Under FRS 102, a loan at no interest or below a market rate, or a sale on credit beyond normal business terms, is a financing transaction. It is recorded at the present value of the future payments, discounted at a market rate for a similar debt, and the difference from the cash amount is accounted for according to why the lender gave the better terms. Intercompany loans are the most common example; loans repayable on demand are not discounted.

What counts as a financing transaction?

Paragraph 11.13 of FRS 102 says an arrangement is a financing transaction if payment is deferred beyond normal business terms or is financed at a rate of interest that is not a market rate. The standard’s own examples are interest free credit given to a buyer of goods and an interest free or below market loan to an employee. Such an arrangement is measured at the present value of the future payments, discounted at a market rate of interest for a similar debt instrument as determined at initial recognition, adjusted for transaction costs.

The examples after paragraph 11.13 show the range. Goods sold on short term credit give a receivable at the invoice price. An item sold on two years’ interest free credit gives a receivable at present value, and in an arm’s length sale the cash price for immediate payment would normally approximate to that present value.

Three situations are outside the discounting rule:

  • Normal credit terms. Under paragraph 11.14(a)(ii), non interest bearing balances payable or receivable within one year on normal business terms are carried at the undiscounted amount.
  • Exceptions in paragraph 11.13A. A small entity’s loan from a director shareholder’s close family group, a public benefit entity concessionary loan, and a trade receivable or contract asset where payment is expected within 12 months of transferring the goods or services can be measured at transaction price. The director concession is explained on directors’ loans under FRS 102.
  • Loans repayable on demand. ICAEW explains that an intercompany loan repayable on demand is recognised at the undiscounted amount, shown as a current liability, and is not a financing transaction.

How is the market rate chosen?

The standard asks for a market rate of interest for a similar debt instrument, fixed at initial recognition. In practice that means the rate the borrower would pay to borrow on similar terms: the same currency, a similar term, and comparable security and credit standing. A parent’s group borrowing rate is not automatically right for a subsidiary with weaker credit. Once set, the rate becomes the effective interest rate for the life of the loan and is not updated when market rates move. Keep a record of how it was set, because it drives both the initial discount and every year’s interest charge.

Where does the difference go?

ICAEW notes that FRS 102 does not set out where the difference between the face value and the amount first recognised is taken. The entity chooses a policy under paragraph 10.4 that gives relevant and reliable information, looking at why the lender agreed to a non market rate. For group loans ICAEW gives the following analysis:

Loan Lender records the difference as Borrower records the difference as
Parent to subsidiary Additional investment in the subsidiary Capital contribution in equity
Subsidiary to parent Distribution Income from the subsidiary in profit or loss
Subsidiary to subsidiary, at the parent’s direction Distribution Capital contribution

For a loan from a subsidiary to its parent, ICAEW stresses that the difference is legally a distribution, so the subsidiary needs sufficient distributable reserves for the loan to be permitted. In ICAEW’s worked entries the parent credits the difference to profit or loss as income from the subsidiary. For loans between subsidiaries, no entries are generally needed in the parent’s own accounts. ICAEW applies the same approach to entities outside a group that are owned and controlled by the same person, unless the facts show another reason for the terms. Where a loan to an employee is interest free for a specific purpose, the difference is an employee benefit under Section 28.

How does an intercompany example work?

Illustration only. A parent lends its subsidiary £400,000 interest free, repayable in three years. A similar loan would carry interest at 5%. The present value is £345,535.

Year Opening balance Notional interest at 5% Closing balance
1 £345,535 £17,277 £362,812
2 £362,812 £18,141 £380,952
3 £380,952 £19,048 £400,000

The subsidiary debits cash £400,000, credits the loan with £345,535 and credits equity with a capital contribution of £54,465. Each year it charges the notional interest to profit or loss and adds it to the loan. The parent debits the loan receivable with £345,535 and its investment in the subsidiary with £54,465, then recognises the same interest as income. ICAEW notes that the subsidiary’s capital contribution and interest charge are not treated as realised profits or losses, and that the parent’s investment is subject to impairment testing where there are indicators.

What about rolling notice periods and letters of support?

Where a loan has an agreed rolling notice period of a year or more, ICAEW says it is discounted over the length of the notice period. It then stays at that amount until notice is given, when interest begins to accrue. Discounting may not be needed if the effect is immaterial, as it may be for a one year notice period. A letter of support saying the parent will not demand repayment is usually just a statement of intention, not a binding document, and in that case it does not change the accounting.

A demand loan is not entirely free of complications. ICAEW notes that an interest free loan legally repayable on demand may still be a distribution as a matter of law if the borrower has no practical ability to repay in the foreseeable future.

Is a below market loan still a basic instrument?

Usually, but ICAEW warns that this should not be assumed without analysing all the contractual terms. A loan with a fixed or determinable repayment date and no interest normally meets the conditions in paragraph 11.9, but a feature such as profit linked repayment could push it into Section 12 and fair value through profit or loss. See FRS 102 Section 11 and FRS 102 Section 12.

How is the notional interest taxed?

For corporation tax, loan relationship credits and debits are based on amounts recognised in the accounts as items of profit or loss (section 308 CTA 2009). A capital contribution or distribution taken directly to equity is therefore outside the loan relationship computation. Where the lender and borrower are connected companies, section 349 requires the amortised cost basis, and section 313(4) now gives amortised cost its accounting meaning, using the effective interest method. HMRC’s guidance at CFM35170 confirms that connected companies must use the amortised cost basis.

Section 446A then restricts the borrower. Where a debt was first recognised at less than the transaction price and the discount was not taxed as a credit, the debits relating to that discount are not deductible. For a company lender, this applies only if the lender is resident in, or effectively managed in, a non qualifying territory, so most loans between UK group companies are not affected by it. For the wider group picture, see group relief.

What are the common mistakes?

  • Leaving a fixed term interest free intercompany loan at face value in both companies.
  • Taking the difference to profit or loss on day one instead of to investment or equity.
  • Discounting loans that are genuinely repayable on demand.
  • Making a below market loan from a subsidiary to its parent without checking the subsidiary’s distributable reserves.
  • Updating the discount rate each year instead of using the rate fixed at initial recognition.
  • Assuming the small entity director concession applies to group loans.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.