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When Credit Risk Materialises: Luxembourg Administrative Court Provides Guidance on Distressed Intercompany Financing
In its decision of 22 July 2026 (No. 53194C), the Luxembourg Administrative Court (‘Court’) provided important guidance on the application of the arm’s length principle where the creditworthiness of a related-party borrower has materially deteriorated.
While the decision confirms that an independent lender may accept an interest waiver as part of a distressed-debt restructuring, depending on the options realistically available for the parties; the judgment also raises a broader transfer pricing consideration: where the borrower’s financial position materially deteriorates and the original financing conditions are no longer sustainable, any subsequent change to the original financing arrangement should be assessed for consistency with the arm’s length principle.
In particular, the decision illustrates that:
- Changes to financing terms require a contemporaneous arm’s length assessment. Where the original terms are subsequently amended, waived or restructured, the arm’s length nature of the change should be assessed based on the economic circumstances prevailing at that time.
- The materialisation of credit risk may affect the lender’s actual return. The parties’ options realistically available should be analysed on a case-by-case basis to determine whether an independent lender would have agreed to reduce or waive interest, even when its own funding costs continue to accrue.
- Contemporaneous TP documentation is critical when circumstances change. The borrower’s updated financial position, the lender’s realistically available alternatives and the commercial rationale for the action taken should be documented when the relevant decision is made.
- An accounting impairment does not automatically reduce the principal amount on which interest is calculated. The Court confirmed, in the circumstances of the case, that the contractual principal remained the relevant basis notwithstanding the accounting write-down.
Background
- LuxCo financing structure: LuxCo granted a EUR-denominated loan to its French subsidiary bearing interest at 12%, funded through USD-denominated bonds issued to its Luxembourg parent. A TP analysis supported both the 12% rate and a 0.147% net financing margin for LuxCo.
- Borrower deterioration: The French borrower later faced severe operational and financial difficulties, leading stakeholders to negotiate a broader financial restructuring finalised in 2018.
- Interest waiver and restructuring: LuxCo waived interests for the period from 16 October to 31 December 2017. The March 2018 restructuring included a partial debt-to-equity conversion, new financing at 6%, additional guarantees, and concessions made by other third-party stakeholders.
Court decision:
- Although the LTA, and initially the Administrative Tribunal, considered that LuxCo should have continued to recognise interest at 12%, the Court held that the interest waiver was consistent with the arm’s length principle, having regard to the borrower’s deteriorated financial position, LuxCo’s options realistically available and the broader restructuring context, including the involvement of an unrelated third party in the negotiations.
- The Court also rejected the LTA’s attempt to calculate deductible interest by reference to the impaired accounting value of LuxCo’s funding instruments, confirming that, in the circumstances of the case, the contractual principal remained the relevant basis.