6.4 Long-Term Intra-Entity Transactions

ASC 830-20

35-3 Gains and losses on the following foreign currency transactions shall not be included in determining net income but shall be reported in the same manner as translation adjustments: . . .

b. Intra-entity foreign currency transactions that are of a long-term-investment nature (that is, settlement is not planned or anticipated in the foreseeable future), when the entities to the transaction are consolidated, combined, or accounted for by the equity method in the reporting entity’s financial statements.

35-4 Intra-entity transactions and balances for which settlement is not planned or anticipated in the foreseeable future are considered to be part of the net investment. This might include balances that take the form of an advance or a demand note payable provided that payment is not planned or anticipated in the foreseeable future.

A consolidated entity should pay particular attention to long-term intra-entity transactions, since the facts and circumstances associated with such transactions may result in an accounting treatment for the consolidated entity that is inconsistent with the general principles in ASC 830.

6.4.1 Meaning of “Foreseeable Future”

ASC 830-20-35-3(b) contains an exception that allows entities to recognize exchange rate gains or losses as a currency translation adjustment within OCI for intra-entity transactions that are “of a long-term-investment nature” (i.e., the settlement of such transactions “is not planned or anticipated in the foreseeable future”). Whether repayment is planned is a key factor in applying this exception.

The FASB 52 Implementation Group discussed this issue at its December 1981 meeting, concluding that the term “foreseeable future” does not imply a specific period but is an intent-based indicator. Specifically, the group noted that an intra-entity transaction may qualify for the ASC 830-20-35-3(b) exception if:

There are no planned or anticipated repayments.1
Management, having the appropriate authority, represents that (1) it does not intend to require repayment of an intra-entity account and (2) the parent company’s management views the intra-entity account as part of its investment in the foreign subsidiary.

If the criteria for the exception are met, the exchange rate gains and losses are recorded through the currency translation adjustment as if they were part of the net investment.

Example 6-3

Short-Term Intra-Entity Debt

Company C is a wholly owned U.S. subsidiary (whose functional currency is the USD) of Company D, a Swiss-based holding company. Company C has notes due to D that are denominated in EUR. The notes have stated maturities ranging from six months to one year. Although the notes are short-term by contract, D represents each year that it will not demand payment for that year; historically, the notes have been renewed each year.

In this case, the short-term notes would not qualify for the exception in ASC 830-20-35-3(b). Company D only represents that it will not require payment in the current year on the rolled-over short-term notes; it does not represent that it will not demand payment on the notes in the foreseeable future (i.e., the timing of the repayment appears uncertain).

In other words, because D (the parent) cannot assert that repayment will not be required in the anticipated or foreseeable future, it is inappropriate for D to apply the exception in ASC 830-20-35-3(b). Further, the FASB 52 Implementation Group concluded that rolling- or minimum-balance intra-entity accounts do not qualify for this exception (see Example 6-5).

As demonstrated in the example above, uncertainty regarding the timing of a repayment is not a criterion under which a transaction can be considered long-term in nature. For an entity to apply the exception in ASC 830-20-35-3(b), there must not be a planned or anticipated repayment in the foreseeable future. Conversely, an intra-entity loan or advance may have a stated maturity or be due on demand, but if the lending entity does not intend to demand repayment despite the maturity date (i.e., management has stated its intentions to renew the loan or advance), it may be acceptable to apply the exception. The appropriate accounting in such cases will depend on management’s specific, stated intentions. In the example below, an intra-entity loan may seem to be long-term in nature given management’s intentions but does not, in fact, qualify for the exception.

Example 6-4

Determining Whether Linked Transactions Can Be Accounted for as Long-Term in Nature

Company A, which uses its local currency (EUR) as its functional currency, is a subsidiary of a U.S. parent company, P. Bank B has loaned A $100 million USD that is due in 20X4. Company A currently makes interest-only payments. The debt with B is collateralized in full with a letter of credit from P. Company A will most likely not be able to make its balloon payment (and possibly not its interest payments) under the existing agreement and will not be able to obtain alternative financing. Therefore, B is expected to convert the letter of credit in full payment of the debt as soon as A defaults. After default, P will have the third-party B debt and a USD-denominated intra-entity receivable from A. Company A will have a USD-denominated intra-entity payable to P.

In accordance with ASC 830-20-35-3(b), it is not acceptable for A to currently account for its debt to B as an intra-entity foreign currency transaction that is “of a long-term-investment nature” even though there is a high probability of default and conversion to an intra-entity payable is expected.

Company P’s settlement of A’s debt with B is anticipated in the near future with the creation of a new debt instrument also from P (its obligation under the letter of credit), and A will have an intra-entity payable to P. The settlement of A’s existing debt with B, the borrowing under the letter of credit, and the intra-entity transaction are not seen as one continuous transaction under ASC 830. Therefore, A’s debt to B does not currently meet the criteria to be reported in the same manner as a translation adjustment.

Because A currently makes USD-denominated interest payments to B, its functional currency cash flows are affected by changes in the foreign currency exchange rate. Changes in the foreign currency exchange rate affect A’s actual and expected functional currency cash flows. Therefore, the exchange rate gains and losses on such borrowings should continue to be accounted for as transaction gains and losses to be included in the determination of net income.

Management should also consider factors other than its intent in determining whether a transaction qualifies as long-term in nature. For instance, management should consider its history with similar instruments for which the intention was not to repay. If the entity, despite management’s intention, has historically been unable to maintain the long-term nature of similar instruments (e.g., repayments were necessary as a result of cash flow constraints), the entity may conclude that the instrument does not meet the “foreseeable future” criterion and that it cannot apply the exception. Other factors for an entity to consider in determining whether it qualifies for the exception are (1) its ability to control whether and, if so, when repayment will occur (e.g., if repayment is contingent on the occurrence of a certain event or transaction) and (2) whether there is a legitimate business purpose for not settling the intra-entity account. Further, when applying this exception, management should ensure that its intentions related to long-term intra-entity accounts are consistent with assertions being made for other purposes (e.g., indefinite reinvestment assertions for income tax purposes).

Connecting the Dots

The amounts subject to these long-term intra-entity transactions are often large enough that board approval is needed. An entity should therefore ensure that management personnel with the appropriate level of authority have approved the fact that the loans will not be repaid in the foreseeable future.

In addition, management should look for contradictory evidence regarding the assertion that the loans will not be repaid in the foreseeable future. For example, often these loans are created to generate an interest expense deduction in a high-tax-rate jurisdiction. Many tax jurisdictions require that an entity repay the loan at some point in time to receive the tax deduction.2 Accordingly, management will need to determine whether the assertion made for tax purposes (i.e., the intention to receive the deduction) contradicts the assertion made for financial reporting purposes (i.e., the settlement of such a transaction “is not planned or anticipated in the foreseeable future”). If the two assertions are contradictory, management will need to evaluate whether the deferral of foreign currency transaction gains and losses is appropriate or whether an uncertain tax position should be established for the interest deduction. See Deloitte’s Roadmap Income Taxes for additional information on the tax accounting impacts of these types of transactions.

The long-term-nature exception discussed above applies only to the consolidated entity’s financial statements. If an individual entity in the intra-entity transaction (e.g., a subsidiary) compiles stand-alone financial statements, the general rules in ASC 830 would apply and the transaction gains and losses associated with such accounts would be recorded in earnings. Similarly, if an ultimate parent entity enters into an intra-entity advance or loan with a third-tier subsidiary that is consolidated into an intermediary subsidiary, the accounting for the transaction in the intermediary’s stand-alone, consolidated financial statements would not qualify for the exception because the transaction is between the intermediary’s subsidiary and an entity outside its stand-alone, consolidated group (i.e., its ultimate parent). The image below illustrates this concept.

Accounts that are not determined to be long-term in nature (and are therefore subject to the same accounting treatment as similar accounts with third parties) will expose the entity to foreign currency exchange rate fluctuations since the effects of such fluctuations are reported in earnings.

6.4.2 Intra-Entity Debt With Interest Payments

If an intra-entity debt instrument is determined to be long-term in nature in accordance with the guidance discussed above, any related interest receivable or payable would not qualify for the same exception as the debt instrument itself when periodic interest payments are required. Rather, any transaction gains or losses related to the interest receivable or payable would be recorded in earnings (and would not be reclassified into a CTA upon consolidation). Such gains and losses would survive consolidation in a manner consistent with those that occur in the normal course of business (as discussed in Section 6.2).

6.4.3 Rolling or Minimum Balances

Many parent entities will maintain a minimum balance when managing intra-entity receivable or payable accounts. Management often views this minimum balance as a component in its financing of the subsidiary; however, rolling-balance and minimum-balance intra-entity accounts generally do not qualify for the exception for long-term investments under ASC 830.

Example 6-5

Rolling or Minimum Balances Viewed as Long-Term Investments

Company A, whose functional currency is the USD, advances EUR to its foreign subsidiary, AB, which has identified the EUR as its functional currency. Subsidiary AB may repay some of the advances; generally, however, they are replaced with new advances within a short time frame (i.e., three to five days). In total, AB has 50 million EUR advances outstanding at all times.

The advances from A to AB do not qualify as a long-term investment under ASC 830-20-35-3(b). Company A should therefore recognize transaction gains or losses related to such advances in earnings.

The FASB 52 Implementation Group addressed a similar question at its December 1981 meeting, concluding that the “aggregate balance of trade receivables or payables (each open invoice will be settled) cannot qualify as a long-term investment.” The group further concluded that intra-entity transactions must be evaluated individually, not on an aggregate or net basis (i.e., even if all intra-entity balances are aggregated in one general ledger account, an entity must consider the transactions individually to determine which ones qualify as long-term in nature).

6.4.4 Parent’s Guarantee of a Foreign Subsidiary’s Debt

Like the linked transaction in Example 6-4, a parent company’s guarantee of a subsidiary’s debt (either through contribution of equity or intra-entity lending) does not qualify for the long-term investment exception in ASC 830-20-35-3(b). Consider the following example:

Example 6-6

Parent’s Guarantee of Foreign Subsidiary’s Debt

Company AA, a U.S. company, has a Mexican subsidiary, BB, whose functional currency is the MXN. Subsidiary BB borrows USD from a U.S. bank, and AA guarantees repayment of the loan. Company AA could have provided an intra-entity loan to BB but decided not to do so for tax reasons. For tax reasons, BB, rather than AA, makes the interest payments. Subsidiary BB is not expected to repay the loan in the foreseeable future.

At its May 1982 meeting, the FASB 52 Implementation Group concluded that a parent company’s guarantee of a subsidiary’s foreign-currency-denominated debt does not meet the definition of a long-term investment. Therefore, in the example above, the Mexican subsidiary must recognize the transaction gains or losses in earnings for the USD-denominated debt.

6.4.4.1 Settling Foreign-Currency-Denominated Debt and Making a Long-Term Investment

In a manner consistent with the transactions described above, settlements of third-party debt through an intra-entity borrowing also should be accounted for as separate transactions as they occur. Therefore, any foreign currency adjustment associated with settlement of the debt should be recorded as a transaction gain or loss in the period in which the exchange rate changes, regardless of the nature of the intra-entity borrowing. However, if the intra-entity foreign currency transaction is determined to be of a long-term investment nature for which settlement is not planned or anticipated in the foreseeable future, future foreign currency adjustments associated with such an intra-entity loan may be accounted for as a translation adjustment in accordance with ASC 830-20-35-3(b).

Example 6-7

Parent’s Settlement of Foreign Subsidiary’s Debt Through Intra-Entity Borrowing

Company M is a subsidiary of Company K. Company M’s functional currency is MXN, and K’s functional currency is the USD. Company M has third-party USD-denominated debt on its books for which it must recognize transaction gains and losses for the changes in the USD-to-MXN exchange rate. Company K agrees to repay M’s foreign-currency-denominated (i.e., USD-denominated) debt, and M will record an intercompany MXN-denominated payable to K.

In these circumstances, it would not be appropriate for M to record the foreign currency adjustment associated with settlement of the USD-denominated debt as a translation adjustment instead of as a foreign currency transaction gain or loss. Rather, the intercompany borrowing and settlement of third-party debt should be accounted for separately. Therefore, any foreign currency adjustment associated with settlement of the USD-denominated debt should be recorded as a transaction gain or loss in the period in which the exchange rate changes. However, if K and M enter into an intercompany foreign currency transaction that is of a long-term investment nature for which settlement is not planned or anticipated in the foreseeable future, future foreign currency adjustments associated with such an intercompany loan may be accounted for as a translation adjustment under ASC 830-20-35-3(b).

6.4.5 Settlements or Reductions of a Long-Term Advance

In certain circumstances, an entity may conclude that an intra-entity balance (or part of an intra-entity balance) that was previously (and appropriately) determined to be long-term in nature no longer qualifies as such.3 In such cases, the entity should, going forward, report transaction gains and losses in earnings; the exchange rate gains and losses previously reported in CTA should not be reversed or otherwise adjusted until “sale or upon complete or substantially complete liquidation of [the] investment in a foreign entity” in accordance with ASC 830-30-40-1. See Section 5.4 for additional discussion of the conditions for release of the gains and losses in CTA.

If only a portion of long-term advances is settled or reduced and the remaining intercompany advances continue to qualify as a long-term investment, the entity would continue to recognize in its CTA the exchange rate gains or losses arising from the portion of the advances that is still considered long-term. Example 5-20 demonstrates the appropriate accounting treatment in these circumstances.

The forgiveness of an intra-entity balance is consistent with the assertion that the amount was not intended to be settled. In such circumstances, exchange rate gains and losses up through the date on which the loan is legally forgiven or extinguished should continue to be recorded in CTA. Once forgiven, the balance of the loan should be reclassified as a capital contribution and no further exchange rate gains or losses should be recognized.

Footnotes

An intra-entity transaction may qualify for the ASC 830-20-35-3(b) exception when a repayment is made, as long as the repayment was not planned or anticipated. The minutes of the December 1981 FASB 52 Implementation Group meeting state, in part, “If a transaction is settled for which settlement was not planned or anticipated, the amount included in the special component of equity (applicable to the period for which settlement was not planned or anticipated) probably should remain there.”

On October 13, 2016, the U.S. Treasury and the IRS released final and temporary regulations under Section 385 of the Internal Revenue Code that (1) “establish threshold documentation requirements that must be satisfied in order for certain related-party interests in a corporation to be treated as indebtedness for [U.S.] federal income tax purposes” and (2) “treat as stock certain related-party interests that otherwise would be treated as indebtedness for [U.S.] federal income tax purposes.” The regulations contain requirements related to documenting certain related-party debt instruments as a prerequisite to treating such instruments as debt. The rules generally require written documentation of the following four indebtedness factors: (1) the issuer’s unconditional obligation to pay a certain sum; (2) the holder’s rights as a creditor; (3) the issuer’s ability to repay the obligation; and (4) the issuer’s and holder’s actions demonstrating a debtor-creditor relationship, such as payments of interest or principal and actions taken on default. For more information on the regulations, see Deloitte’s October 14, 2016, United States Tax Alert.

For example, the United Kingdom’s decision to exit the European Union (known as “Brexit”) may result in entities reassessing their previously appropriate conclusions that certain intercompany balances with entities within the United Kingdom or the European Union are long-term in nature.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.