As a follow up to our previous report, in the next section, we discuss a further ruling by the Federal Fiscal Court (Bundesfinanzhof, BFH) of 18.5.2021 (case reference: I R 4/17) on classifying and assessing the arm’s length nature of interest rates in the case of intra-group loans.
Issue – Granting of intra-group loans
In the case in question, the legal action had been brought by a GmbH [private limited company] whose parent company was a Dutch holding company. The claimant had obtained several interest-bearing loans from an affiliated Dutch company that acted as the financing company for the group. The interest rates were between 4.375% and 6.45%.
The local tax office (Finanzamt, FA) deemed the agreed interest rates to be too high. The tax court (Finanzgericht, FG) that dealt with the action challenging the tax assessment likewise concluded that a constructive dividend had arisen. When calculating the arm’s length interest rates, both the FA as well as the FG had applied the cost-plus method where, as a first step, the costs incurred by the lender have to be determined. A reasonable profit mark-up has to be added to these costs.
Here, the FG was of the opinion that it was not possible to make either an internal price comparison or an external one; therefore, neither a comparison of similar or the same transactions of the business concerned with third parties nor with so-called general business transactions could be taken into account. Rather, in the case in question, the cost-plus method was the only feasible one.
The BFH has a preference for the comparable uncontrolled price method
The BFH did not agree with the view of the FA and the FG. Generally, for the calculation of arm’s length interest rates, the comparable uncontrolled price method should normally be applied; however, if it is not possible to apply this method only then may the cost-plus method be used. The arm’s length interest rate here would be one that would have been granted by an unrelated third party on the date when the loan agreement was concluded. Both an internal price comparison as well as an external one may be used.
According to the BFH, when calculating arm’s length interest rates on loans, the comparable uncontrolled price method should be the method of choice because, essentially, the purpose of the service provided – to make funds available for a specific period – does not vary. Moreover, there are many markets where information and analyses on interest rates are available. If, on the basis of such data, it is possible to determine a price then it would also be relevant if it was above or below the rate calculated on the basis of the cost-plus method (costs incurred by the lender plus a profit mark-up).
- If the market price is above the price calculated on the basis of the cost-plus method then the provider would ask for the market price and keep the difference.
- If the market price is below the price calculated on the basis of the cost-plus method then, normally, the provider would refrain altogether from concluding the transaction because otherwise they would sustain a loss for their company.
According to the BFH, use of the comparable uncontrolled price method may not be rejected, without any further checking, by arguing that there is a lack of comparability of the services provided. If, for example, a group parent company has provided collateral such as a guarantee and, for this reason, a bank loan has been granted at a lower rate of interest, it may still be possible to compare the agreed rate of interest if adjustment calculations can be made.
The BFH clarified that in the case of the creditworthiness assessment, normally, the credit rating of the group as a whole is not important. Rather, it is solely the creditworthiness of the individual borrower that has to be taken into account (the so-called standalone rating). According to the more recent BFH ruling, group support that is not underpinned by legally binding guarantee commitments from other group companies cannot be seen to constitute recoverable collateral. Rational lenders, in their creditworthiness assessments, would generally only include such factors that they would also be able to rely on in a crisis situation.
Yet, the BFH also stressed that group affiliation would potentially be taken into account by unrelated third parties when calculating interest rates and, therefore, when compared with a purely standalone analysis, adjustments could possibly be made.
Please note: In practice, when calculating interest rates that conform to arm’s length principles, the German fiscal authority’s ‘Administrative principles governing transfer pricing’ of 14.7.2021 (there, Chapter III Point J. ‘Financing relationships’) would also have to be taken into account as a matter of course.