March 18, 2019

Federal Ministry of Finance (BMF) intends to apply “Hornbach“ judgment only on restructuring cases

Sec. 1 of German Foreign Tax Act (FTA) basically compatible with European law

Sec. 1 FTA is the central correcting standard for multinational companies that have agreed transfer prices that are not customary for their affiliated foreign enterprises across the border. In the “Hornbach-Baumarkt” case the European Court of Justice (EuGH) ruled on 31 May 2018 that Sec.  1 FTA  was in principle compatible with EU law. However, the taxpayer should be granted the possibility to prove economical (non tax) reasons for deviations from the arm’s length principle. The tax authorities have now commented on this.

„Economical reasons“: narrow interpretation by the Federal Ministry of Finance (BMF)

A correction according to Sec. 1 FTA must be omitted according to the BMF letter dated 6.12.2018, as far as the taxpayer can prove factual, economic reasons, which require an agreement deviating from the arm's length principle, in order to secure the otherwise threatened economic existence of the group of companies as such or of the person close to the taxpayer (restructuring measure). The Federal Ministry of Finance (BMF) defines a restructuring measure as a measure aiming to avoid over-indebtedness or insolvency and to secure the continued existence of the related  person or group of companies.

Broad interpretion by the European Court of Justice (EuGH)

In the opinion of the European Court of Justice (EuGH), such economic reasons alone should justify the deviation from the arm's length principle that result from the parent company's position as a shareholder in relation to its subsidiaries. The European Court of Justice (EuGH) understands, for example, the economic self-interest in the business success of the subsidiaries and thus the prospect of future profit distributions as well as the financing responsibility as shareholder as an economic reason to be recognised. At that time, the court ruling was based on a letter of comfort granted free of charge for a foreign subsidiary with negative equity.

Comment

From the point of view of the European Court of Justice (EuGH), a financial "imbalance" of the subsidiary is already sufficient for justification. The Federal Ministry of Finance (BMF), on the other hand, only refers to "restructuring cases" in which the need for restructuring and the ability to restructure must be proven. In practice, a "middle way" should be found between the probably too broadly defined economic reason in the sense of the European Court of Justice (EuGH) and the restriction only to restructuring cases in accordance with the Federal Ministry of Finance (BMF). In any case, the European Court of Justice (EuGH) ruling should be observed for the defence in the tax Audit. 

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