Executive answer
An intercompany loan should be analyzed before searching for a rate. First determine whether an independent lender would advance that amount to the borrower and under which conditions. Review purpose, capacity, amount, term, currency, amortization, subordination, security, covenants, options and conduct. Only then price it.
An agreement called “loan” does not establish that the entire contribution is debt. Without a reasonable repayment expectation, real maturity, capacity or creditor conduct, another delineation may require consideration. Conversely, a loss-making business may still obtain credit through assets, support, future cash flow or protective terms.
In Mexico, arm’s-length pricing and deductibility are related but distinct tests. A market rate may still face thin capitalization, net interest limitation, withholding, treaty and other requirements. Passing a limit does not prove amount and rate are arm’s length.
Delineation tree
- What is the business purpose and use of funds?
- How much does the borrower need and for how long?
- Can it service interest and principal under reasonable scenarios?
- Would a third party lend the whole amount?
- Which protection would it require: security, covenant, amortization or premium?
- Does currency match cash flows and risk?
- Does the agreement reflect actual terms?
- Do parties make payments, monitor and enforce remedies?
- Is there implicit group support?
- Is there an explicit guarantee?
- Which rating and comparables apply?
- Which Mexican rules additionally affect deduction and withholding?
Record evidence and decisions. The tree is not a legal opinion.
Minimum term sheet
| Element | Definition | Evidence |
|---|---|---|
| Lender/borrower | entities and residence | structure, authority |
| Purpose | use of proceeds | budget, approval |
| Principal | amount and draws | bank, schedule |
| Currency | contractual denomination | cash flows, exposure |
| Term | maturity and extensions | forecast, market |
| Amortization | bullet or partial | repayment capacity |
| Rate | fixed/floating and reference | benchmark |
| Fees | arrangement, commitment, prepayment | comparables |
| Security | asset or corporate | agreement, value |
| Covenants | limits and reports | metrics, monitoring |
| Subordination | priority | capital structure |
| Default | events and remedies | lender conduct |
A timely term sheet supports comparable review and consistent drafting.
Purpose and use
Document whether credit funds working capital, asset, acquisition, dividend, restructuring or deficit. Purpose affects term, amortization and risk. A ten-year loan for a monthly need needs explanation; a long-lived acquisition funded on demand does too.
Trace proceeds. Compare approval and application. If cash returns to the group or replaces equity, analyze substance. It is not automatically improper, but questions change.
Update when purpose changes. A current-account balance becoming permanent may need formalization and different pricing.
Debt capacity
Model cash available for service, not EBITDA alone. Include capital spending, working capital, tax, existing debt, dividends and contingencies. Calculate coverage, leverage and maturities under base and stress cases.
Compare with banking practice and sector. Capacity is not one universal ratio. Growth, infrastructure and seasonal businesses differ. Analyze assets and recovery in default.
If only part is independently financeable, document alternatives: lower debt, equity, guarantee or term. Do not merely increase rate to compensate for implausible principal.
Credit rating
Determine a borrower rating using an explainable method. Consider financials, sector, size, geography, leverage, coverage and risk. Record date and forecast. Do not copy the group rating.
Consider implicit support: membership can affect expected support but does not automatically create a guarantee or fee. Analyze strategic importance, history, integration and public signals. Distinguish stand-alone and adjusted ratings.
Validate against external debt where available, adjusting entity, seniority, currency and date. Rating is an input, not the benchmark outcome.
Currency, term and structure
Evaluate currency from cash flows and alternatives. Dollar debt for a peso earner creates FX risk; it may be reasonable, but pricing and control must reflect it. Do not choose currency solely for a low nominal rate.
Economic term may differ from contract where renewals are predictable or demand loans remain for years. Analyze prepayment and extension options. Long-term fixed and short-term floating loans are not comparable.
Amortization reduces risk relative to bullet. Grace periods, interest capitalization and subordination change risk and comparability.
Rate benchmark
CUP analysis may use borrower or lender external loans, bonds, credit databases or adjusted curves. Define date, currency, term, rating, seniority, security, amount, sector and conditions. A risk-free reference plus spread requires support for the spread.
Use information available when agreed. A year-end study should not import later rates without explanation. For floating rates define reference, tenor, margin, floor and reset. For fixed rates compare fixed instruments or support conversion.
Review fees as well as coupon. Arrangement, commitment, guarantee and prepayment affect total cost. A low rate can be expensive through fees.
If analysis begins with “SOFR plus a spread” but does not prove capacity, currency and term, redelineate before signing or renewal.
Internal comparables
A contemporary bank offer may be useful if binding or detailed enough. An indicative quote helps but does not prove the bank would lend the amount. Compare security, covenants and purpose.
External debt of another group company is not automatically an internal comparable. Adjust rating, jurisdiction and structure. Explain why it is more reliable than external observations.
Where the lender borrows to on-lend, its cost is a reference, not automatic price. Add functions, risk and capital. Avoid a fixed spread without analysis.
Conduct over the life
The lender should monitor information, collections and covenants consistently with its role. The borrower pays on schedule. Renegotiations should document market conditions and distress.
Repeated capitalization of unpaid interest may show original terms became unrealistic. Determine whether an independent party would restructure, enforce security, seek equity or forgive. Do not leave breached terms indefinitely.
Keep statements, certificates, approvals, notices and transfers. Contemporaneous conduct supports delineation.
Withholding, treaty and deduction
Analyze source, recipient, residence, domestic rate and applicable treaty. Retain certificates and requirements. Coordinate accrual/payment date, withholding, remittance and evidence. Do not assume every institution or related party receives the same rate.
Review thin capitalization and net interest limitation, general requirements and documentation. These do not replace arm’s length. Interest may be arm’s length but limited, or inside a limit while outside market.
Consider FX, VAT where relevant, accounting and related-party reporting. Reconcile balances and interest with agreement and study.
Recommended file
- Approval and purpose.
- Term sheet and agreement.
- Draws and use.
- Capacity and scenarios.
- Stand-alone/support rating.
- Currency, term and options.
- Search and comparables.
- Rate and fees.
- Security and covenants.
- Payments and monitoring.
- Withholding and treaty.
- Deduction limits.
- Accounting and reporting.
Risk signals
- Principal without repayment capacity.
- Agreement after funding.
- Permanent demand loan.
- Currency unrelated to flows.
- Parent rating copied.
- Rate without date or comparables.
- Missed payments without response.
- Repeated interest capitalization.
- Guarantee ignored in price.
- Thin capitalization confused with arm’s length.
Governance
Treasury models and executes; business confirms use; tax reviews rules and withholding; legal drafts; transfer pricing delineates and prices; accounting reconciles. A committee approves new credit and changes.
Monitor capacity, covenants, payments and rating quarterly. Update on refinance, extension, currency, security or condition changes. A live loan needs administration, not merely an annual study.
Maintain a complete debt inventory to identify priority and concentration. Contract-by-contract analysis can miss capital structure.
Illustration: plant expansion
A Mexican entity requests USD 25 million to expand a plant. Revenue is mainly dollars, but the project will not generate cash for two years. The parent proposes a five-year bullet, floating rate and no security. Analysis does not begin with the spread.
First model construction, overruns, ramp-up and existing debt. An independent lender might require milestone draws, grace period, later amortization, coverage covenants and asset security. Stress capacity may support only USD 18 million; the remainder could require equity or an explicit guarantee.
Then determine rating considering project and implicit support, search dollar comparables with similar term and priority, price any guarantee and calculate all-in cost. The agreement includes construction reports and remedies. The result may be a lower rate than proposed but stricter conditions; arm’s length does not mean maximizing interest.
Stress testing
Model lower sales, delay, higher rates, devaluation, overrun and customer loss. Do not combine incompatible shocks without explanation. Identify default point and lender recovery. Compare with observed covenants.
Retain assumptions and owners. A mild stress case does not prove capacity; a catastrophic one may not reflect independent decision-making. Use reasonable and severe cases.
Later review compares performance with scenarios without hindsight rewriting original price. If facts materially change, assess refinancing from that date.
Agreement and operating close
The agreement should implement the term sheet: purpose, draws, rate, day count, reference, fallback, tax, gross-up where relevant, payments, prepayment, covenants, information, events and governing law. Define what happens if the reference ceases.
Before funding obtain authority, account, certificates and approvals. Afterward reconcile bank and principal. Calculate interest with a reproducible calendar. Document withholding and remittance. A manual spreadsheet without review creates errors even when the rate is right.
Effective interest and fees
Calculate all-in economics, not only annual coupon. Include arrangement, commitment, unused-line, agency, guarantee and prepayment fees. Determine whether fees compensate a real function or merely shift return. Spread one-time fees over the relevant period where the economic analysis requires.
Compare lender return with funding and capital, but do not cap it mechanically at cost plus. A lender controlling credit risk differs from a conduit. Follow decision makers, monitoring and loss capacity.
Audit questions
- What evidence showed capacity at signing?
- Why is the amount debt rather than equity?
- Who approved and monitored?
- How was rating determined?
- Which comparables were rejected?
- How do guarantee and support affect price?
- Were payments and covenants observed?
- Which rules limited deduction?
- Does withholding reconcile to interest?
- What changed since origination?
Prepare answers with contemporaneous records and reconciled figures. If evidence is missing, identify alternatives and prospective remediation rather than recreating history.
Include negotiation communications. A final agreement does not show which amounts, protections or alternatives the parties rejected. The history helps demonstrate that structure responded to capacity and risk rather than only a tax objective. Control versions, approval dates and changes in assumptions.
Record who owns each follow-up action and its deadline. An unresolved covenant, missing certificate or unreconciled payment can change the factual analysis even when the original pricing memorandum was sound.
Sources and cutoff
This article was verified as of August 2, 2026. Consult current Mexican Income Tax Law, the OECD Guidelines 2022, Chapter X, the OECD financial transactions guidance and the OECD Mexico profile.
Zugzwang’s Intercompany Finance Pricing Memo integrates debt, capacity, rating, terms, benchmark, withholding and Mexican limits into an operable file.