet certain requirements. While AFRs do not override transfer pricing requirements, they act as safe harbors in the U.S. against recharacterization or imputed interest. Accordingly, interest rates that are within 100% to 130% of the AFR are considered to have met the arm’s-length standard.

Implications of the Fed’s rate cut for existing intercompany loans

The Fed’s rate cut has immediate consequences for related-party loans already in place. Floating-rate loans pegged to SOFR or equivalent benchmarks generally remain compliant, since they reset automatically to reflect prevailing market conditions.

By contrast, fixed-rate loans are more problematic. A rate that was arm’s length at the time of issuance might, considering the Fed’s action, now exceed what independent lenders are charging. In such cases, the IRS could contend that the loan no longer is consistent with Section 1.482-2(a), opening the door to adjustments or disallowances.

Crowe observation

In response to the Fed’s rate cut, taxpayers should reassess existing long-term fixed-rate debt, as evolving economic conditions and credit spreads might render current terms inequitable and necessitate recalibration to align.

As taxpayers reassess existing debt, they must document carefully. The regulations mandate contemporaneous documentation, and courts have upheld IRS adjustments where benchmarking analyses were not updated after changes in market conditions, as was the case in E.I. du Pont de Nemours & Co. v. United States.

Additionally, based on Section 482 and the Organization for Economic Cooperation and Development’s transfer pricing guidelines, tax authorities may expect a borrower to refinance its fixed-rate intercompany loan to take advantage of lower market interest rates, even if the fixed rate on the loan was considered arm’s length at the time of initial issuance of the loan.

Implications of the Fed’s rate cut for new intercompany loans

For loans originated after the Fed’s action, benchmarking becomes even more critical. The arm’s-length rate must be grounded in current market data, not outdated comparables. Taxpayers should look at recent bond yields and spreads when setting terms. The resulting rate should fall within the range of what third parties are offering for similarly situated borrowers at current market rates.

The loan structure also must mirror market practice. Covenants, collateral, repayment schedules, and the choice between fixed and floating rates should align with what independent borrowers would accept in today’s environment. The justification for selecting fixed over floating rates, particularly in a declining interest rate climate, should be documented, as tax authorities could question why a related-party borrower agreed to terms that differ from third-party norms.

Cross-border loans present additional challenges. Withholding tax implications under Section 871 and Section 881, the interest limitation rules of Section 163(j), and currency risk adjustments all need to be considered alongside transfer pricing compliance. The AFR determined under Section 1274(d) continues to provide a useful reference point to avoid having a loan recharacterized as equity even as market comparables dictate more precise interest levels.

Looking ahead

The recent Fed rate cut illustrates a central truth about transfer pricing in intercompany financing: The arm’s-length standard is never static. A loan that was compliant when issued quickly can fall out of alignment as market conditions evolve. Multinational groups must treat intercompany lending not as a one-time compliance exercise but as a dynamic process requiring ongoing monitoring, re-benchmarking, and documentation. Taxpayers should consult with transfer pricing specialists to respond proactively by refreshing comparables, reassessing borrower credit profiles, and adjusting terms when necessary. Failure to do so risks adjustments, recharacterization, and costly disputes with tax authorities.