How to Structure Intercompany Loan Agreements (FEMA)

Why Intercompany Loans Require Careful Structuring

When a foreign parent company lends money to its Indian subsidiary, what seems like a simple internal fund transfer becomes a regulated cross-border borrowing under Indian law. Every intercompany loan from an overseas entity to an Indian company is classified as an External Commercial Borrowing (ECB) under the Foreign Exchange Management Act (FEMA) and must comply with the Reserve Bank of India's (RBI) ECB regulations.

Getting the structure wrong has serious consequences. An improperly structured intercompany loan can be deemed void ab initio, requiring the Indian subsidiary to immediately repay the principal. Interest payments made on non-compliant loans may not be tax-deductible. The company and its officers can face penalties under FEMA of up to three times the amount involved. In the worst case, the loan can be reclassified as equity by the RBI, permanently altering your capital structure.

This guide walks you through every aspect of structuring intercompany loan agreements under FEMA, incorporating the significant changes introduced by the Foreign Exchange Management (Borrowing and Lending) (First Amendment) Regulations, 2026, which took effect on February 16, 2026. For broader context on FEMA compliance obligations, see our comprehensive guide on FEMA compliance for foreign companies.

The ECB Framework: Automatic Route vs. Approval Route

Automatic Route

Under the automatic route, intercompany loans can be raised without prior RBI approval, provided they conform to all prescribed parameters. The borrowing is routed through an Authorised Dealer (AD) bank in India, which verifies compliance before processing the transaction. Most intercompany loans between a foreign parent and its Indian subsidiary qualify for the automatic route.

Under the 2026 amended regulations, the automatic route has been significantly liberalized. Key changes include:

• Expanded lender eligibility: Any person (including individuals) resident outside India can now lend under the ECB framework. Previously, lenders were restricted to recognized financial institutions, equity holders, and specific categories of foreign entities
• Reduced minimum maturity: The minimum average maturity period (MAMP) has been reduced to 3 years for all ECBs, regardless of end-use. Previously, certain end-uses required a MAMP of 5 or 10 years
• Manufacturing sector relaxation: Manufacturing entities can raise ECBs with MAMP between 1 and 3 years, subject to an aggregate outstanding cap of USD 150 million
• Removal of all-in-cost ceiling: The previous cap of benchmark rate plus 500 basis points has been removed. Pricing is now market-determined, though related-party ECBs must still be at arm's length

Approval Route

If your loan does not conform to the automatic route parameters, it requires prior approval from the RBI. Common reasons for approval route borrowings include:

• ECB proceeds to be used for end-uses not permitted under the automatic route
• Borrower entity type not eligible under the automatic route
• Any other parameter deviation from the prescribed norms

Approval route applications are submitted through the AD bank to the RBI's Foreign Exchange Department. Processing typically takes 4-8 weeks, but can extend to 3-4 months for complex transactions.

Key Parameters for Intercompany Loans

Eligible Borrowers

Under the revised ECB regulations, the following entities can borrow through the ECB route:

• Companies registered under the Companies Act, 2013 (including private limited companies and public limited companies)
• Limited Liability Partnerships (LLPs) registered under the LLP Act, 2008
• Startups recognized by DPIIT
• SEZ units
• Port trusts and units in International Financial Services Centres (IFSCs)

Branch offices and liaison offices of foreign companies cannot borrow under the ECB route, as they are not separate legal entities under Indian law.

Minimum Average Maturity Period (MAMP)

The 2026 amendments have simplified the MAMP requirements:

MAMP is calculated as the weighted average of the maturity period, considering the principal repayment schedule. A 5-year loan with quarterly repayments starting from Year 2 will have a MAMP shorter than 5 years, so model your repayment schedule carefully to meet the minimum.

Interest Rate and All-in-Cost

The 2026 amendments represent a paradigm shift in ECB pricing. The previous all-in-cost ceiling (benchmark rate + 500 basis points for foreign currency ECBs, benchmark rate + 450 basis points for INR-denominated ECBs) has been removed entirely. The market now determines pricing.

However, for intercompany loans, the arm's length requirement under transfer pricing rules remains critical. The interest rate on a parent-to-subsidiary loan must be at arm's length, meaning it should reflect what the subsidiary would pay to an independent lender for a similar loan. Key considerations:

• Benchmark: For USD-denominated loans, the Secured Overnight Financing Rate (SOFR) is the standard benchmark, replacing the now-discontinued LIBOR
• Credit spread: Add a credit spread reflecting the subsidiary's standalone credit risk (not the parent's rating). For a new Indian subsidiary with limited track record, spreads of 200-400 basis points over SOFR are common
• Safe harbour rates: India's transfer pricing safe harbour rules prescribe minimum interest rates for intercompany loans. For USD-denominated loans, the safe harbour rate is SOFR plus 150 basis points. Pricing at or above the safe harbour rate eliminates transfer pricing adjustment risk
• All-in-cost: For ECBs with MAMP of less than 3 years (available to manufacturing entities), the cost must comply with Trade Credit ceilings specified by the RBI

Currency and Hedging

Intercompany loans can be denominated in any freely convertible foreign currency (USD, EUR, GBP, JPY, etc.) or in Indian Rupees (INR-denominated ECBs). For INR-denominated ECBs, the foreign lender bears the currency risk.

The RBI does not mandate hedging of ECB exposures, but the AD bank must advise the borrower on currency risk management. Many Indian subsidiaries hedge their ECB exposure through forward contracts, especially if the loan constitutes a significant portion of their balance sheet. Hedging costs should be factored into the total cost of borrowing when comparing ECB funding against domestic alternatives.

End-Use Restrictions

The 2026 amendments codify end-use restrictions under Regulation 3A. ECB proceeds can be used for:

• Capital expenditure (plant, machinery, equipment)
• Working capital (subject to conditions)
• General corporate purposes (including repayment of INR loans obtained for permitted end-uses)
• On-lending by eligible entities for permitted end-uses

ECB proceeds cannot be used for:

• Real estate business: Purchase, sale, or lease of land or immovable property with a view to earning profit. However, construction of industrial parks, SEZs, integrated townships, and properties for the company's own use are permitted
• Capital market investments: Investment in equity shares, derivatives, or speculative activities
• Chit funds and Nidhi companies
• Repayment of INR loans that were themselves used for restricted end-uses
• On-lending for restricted purposes

A common trap for foreign subsidiaries: using ECB proceeds to fund security deposits for office leases. If the lease qualifies as a "real estate" transaction, the use may be challenged. Structure your fund utilization carefully and maintain detailed records of how every rupee of ECB proceeds is deployed.

RBI Reporting and Compliance

Loan Registration Number (LRN)

Every ECB must be registered with the RBI through the AD bank. Under the 2026 amendments, the borrower files Form ECB 1 to obtain a Loan Registration Number (LRN). The LRN must be obtained before the first drawdown. Without an LRN, the AD bank cannot process the inward remittance of loan proceeds.

Ongoing Reporting

Under the revised framework, the monthly Form ECB-2 certification requirement has been eliminated. Instead, the borrower must file a Revised Form ECB 1 within 7 days of month-end to report any changes in previously reported parameters (drawdowns, repayments, interest payments, etc.). If there are no changes in a given month, no filing is required.

This is a significant simplification from the previous regime, which required monthly certification regardless of transaction activity.

Annual Return on Foreign Liabilities and Assets (FLA)

Every Indian company that has received foreign investment (including ECB) must file the FLA Return with the RBI by July 15 each year. The FLA Return captures the company's foreign liabilities (including ECB outstanding) and foreign assets as of March 31.

Tax Implications of Intercompany Loans

Withholding Tax on Interest Payments

Interest payments on intercompany loans to a non-resident parent company attract withholding tax (TDS) under Section 195 of the Income Tax Act. The applicable rates are:

The parent company's home country's Double Taxation Avoidance Agreement (DTAA) with India often provides a lower withholding rate. For example, the India-US DTAA caps interest withholding at 15%, the India-UK DTAA at 15%, the India-Singapore DTAA at 15%, and the India-Netherlands DTAA at 10%. To claim DTAA benefits, the parent must provide a Tax Residency Certificate (TRC) and the Indian subsidiary must file Form 15CA/15CB before making the remittance.

Deductibility of Interest

Interest paid on intercompany loans is generally deductible as a business expense for the Indian subsidiary, subject to:

• Arm's length pricing: The interest rate must be at arm's length under transfer pricing rules. If the TPO determines that the rate is excessive, the excess interest will be disallowed
• Thin capitalisation rules: Under Section 94B, interest paid to associated enterprises exceeding INR 1 crore is deductible only to the extent of 30% of EBITDA. Excess interest can be carried forward for 8 years. This rule applies when the debt from associated enterprises exceeds a 2:1 debt-to-equity ratio threshold
• Section 14A disallowance: If the subsidiary earns exempt income (e.g., dividends from Indian companies), a proportionate disallowance of interest may apply

GST on Interest

Interest on loans is exempt from GST under the RBI-regulated financial services exemption. However, if the intercompany agreement bundles interest with other services (such as financial advisory or treasury management fees), the service component may attract GST at 18% under the reverse charge mechanism.

Structuring Best Practices

Debt-to-Equity Ratio

While the RBI does not prescribe a maximum debt-to-equity ratio for ECBs (the previous 7:1 ratio was removed in 2019), the thin capitalisation rule under Section 94B effectively limits the tax-efficient debt from related parties. For practical purposes, maintain a debt-to-equity ratio below 2:1 for intercompany debt to ensure full interest deductibility.

Intercompany Loan Agreement: Essential Clauses

Every intercompany loan must be governed by a formal written agreement. The agreement should include:

1. Parties: Full legal names and registered addresses of the lender and borrower
2. Loan amount and currency: Maximum facility amount and denomination
3. Purpose/End-use: Specific permitted uses aligned with ECB end-use restrictions
4. Interest rate: Fixed or floating rate, benchmark, spread, payment frequency, and day count convention
5. Maturity and repayment schedule: Tenor, repayment dates, and amounts (ensure MAMP compliance)
6. Drawdown conditions: Conditions precedent to each drawdown (LRN, board resolution, etc.)
7. Prepayment provisions: Rights and notice periods for early repayment
8. Events of default: Non-payment, insolvency, material adverse change, breach of covenants
9. Representations and warranties: ECB compliance, authorized borrowing, no litigation
10. Governing law and dispute resolution: Typically Indian law with arbitration in a neutral venue
11. Tax gross-up clause: Whether the borrower must gross up interest payments for withholding tax
12. Currency hedging provisions: Obligations or options for currency risk management

Board and Shareholder Approvals

The Indian subsidiary's board of directors must pass a resolution approving the intercompany borrowing, specifying the amount, terms, and authorized signatories. If the loan exceeds the limits prescribed under Section 180(1)(c) of the Companies Act, 2013 (total borrowings exceeding paid-up share capital plus free reserves), a special resolution of shareholders is required.

Equity vs. Debt: Choosing the Right Funding Mix

Before structuring an intercompany loan, consider whether debt is the optimal funding instrument. The choice between equity and debt has significant implications for tax efficiency, repatriation flexibility, and regulatory burden.

When Debt Is Preferred

• Tax shield: Interest payments are deductible expenses for the subsidiary, reducing corporate tax liability. Dividend distributions, by contrast, come from post-tax profits
• Repatriation flexibility: Principal repayments and interest payments can be remitted on a scheduled basis without shareholder approval. Dividend repatriation requires board approval and adequate distributable profits
• Temporary funding needs: For working capital or project-specific requirements with a defined repayment timeline, debt is more appropriate than permanent equity
• Capital structure optimization: Maintaining an appropriate debt-to-equity ratio can improve return on equity metrics for the group

When Equity Is Preferred

• Permanent capital needs: Fixed assets, long-term infrastructure, and foundational business investments are better funded through equity
• Thin capitalisation constraints: If interest deductibility is already limited under Section 94B, additional debt provides diminishing tax benefits
• Regulatory simplicity: Equity infusion through the FC-GPR route involves one-time reporting, whereas ECBs require ongoing compliance with RBI reporting norms
• Creditworthiness signals: Indian banks and creditors evaluate the subsidiary's debt-to-equity ratio when extending local credit facilities. Excessive intercompany debt may limit access to local bank borrowing

Many foreign companies use a blended approach: equity for permanent capital and intercompany loans for variable funding needs. A typical structure for a new subsidiary might be 60-70% equity and 30-40% intercompany debt, ensuring full interest deductibility while maintaining a healthy balance sheet.

Common Pitfalls and How to Avoid Them

1. No written agreement: Some parent companies transfer funds informally. Without a written agreement specifying ECB-compliant terms, the transfer may be treated as equity or as an unauthorized borrowing under FEMA
2. Interest rate not at arm's length: Charging zero interest or below-market interest triggers transfer pricing adjustments. Even interest-free loans are subject to arm's length pricing, and the TPO can impute a market rate
3. Missing LRN: Drawing down funds before obtaining the Loan Registration Number from the RBI is a FEMA violation. Always file Form ECB 1 and obtain the LRN first
4. End-use violation: Using ECB proceeds for a prohibited purpose (even inadvertently) requires disclosure and FEMA compounding. Maintain a separate bank account for ECB proceeds and track utilization meticulously
5. MAMP miscalculation: The minimum average maturity period is a weighted average, not the final maturity date. A loan with bullet repayment has a higher MAMP than one with amortizing payments. Model the MAMP before signing the agreement
6. Forgetting Form 15CA/15CB: Every interest payment remittance to the parent company requires prior filing of Form 15CA (by the company) and Form 15CB (by a CA). The AD bank will not process the remittance without these forms
7. Ignoring thin capitalisation: Excess intercompany debt (above the 2:1 debt-to-equity threshold) results in interest disallowance under Section 94B, increasing the effective cost of the loan

Key Takeaways

• Every intercompany loan to an Indian entity is an ECB under FEMA and must comply with RBI regulations
• The 2026 amended ECB regulations removed the all-in-cost ceiling and reduced MAMP to 3 years, significantly liberalizing the framework
• Obtain the Loan Registration Number (LRN) via Form ECB 1 before any drawdown
• Price the interest rate at arm's length; use the safe harbour rate (SOFR + 150 bps for USD loans) as a floor to eliminate TP risk
• Maintain a debt-to-equity ratio below 2:1 for intercompany debt to ensure full interest deductibility under Section 94B
• Execute a comprehensive written loan agreement covering all ECB-mandated terms and obtain board (and if required, shareholder) approval
• For alternative funding strategies, see our guide on 5 ways to fund your Indian subsidiary, and for ongoing payment compliance, read our article on intercompany payments compliance
• Engage a specialist FEMA and RBI compliance advisory firm to structure your first ECB and ensure full regulatory compliance