New regulations on intra-group financing: tax authorities publish draft

New regulations on intra-group financing in the Growth Opportunities Act

With the Growth Opportunities Act, new provisions on cross-border financing relationships within multinational groups came into force in spring 2024 (see our blog dated April 9, 2024). On the one hand, these rules determine whether and to what extent interest payments to a foreign group company can be deducted as operating expenses in Germany (section 1 para. 3d AStG revised version). On the other hand, these rules categorize certain types of financing activities as regularly low-function and low-risk services. This categorization leads to the application of the cost-plus method and results in a comparatively low profit mark-up (section 1 para. 3e AStG).

Tax authorities endeavour to ensure legal certainty

The introduction of the new legal regulations has been criticised by the companies affected. On the one hand, these regulations deviate in part from the OECD guidelines, potentially leading to double taxation and on the other hand, the legislator has created a series of undefined legal terms, posing significant interpretation difficulties for companies. In light of this legal uncertainty, it is very welcome that the Federal Ministry of Finance (BMF) published a draft revision of the Administrative Principles on Transfer Pricing 2023 on August 14, 2024. Notably, this draft includes a comprehensive revision of the chapter on financing relationships to align with the new legal framework.

Mainly simplifications for companies

Besides the legal certainty, the draft contains – also content-wise – predominantly good news for the affected companies, as the tax authorities tend to provide relief for taxpayers in many doubtful questions arising from the wording of the law. In this context the draft, inter alia:

• Outlines that other assets of the debtor as well as any necessary follow-up financing (for example in the case of long-term property investments) may be considered for the determination of the debt servicing capacity. Ultimately, it is the overall view of the circumstances that is important.
• Clarifies that particularly risky financing relationships, where the ability to service the debt may be subject to considerable uncertainty (e.g. in the start-up sector), are considered to be in line with the arm's length principle.
• Provides a generous interpretation of the legal requirements regarding the use of debt capital, which must be in line with the purpose of the company. In particular, it is important that the utilisation for capital distributions does not contradict the purpose of the company. In addition, in the case of acquisition financing, it should be harmless to maintain a certain liquidity reserve, which can also be invested in the group's internal cash pool in the short term.
• Clarifies that, in order to be recognised for tax purposes, the criteria ‘ability to service debt’, ‘economically necessary’ and ‘use for the purpose of the company’ must be fulfilled cumulatively. The taxpayer must provide credible evidence of this, whereby an overwhelming probability should be sufficient. Should the taxpayer not be able to provide such credible evidence, the deduction of its related operational expenses is not denied in full, but in the amount that is considered not to be at arm’s length.
• Specifies the requirement, that the determination of the applicable interest rate must be based on the group rating. However, this draft allows for various simplifications and, in certain cases, the use of individual ratings.
• Stipulates, with regard to the date of application, that the new provisions of section 1 para. 3d AStG are not yet applicable in 2024 to existing financing relationships that were agreed on before January 1, 2024 and whose actual implementation began before that date, unless significant changes occurred after December 31, 2023. From January 1, 2025, however, old financing agreements are also expected to fall under the new legal regulation, if they are continued.

A slight sigh of relief, but not the time for an all-clear

‘It could have been much worse,’ could be a preliminary conclusion on the draft from the perspective of companies affected. The BMF is evidently striving to ensure legal certainty and not to further increase double taxation risks. Nevertheless, it is not the time for an all-clear yet: The legal regulations continue to demand a high level of documentation of the affected companies and significantly restrict their flexibility. The transitional regulation gives companies time to adjust their existing financing relationships to the new regulations - but only until the end of this year. After that, even old agreements will be subject to the new rules. Furthermore, the BMF letter is ‘only’ a draft to which associations may provide their feedback until September 6, 2024. We will keep you informed about further developments - and will be pleased to assist you on the review and potential adjustment of your financing relationships.