The Indian government is clamping down on the use of inter-company loans, with more restrictions placed on loan requirements and loan rates from April 1. 

Under India’s new Companies Act, lending rates for inter-company loans must now be benchmarked against Indian government bonds, instead of to the Reserve Bank of India (RBI) rates. These rates shall not be lower than the prevailing yield of one-year, three-year, five- year, or 10-year government bonds – closest to the tenor of the loan.

The other main changes to the rules on inter-company loans, are:.

• rules on loans and investments concerning the characteristics of counter-parties, and terms of the loans: Previously, a public company (and private subsidiaries of public companies) needed a special resolution from its members for lending more than 60% of its paid-up share capital and free reserves, to another company. In the new legislation, this provision has been amended to exclude the exemption for private companies. The threshold has been amended to include securities premiums when calculating that 60% for the lending company.
• rules concerning conflicts of interest between company directors: The new rules ban loans by a company to its directors or loans to entities that director may have an interest in.
• disclosures rules: A company providing inter-company loans must now disclose full particulars of the loans, including the purpose for which it is given, in its financial statements.

Local treasurers believe this will probably make inter-group rates more volatile

Higher disclosure rules and penalties

The new rules include higher disclosure requirements on inter-company loans, tightens restrictions. The new bill also increases the penalties on defaults. Previously, imprisonment could be evaded or reduced by repaying the full or part of the defaulted inter-company loan. But now this exemption no long exists.

The scope of penalty has also been increased. A company that breaks the rules on inter-company loans will have to pay a fine up to Rs500,000, an increase from the earlier cap of Rs25,000.

Impact

These new regulations were introduced amid concerns that private companies were taking advantage of inter-company lending to release trapped cash, rather than a funding tool for companies in India. The revisions are intended to provide transparency to let stakeholders evaluate a company’s financial health more accurately. However, some experts believe that some of the provisions under the 2013 Act may actually make it more difficult to make genuine inter-company loan transactions.