Transfer pricing: Significant tightening for financial transactions and services

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.