Transfer Pricing: Significant Tightening For Financial Transactions And Services

On 22 March 2024, the Ger­man Fe­deral Coun­cil ap­pro­ved the Me­dia­tion Com­mit­tee's com­pro­mise pro­po­sal on the Growth Op­por­tu­nities Act. As a re­pla­ce­ment for the ori­gi­nally in Ger­many plan­ned in­te­rest rate cap, which was re­mo­ved from the draft bill, new re­gu­la­ti­ons for cross-bor­der fi­nan­cial tran­sac­tions and ser­vices will the­re­fore be in­tro­du­ced from the 2024 tax pe­riod (Sec­tion 1 (3d) and (3e) For­eign Tran­sac­tions Tax Act (AStG)).

Sec­tion 1 (3d) AStG, as amen­ded by the Growth Op­por­tu­nities Act, is ex­tre­mely re­le­vant in prac­tice for the de­duc­tion of in­te­rest ex­pen­ses by in Ger­many lo­ca­ted com­pa­nies of mul­ti­na­tio­nal en­ter­pri­ses (in the fol­lo­wing: MNE) if the com­pany lo­ca­ted in Ger­many is the re­ci­pi­ent of fi­nan­cing pro­vi­ded from ab­road (in­bound fi­nan­cing). Sec­tion 1 (3d) AStG re­gu­la­tes the con­di­ti­ons un­der which in­bound fi­nan­cing that re­sults in (in­te­rest) ex­pen­ses for the Ger­man com­pany should not com­ply with the arm's length prin­ci­ple. The term fi­nan­cial tran­sac­tion is broadly de­fi­ned and, in ad­di­tion to loan re­la­ti­ons­hips, in­clu­des the use and pro­vi­sion of bor­ro­wed ca­pi­tal or in­stru­ments si­mi­lar to bor­ro­wed ca­pi­tal.

Pur­su­ant to Sec­tion 1 (3d) AStG, a fi­nan­cial tran­sac­tion is only at arm's length if the re­ci­pi­ent of the fi­nan­cing can cre­di­bly de­mons­trate that

• he would have been able to ser­vice the debt for the ent­ire term of the fi­nan­cial tran­sac­tion from the out­set,
• he has an eco­no­mi­cal need for the fi­nan­cing and
• the debt is used for busi­ness pur­po­ses.

The terms "use for busi­ness pur­po­ses" and "eco­no­mi­cal need" are not de­fi­ned by law and leave plenty of scope for in­ter­pre­ta­tion. If the afo­re­men­tio­ned re­qui­re­ments are not met, the in­te­rest de­duc­tion is com­ple­tely de­nied.

Fur­ther­more, a fi­nan­cial tran­sac­tion is not at arm's length if the in­te­rest rate to be paid by the re­ci­pi­ent of the fi­nan­cing for a cross-bor­der fi­nan­cing re­la­ti­ons­hip with a re­la­ted party ex­ceeds the in­te­rest rate at which the com­pany could ob­tain fi­nan­cing from un­re­la­ted third par­ties ba­sed on the ra­ting for the cor­po­rate group. The in­te­rest de­duc­tion is the­re­fore li­mited to the group in­te­rest rate. In in­di­vi­dual ca­ses, the re­ci­pi­ent of the fi­nan­cing can prove that a dif­fe­rent ra­ting de­ri­ved from the group ra­ting com­plies with the arm's length prin­ci­ple. Howe­ver, the wording of the law does not cla­rify the ques­tion of how this proof should be pro­vi­ded in de­tail. Only the ex­planatory me­mo­ran­dum to the law re­fers to the pos­si­bi­lity of pro­vi­ding evi­dence by me­ans of an in­te­rest rate bench­mar­king study.

Ac­cor­ding to the wording of Sec­tion 1 (3d) sen­tence 1 AStG, only in­bound fi­nan­cing is co­vered. It is ques­tio­nable whe­ther the tax aut­ho­ri­ties will also ap­ply (or ac­cept) the spe­ci­fi­ca­tion of the arm's length prin­ci­ple to out­bound fi­nan­cing (e.g. do­mestic tax­payer grants a loan at an in­te­rest rate ba­sed on the cor­po­rate group ra­ting).

Fi­nally, with the in­tro­duc­tion of Sec­tion 1 (3e) AStG, there is a re­buttable pres­ump­tion in the case of in­tra-group fi­nan­cing ser­vices (e.g. li­qui­dity ma­nage­ment, bro­ke­ring of funds, cur­rency risk ma­nage­ment, etc.) that these are rou­tine ser­vices that are to be re­mu­nera­ted using the cost-plus me­thod.

The over­all im­pres­sion is that the new re­gu­la­ti­ons do not com­ply with Chap­ter X of the OECD Trans­fer Pri­cing Gui­de­lines in key points, de­spite the le­gis­la­tor's state­ments to the con­trary. Mo­re­over, the ex­planatory me­mo­ran­dum does not re­fer to the re­cent de­ci­si­ons of the Ger­man Fe­deral Fis­cal Court (BFH). Howe­ver, the BFH has re­fer­red to Chap­ter X of the OECD Trans­fer Pri­cing Gui­de­lines in se­veral of its re­cent de­ci­si­ons. These state­ments could have ser­ved as a point of re­fe­rence.

Recommended measures

In or­der to en­sure the de­duc­tibi­lity of in­te­rest ex­pen­ses, in Ger­many lo­ca­ted com­pa­nies of MNEs are well ad­vi­sed to do­cu­ment their abi­lity to ser­vice the debt at the time the fi­nan­cing is pro­vi­ded, par­ti­cu­larly in the case of in­bound fi­nan­cing wi­thin the group. In ad­di­tion, if agre­eing in­te­rest ra­tes that de­viate from the group in­te­rest rate, it is ad­visa­ble to pre­pare an in­te­rest rate bench­mar­king study as proof of ap­pro­pria­ten­ess - as also sta­ted in the ex­planatory me­mo­ran­dum to the Growth Op­por­tu­nities Act. RSM Eb­ner Stolz will be happy to ad­vise you on the de­ter­mi­na­tion and do­cu­men­ta­tion of debt ca­pa­city ana­ly­sis and the pre­pa­ra­tion of in­te­rest rate bench­mar­king stu­dies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.