New requirements for cross-border group financing

Why have the requirements for cross-border group financing been tightened?

Intra-group financing relationships are regularly the focus of tax audits of multinational corporate groups. Now, with the aim of minimising the potential for inappropriate profit shifting, the German legislator has introduced additional requirements for the tax recognition of such financing in 2024, which, although they must generally be observed from the beginning of 2024, will only apply in so-called old cases from 2025.

With the specific standardisation of the arm's length principle for cross-border financing between related parties, multinational corporate groups in particular are faced with new obligations to provide evidence.

What are the new requirements?

Until now, the prerequisite for the tax deductibility of interest expenses from cross-border financing within a corporate group was that the agreed interest rate was at arm's length. There were previously no tax regulations that addressed the question of the arm's length nature of the interest rate, for example. Additional regulations have now been created for the acceptance of financing relationships, both in terms of reason and amount, which must be taken into account to ensure that interest expenses in connection with loans granted by foreign group companies are deductible as business expenses in Germany.

According to Sec. 1 (3d) Foreign Tax Act (AStG), for the financing relationship to be accepted, it must now be substantiated that

• the debt service can be provided for the entire term of the financing at the time it is agreed (so-called debt service capacity),
• the financing is economically necessary and
• is used for corporate purposes.

In addition, the amount of the financing relationship is only recognised for tax purposes if the interest rate to be paid does not exceed the rate that would have been agreed between unrelated third parties, considering the group’s rating.

If these conditions are not met, the interest deduction is to be reversed in the amount of the non-arm’s length portion, which can result in a higher tax burden in Germany and the risk of double taxation due to the possible taxation of interest income by the interest provider abroad.

Note: As the legal regulations left a large number of application questions unanswered, the German Federal Ministry of Finance (BMF) addressed the new requirements in the 2024 Transfer Pricing Administrative Principles published on 12 December 2024 and clarified their application, at least in some respects. You can read more about this here.

In principle, the new regulations will apply for the first time from the 2024 assessment period. However, a further amendment to the law at the end of 2024 introduced a transitional provision. A "grace period" is provided for old cases, i.e. financing relationships that were effectively agreed under civil law before 1 January 2024 and whose actual implementation began before 1 January 2024. In these old cases, the provisions of Sec. 1 (3d) AStG only apply to expenses incurred after 31 December 2024.

If intra-group financing relationships were and are newly agreed upon after 31 December 2023 or if significant changes were made to the underlying agreement in existing cases in 2024, the expenses have been subject to the requirements of Sec. 1 (3d) AStG since 1 January 2024 or since the date of the initial agreement or modification in existing cases.

Further requirements relate to certain types of financing services (e. g. liquidity management, brokerage of funds, or currency risk management), for which it is rebuttable presumed from the 2024 assessment period that these are low-function and low-risk services. This means that the services are to be remunerated using the cost-plus method (Sec. 1 (3e) AStG). This means that only a lower price for the service is likely to be recognised for tax purposes.

How we support you

To structure financing agreements securely under these additional statutory requirements within a corporate group, examining the proposed interest rate considering the further financing conditions for its arm's length nature through a benchmarking study is advisable. In addition, the further requirements of debt service capacity, economic utilisation and use for the corporate purpose should already be documented when the financing is taken out.

We are happy to advise you

• in the determination and documentation of debt service capacity and utilisation requirements, and
• the review of existing cross-border financing relationships within your corporate group.
• In addition, we offer customised benchmarking studies tailored to you needs.