A transaction that takes place when two entities belonging to the same legal parent engage in certain activities with each other, as part of each entity’s direct area and towards fulfillment of the overarching objectives of the parent entity. These include transactions arising and implemented between the parent company and the subsidiary, or transactions between two subsidiaries owned by the same parent company. Category-wise, intercompany transactions are categorized into three types: downstream (parent to subsidiary), upstream (subsidiary to parent) or lateral (between subsidiaries).

In terms of purpose, intercompany transactions can take a variety of different forms, and certain common examples of these transactions include loans (intercompany loans), finances, cost allocations, royalties, and the exchange of goods and services.

Intercompany transactions can entail both monetary and non-monetary transfers. These transactions might involve the transfer of debt or the exchange of human resources and other economic resources such as fixed assets (e.g., equipment). In this sense, these transactions provide a viable means of utilizing and optimizing the shared resources at the level of a corporate group (parent entity).

For example, an intercompany loan is a loan extended within a parent (corporate group) from one business unit (or subsidiary) to another. The business units or subsidiaries are, by nature, separate legal entities. Companies with subsidiaries have this type of internal loans provided as private transaction within. In many ways, these loans have similarities with bank loans, given their very nature as sources of liquidity. But the benefits may be comparably wider, considering the greater flexibility and lower costs of funding. In other words, as a flexible, cost-effective financing option, an intercompany loan helps parent companies manage internal cash flows and direct funds to new projects, while maximizing financial resources and have potential for more operational flexibility.

An entity might offer loans to one of its subsidiaries at better terms than banks or other third parties. This is an example of a downstream transaction, which can help the subsidiary expand its operations more efficiently and at lower funding costs. Likewise, dividends distribution (another downstream transaction) can be effected through a profit-sharing agreement that allows an entity (parent) to distribute certain amounts from its dividends to its subsidiaries. An example of an upstream transaction is payment of royalties in exchange for the use of patents and copyrights.