Concept of intercompany transaction

An intercompany transaction is defined as 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).

Intercompany transactions: key examples

Intercompany transactions may be sought through multiple arrangements and structures, including purchases of goods and services, intercompany loans, dividends distribution, cost allocation, and royalties:

• Purchasing of goods and services: subsidiaries within the same group might need to purchase various goods and services from each other. Such goods include equipment, inventory, or supplies. Services may be those of personnel moving from one entity to another in order to make their expertise available there and hence increase the impact. Such purchases are examples of lateral transactions.
• Intercompany loan: 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. 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. Intercompany loan is a downstream transaction.
• Dividends distribution: a downstream transaction that takes place through a profit-sharing agreement that allows an entity (parent) to distribute certain amounts from its dividends to its subsidiaries.
• Payment of royalties: an example of an upstream transaction where royalties are paid in exchange for the use of patents and copyrights.