Intragroup Funding: Lending Between Entities of One Group

Intragroup funding is one entity of a group lending to another. Done properly it carries three things: a document, a price and a repayment schedule. Without them the money has moved and nothing has been created. No obligation exists that anybody can enforce, price, unwind or audit. Intragroup funding also moves exposure between names inside the group without changing what the group owes outside it.

Almost every group of any size does this, and a surprising number of them do it without ever writing it down. The money is real, it leaves one company and arrives at another, and somebody decides years later whether it was a loan, an investment or a gift. The difference between those three is half the subject. The other half is a consequence most people meet only when a lender asks an awkward question.

What is intragroup funding, and why does a group need it at all?

Start with the fact everything else rests on. A group is not one pocket. A group is a set of separate companies, each with its own accounts, its own auditors and its own name on somebody's records. Intragroup fundingOne entity of a group lending to another entity of the same group. exists because cash sits where it is collected and is needed where it is spent, and inside a group of several companies those two places are hardly ever the same one. Money crossing from one entity to another does not stay inside a single balance sheet: it leaves one and arrives on another, and something has to record the difference.

Here is the everyday version. Two brothers run two shops on the same street. The shops share a name over the door and share a reputation, but they keep separate books, separate stock and separate takings. On a Tuesday the first shop has cash in the drawer and the second has a supplier standing at the counter. The first hands over the cash. Nothing about the shared name over the door changes what just happened: shop one is now owed money by shop two, and if the two of them never write that down, then in three years neither of them will be able to say whether it was a loan, a contribution to the business or a favour. The signage does not merge the books.

Nirjhar Industries Limited, invented, is that pair of shops at Rs 9,180 crore of total assets. The group makes steel and alloys and holds three legal entitiesA separate company with its own balance sheet, its own obligations and its own name on a lender's records.. E1 is Nirjhar Industries Limited itself, the parent, in India. E2 is Nirjhar Alloys Private Limited, in India, held in full by E1. E3 is Nirjhar Trading FZE, an overseas trading entity in a Gulf jurisdiction. The group treasurer is Girish Talwalkar. E1 lends E2 Rs 240 crore, and almost everything that follows comes out of that one sentence.

What turns an internal transfer into a loan rather than a movement of money?

Three things, and each one of them answers a question somebody will eventually ask. The first is a document. Without one there is no obligation anybody can enforce. The second is a price. Without one, value has moved between two balance sheets and nobody has measured how much. The third is a repayment scheduleThe written dates on which a loan is to be repaid, without which nobody can say whether it is current.. Without one, nobody can say whether the loan is current, overdue or in fact permanent. Take away any one of the three and what is left is a movement of cash wearing the word loan as a label.

The reason this matters is that the bank statement looks exactly the same either way. Rs 240 crore leaves an account in the name of E1 on a Tuesday and lands in an account in the name of E2 on the same Tuesday. The statement cannot show which of the two things happened, and neither can anybody reading it three years later. The document, the price and the schedule are the only things that separate them, and none of the three is visible in the movement itself.

So what is an undocumented transfer, if it is not a loan? Honestly, nobody knows until somebody decides, and that is the problem. An undocumented transfer might be treated as a loan by one party and a capital contribution by the other. One side might write it off while the other still carries it. In a year when both entities are healthy nobody asks. In the year when one of them is not, three separate people ask at once, and the answer is assembled backwards from bank statements by somebody who was not there. Calling a transfer a loan does not make it one; the three things do, and they only work if they existed before the money moved.

How is an intragroup loan priced, and who decides the price is acceptable?

The Rs 240 crore from E1 to E2 carries a price. The price is the group's own contracted rate, and the level of that rate is not the point. Somebody chose that rate, wrote it down and can say why.

The interesting case is the group that lends at zero. Lending at zero happens constantly, and the reasoning always sounds the same: it is all one group anyway, so why charge ourselves. Notice what has actually happened there. A rate of zero is a price. A group lending at zero has priced the loan, and it has done so without recording that it made the choice. That is different from having no price, and it is worse than a price nobody likes, because a price nobody likes at least has a reason attached to it somewhere. Value has moved from one balance sheet to another for nothing, and in three years the person asked to explain why will not be the person who did it.

What a tax authority can do to an internal price

There is a second question standing behind the price, and it is a real one. Transfer pricingWhether an internal price is acceptable to a tax authority, which advisers settle on the facts. asks whether the rate two connected entities agreed between themselves is acceptable to a tax authority, or whether the authority will substitute the rate it thinks unconnected parties would have reached on the same facts. The rate the authority would substitute is what people mean by an arm's length priceA price two unconnected parties would have agreed on the same facts, which is a question for advisers..

Each tax authority sets its own requirement, its own expected documentation, its own preferred method and its own effective dates, and those are covered separately. The answer depends on the facts, on the jurisdictions at both ends and on rules that move. The group's advisers settle it, and where an Indian entity is involved what actually binds comes from the sources named in the reference block below. Knowing that the question exists, and that it attaches to every intragroup price including a price of zero, is the part that matters.

Why is one entity funded by a loan and another by equity?

E2 got a loan. E3 got equity fundingMoney put into an entity as capital rather than as a loan, so nothing is repayable on a date. instead, on the group's own decision, and the two routes are not interchangeable. A loan is repayable on dates, carries a price, sits as a payable on the receiving entity and disappears when it is repaid. Equity is repayable on no date, carries no price, sits as capital and comes back only if the entity pays it out or is wound up. The same rupees put in by the two routes create two different objects with different consequences for everybody downstream.

Why did this group split them that way? Because E3 sits overseas and the money would have to cross a border. Moving cash across a border is a separate decision with its own consents, and what an Indian entity may actually do is set by the Reserve Bank of India rather than by a treasurer's preference. The group looked at the choice, took advice and recorded a reason. The point is not that a loan is right and equity is wrong: it is that a group with an overseas entity faces a live choice, and a group that has never made the choice explicitly usually discovers it has made it by accident.

What does intragroup funding do to what an outside lender can see?

Now cross the table and sit on the other side of it. Nirjhar Industries Limited is not only a group with a treasury: it is also counterparty C1 of Vindhya Commercial Bank Limited, invented, and it is that bank's largest single-name exposure. The bank's record on C1 reads funded Rs 1,680 crore, undrawn Rs 720 crore and derivative current exposure Rs 96 crore, for a total of Rs 2,496 crore. The total is 1,680 plus 720 plus 96, and it is 94.5 per cent of the bank's own single-name limit L1 of Rs 2,640 crore.

The bank also has a second record. E2 Nirjhar Alloys Private Limited carries funded Rs 660 crore and undrawn Rs 12 crore from the same bank. The two add to Rs 672 crore of single-name exposureWhat a lender has to one legal entity, which is a different figure from the group total.. Both records are complete and both are correct. The bank reports Nirjhar Alloys inside the group line rather than as a single name, so Nirjhar Alloys appears nowhere on the bank's published list of its ten largest single names. On the funded basis the bank actually publishes, Rs 660 crore would have sat ninth, between C8 Palar Auto Components Limited at Rs 720 crore and C9 Lohit Valley Tea Estates Limited at Rs 600 crore.

Adding the two records gives the number that measures what the bank has actually put at risk on one business: 2,496 plus 672 is Rs 3,168 crore of group exposureThe total a lender has to every connected entity of one borrower group, added on one row., and that figure exists on neither record. It is 80.0 per cent of the bank's own group limit L2 of Rs 3,960 crore, which is 60.0 per cent of its tier 1 capital of Rs 6,600 crore, and it is Rs 528 crore more than the entire single-name cap L1. Inside that line C1 is 78.8 per cent and E2 is 21.2 per cent. Limit L2 exists for exactly one reason: to force somebody to add those two rows together on a day when nobody has a reason to.

What happens to the numbers as the internal loan grows?

The loan can now be made to move. E2 needs a fixed quantity of funding, and where it comes from is the only thing changing. Its total funded requirement is Rs 660 crore from the bank plus Rs 240 crore from E1, being Rs 900 crore, and that Rs 900 crore is held constant throughout. Holding it constant is an assumption of this illustration and it is worth naming: in real life a group that changes its internal funding often changes what it needs at the same time.

Write L for the intragroup loan. External funded borrowing is 900 less L. E2's total exposure to the bank is that plus the Rs 12 crore of undrawn line, being 912 less L. The group line is C1's Rs 2,496 crore plus that, being 3,408 less L. At the actual L of Rs 240 crore the group line is Rs 3,168 crore, and the figure reproduces the bank's record exactly. At L of zero it would be Rs 3,408 crore, being 86.1 per cent of limit L2, so the group sits inside that limit at every size of loan from nothing upward and the intragroup structure is not concealing a breach anywhere on the range.

Move the control and two things happen that are worth separating. The group line falls, one rupee for one rupee, and it falls in the direction of safety, so nothing about it ever troubles limit L2. Meanwhile E2's exposure to the bank falls through two thresholds that have nothing to do with any limit at all. E2's exposure drops level with C10 Betwa Speciality Chemicals Limited at Rs 780 crore once L reaches Rs 132 crore, and level with C9 Lohit Valley Tea Estates Limited at Rs 660 crore once L reaches Rs 252 crore. The first thing intragroup funding changes is what a ranked list looks like. The crossings on that list happen long before any limit crossing does, and in this case no limit crossing happens at all.

How does a daily cash sweep create intragroup loans nobody signed?

One form of it catches groups who thought they had no intragroup funding at all. Nirjhar runs a physical cash concentration: 18 of its 26 bank accounts, all belonging to E1 and E2, are swept into one header account every day. Moving cash across a border is a separate decision with its own consents, so the other 8 accounts belong to E3 and sit outside the sweep. Nobody at Nirjhar thinks of the sweep as lending. The sweep is plumbing.

But watch the plumbing. On Tuesday evening a credit balance sitting in an account in the name of E2 is moved into a header account in the name of E1. The cash is now on E1's balance sheet and E2 is owed it. On Wednesday it happens again, and on Thursday, and in the other direction whenever an E1 account is in credit and the header account belongs elsewhere. A physical sweep moves cash between legal entities, so it creates an intragroup obligation every single evening, and the document recording that obligation was either written in advance or was never written at all.

A sweep is the single most common way a group ends up with internal lending it never chose. The sweep is also why the paperwork has to come first: a document written after two hundred sweeps is a reconstruction, and a reconstruction is exactly what nobody can rely on. The full arithmetic of what physical concentration is worth in rupees, and how it differs from a notional pool that moves no cash at all and therefore creates none of this, is settled separately.

Who actually reads this, and what do they do with it?

Three people, and they want three different things from the same structure. The credit analyst at the lender wants the group line and nothing else. The group line is the only figure that tells her what she loses if the business fails rather than what she loses if one company of it fails. She will ask for a list of connected entities before she asks for anything about the borrower's trading, and she will treat a group that cannot produce one as a group whose true exposure she cannot compute. Rs 3,168 crore against a limit of Rs 3,960 crore is a comfortable answer; not being able to reach the figure at all is not.

The group treasurer wants a different thing: he wants to know that every rupee that has moved between his entities is written down, priced and scheduled before anybody outside asks about it. Writing it down is not paperwork for its own sake. The documents are the difference between answering a question in an afternoon and reconstructing four years of bank statements. Girish Talwalkar runs 26 accounts across 4 banks in 3 currencies with about 1,840 payments a month, and the sweep is doing this to him nightly whether or not the documents keep up.

The third reader is the auditor, and the auditor is looking for the one thing the first two take for granted: that the receivable on E1 and the payable on E2 are the same number. Where a group has documented its internal lending, those two figures reconcile by construction; where it has not, they are two independent guesses about the same money and they almost never agree. The household version is a person who lends a cousin money over four years in seven instalments and keeps no note. Both of them remember a figure. The figures differ, and the relationship pays for the difference.

What can intragroup funding not do?

Two things, and being clear about both of them keeps the subject honest. Intragroup funding cannot create cash the group does not have. Moving Rs 240 crore from E1 to E2 leaves the group with exactly the cash it started with, and the group still carries Rs 4,320 crore of debt to outside lenders against equity of Rs 3,240 crore. An internal loan changes who inside the group holds a claim and who inside it carries an obligation. An internal loan changes nothing about what the group as a whole owes the outside world.

And it cannot make a group exposure smaller in any way that matters to the lender. Replacing external borrowing with internal borrowing does lower the group line, one rupee for one rupee. The reduction is real and it happened here: Rs 3,408 crore became Rs 3,168 crore. But it cannot make the underlying business less concentrated, and it cannot make a name that would otherwise appear on a list disappear from the total that the list is supposed to summarise. Intragroup funding moves visibility, and visibility is only worth having if somebody is still adding the names up.