Increased Transfer Pricing Regulations in Germany

25^th july 2024

Starting from January 1, 2024 onwards, new German rules increase the scope of required transfer pricing analyses for inbound transactions. All interest rate payments to a foreign related party are affected.  In Germany, interest expenses of a domestic taxpayer related to a cross-border financial transaction are generally tax-deductible if the following apply:

• if the domestic taxpayer can prove that it has the financial wherewithal  to assume/service the debt (“debt capacity analysis“);
• that the financing is commercially necessary as well as used for the purpose of the business; and
• that the applied interest rate is, equal to or below the interest rate that would have been granted by an external third-party based on the group credit rating, unless it can be proven that a credit rating that differs from the group rating – but which is still derived from the group rating – would be at arm’s length.

In a nutshell, the new guidance shifts the burden of proof completely to the taxpayer.  It also appears to assume that unrelated lenders would only ever demand an interest rate, under their own specific and most favorable conditions (given their own particular facts and circumstances), regardless of the credit worthiness of the particular borrower they are facing.  In other words, there is a fairly difficult road to follow if the group chooses any rate other than the consolidated group borrowing rate. This, of course, will fairly easily lend itself to transfer pricing disputes especially for interest payments to French-based multinationals, because, in France, the rating of the borrower should be assessed on a stand-alone basis, as the group rating is effectively irrelevant. 

Furthermore, an assumption is made that on-lending within a multinational corporate group is always a low-function/low-risk service which can only be remunerated with a cost-plus mark-up. The rule applies as well if a company within the corporate group assumes the activities of managing financial resources for one or more companies in the corporate group, such as liquidity management, financial risk management, currency risk management, or acting as a financing company.  In this circumstance, cost-plus may not be seen by many (other than the German government) as the correct result.

French-based multinationals with related parties in Germany should consider, at a minimum, undertaking the following:

• review existing financing relationships with German group entities
• assess the interest rate charged to any German related party, and the determination of this rate. Further consideration of the applied interest rate may be required to the extent the stand-alone credit rating of the German borrower is significantly different from the group rating. 
• adjust contractual relationships if necessary

The concept of debt capacity analyses, for related parties, as it relates to financing transactions, is not currently “hard-coded” into French tax or transfer pricing law, unlike for instance, in the US, Germany, and many other jurisdictions. Even if not explicitly addressed in the new guidelines of the French tax authorities, the concept of being financially capable of assuming and servicing debt is fully aligned with the arm’s-length principle. On this basis, one can fully anticipate the French tax authorities will continue to monitor the situation, will consider debt capacity analyses further, when examining intercompany financing arrangements involving a French taxpayer. 

It's good to remember in situations like these that the French-German Treaty trumps domestic law in either country, leaving any transfer pricing controversy arising from the new German rules subject to negotiation between the 2 countries, with a formal commitment to ultimate conflict resolution.