Clarification on Cross-Border Group Financing

Timing requirements for application

Essentially, the additional requirements according to Sec. 1 (3d) AStG must already be considered for the 2024 assessment period to ensure that expenses from cross-border financing within a corporate group are tax-recognized. However, a "grace period" is provided for old cases, so expenses arising only after 31 December 2024 fall under the regulations. Old cases are considered financing relationships that were legally effective before 1 January 2024 and whose actual implementation began before 1 January 2024.

Ultimately, it applies that for financing relationships newly agreed after 31 December 2023, expenses in total, and for old cases, if significant changes to the underlying agreement are made in 2024, are subject to the requirements of Sec. 1 (3d) AStG from the time of modification. For old cases, the requirements apply regarding expenses, which occur after 31 December 2024.

Additional requirements to be checked

According to Sec. 1 (3d) AStG, cross-border financing relationships within a corporate group are only recognized for tax purposes if

• the ability to service debt,
• the economic necessity of financing, and
• the use for corporate purposes

of the debtor can be credibly demonstrated.

For tax purposes, expenses are only recognized 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.

Clarification by the BMF

The BMF addresses the individual criteria in the updated 2024 Transfer Pricing Administrative Principles. Already within a draft published in August 2024, the BMF showed openness to the practical application of the requirements. This tendency is pleasingly reinforced by the explanations now included in the final announcement.

Specifically, the following explanations can be found regarding the individual criteria:

• The ability to service debt generally requires that at the beginning of the financing relationships, sufficient assets or cash flows are expected to cover all repayment and interest payments. Follow-up financing can be included in the consideration. The necessity of such does not already lead to the non-arms length nature of the capital provision. The arm's length nature of the capital provision is to be assessed in the overall view of circumstances. Here, indicators like the existence of a fixed repayment date, the obligation and modalities for interest payment, the right to enforce capital and interest payment, and the recipient's ability to borrow on comparable conditions from independent third parties must be considered. In old cases, the BMF allows for the proof of ability to service debt for simplification reasons also as of 31 December 2024. Simplifying, the BMF also added in its final version that, for short-term capital provisions, especially from a cash pool, the ability to service debt is generally assumed. The ability to service debt should also be affirmed if, after the financing agreement, a rating in the investment-grade range, i.e., at least a "BBB" rating (Standard & Poor's) or "Baa" (Moody's), exists.
• The economic necessity of financing, according to clarifying BMF elaborations, particularly exists if the financing is necessary for the operation or maintaining business capability, e.g., if operating resources or investments in machinery are to be financed. However, the BMF continues to adhere to the return consideration known from the August 2024 draft, whereby a justified prospect for a return covering the financing costs must exist.
• According to the BMF, use for corporate purposes is not present if funds are placed in daily money accounts or an intragroup cash pool. However, with the final version, the BMF further elaborates that maintaining market-standard liquidity reserves or capital buffers is not excluded by this. It shall also be possible to finance dividend distributions. However, this opening of the use of funds is now restricted by the BMF, stating that loan-financed dividend distributions must correspond to the usual distribution policy of the distributing company.
• Clarifying, the BMF states that limiting the recognition of financing relationships in terms of amount means a correction is only necessary if the agreed interest rate falls outside the range of arm's length interest rates. In terms of examining the arm's length nature and considering the rating, the BMF also allows for a rating different from the corporate group rating. However, it is required that the strategic importance of the borrower for the corporate group is demonstrated. Simplifying, it is possible, according to the BMF, to use a rating employed by an unrelated third party when a comparable and timely financing situation exists and is indeed conducted. The BMF also mentions the possibility of using the creditworthiness analysis created by the Deutsche Bundesbank for the corporate group, though in practice, it should be noted that such analysis will not be appropriate and adequate for all financing occasions. Accepted is also a rating created using market-standard rating software, documenting how qualitative and quantitative factors were considered in the rating.

Conclusion

The explanations of the BMF in the letter dated 12 December 2024 are to be welcomed as they facilitate the practical application of the very abstract and openly formulated provisions of Sec. 1 (3d) AStG. Companies should already consider these provisions in planned group financing to avoid tax disadvantages. It remains to be seen to what extent the characterized requirements for cross-border financing relationships formulated so far will also have an impact on the tax recognition of domestic agreements.

In addition to Sec. 1 (3d) AStG, Sec. 1 (3e) AStG was also introduced for the first-time application in the 2024 assessment period. The specifications contained therein affect the mediation and forwarding of intragroup financing relationships. Regarding the application of Sec. 1 (3e) AStG, the 2024 Transfer Pricing Administrative Principles do not contain any significant changes compared to the draft published in August 2024.

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. We offer tailored solutions, which we would be pleased to explain personally.