Initial situation
The determination of an appropriate, i.e. arm's length, interest rate for a loan granted within a group of companies has for years been one of the most hotly disputed issues in the field of transfer pricing for tax purposes, which is not lacking in potential for dispute. Since financing transactions can presumably be used to shift large amounts of profits within a group of companies to companies in low-tax jurisdictions, the tax authorities are paying particular attention to this issue. Relevant case law on this subject, especially from the highest courts, has been comparatively rare to date. Therefore, a recent decision of the Federal Fiscal Court (Bundesfinanzhof, BFH) deserves attention.
Facts
A German GmbH, which belongs to a Dutch group, had taken out several loans without collateralisation from a group financing company (sister company) also based in the Netherlands, for which interest rates of between 4.375% and 6.45% were charged in the years 2001 to 2004. The interest rates were determined by the lender using the price comparison method (Euribor plus interest margin). In the course of an external tax audit, the tax office took the view that the cost-plus method should be applied instead of the price comparison method because a group financing company is not comparable to a "real" bank in terms of its functions and risks. Applying the cost-plus method, the tax office arrived at lower interest rates and treated some of the interest paid by the GmbH as hidden profit distributions. The Münster Fiscal Court basically followed the tax office with regard to the choice of method, but made a different calculation and thereby determined higher interest rates.
Decision
The BFH reversed the decision and referred the case back to the tax court. In the reasons for its decision, the BFH sets out clear guidelines for the determination of arm's length interest on group loans, which must not only be observed by the Münster Fiscal Court in the second instance, but which are also of fundamental importance for similar cases:
- The BFH describes the price comparison method as the "basic method for determining appropriate transfer prices", which is regularly applied in particular for determining arm's length loan interest rates. This also explicitly applies in cases where the loan is not secured.
- According to the BFH, both the internal and the external price comparison are to be taken into account for the determination of arm's length loan interest rates. When applying the external price comparison, corporate bonds would in principle offer a suitable benchmark.
- The assessment of creditworthiness is not based on the creditworthiness of the Group as a whole ("Group rating"), but on the creditworthiness of the Group company taking out the loan ("stand alone rating"). A Group backstop that has not been solidified by legally binding purchase commitments is only to be taken into account if a lender outside the Group would assign a higher credit rating to the Group company as a result.
Conclusion
After various decisions of the BFH on transfer pricing issues have met with considerable criticism from experts in recent years, the present ruling is to be welcomed without reservation. In its convincing reasoning, Germany's highest tax court makes the priority of the price comparison method, on the one hand, and the application of a stand-alone rating, on the other, pleasingly clear. This clear positioning is also in line with the OECD Transfer Pricing Guidelines and should thus make an important contribution to avoiding disputes in the course of tax audits. It remains to be seen with interest whether the tax authorities will apply the ruling beyond the case decided.
Other decisions
In the meantime, the BFH has published two further rulings on the appropriateness of interest rates for intra-group loans. Both rulings concerned cases in which the loans were granted within a group without collateral. According to the BFH, a lack of collateral for a loan regularly justifies or requires a higher interest rate than for a secured loan. This also applies in principle if the lack of collateralisation is in connection with a statutory subordination of shareholder loans (section 39 (1) no. 5 InsO).