The Federal Fiscal Court’s (Bundesfinanzhof, BFH) ruling on interest rates for shareholder loans has been a subject covered in our previous articles on a number of occasions, most recently in view to Arm’s length interest rates for intra-group loans as well as the BFH ruling. In a recent ruling, the BFH has now expressed its view on the arm’s length nature of a lack of collateral for cross-border group loans and the potential consequences.
Issue and procedural odyssey
In the case in question, a German GmbH [private limited company] had a claim against a Belgian subsidiary company because of a non-collateralised offset account. A debt waiver with a debtor’s warrant was agreed and the German parent company wrote off the claim and consequently reduced taxable profit. The local tax office (Finanzamt, FA) did not recognise, for tax purposes, the reduction in taxable profit pursuant to Section 1(1) of the Foreign Transactions Tax Act (Außensteuergesetz, AStG). The legal action was successful. Düsseldorf’s tax court (Finanzgericht Düsseldorf, FG) clarified that “an adjustment to the income pursuant to Section 1(1) AStG would only be possible if “the (appropriateness) of the price agreed upon between the affiliated companies did not stand up to an arm’s length comparison.” Furthermore, the FG Düsseldorf criticised that an amount equivalent to the full extent of the write-down had been added back and not the amount of the interest rate differential between the agreed interest rate and an “appropriate” one. The FA had moreover not produced any proof that the agreed interest rate level had been non-arm’s length. After the BFH had then ruled in favour of the FA, on 27.2.2019 (case reference: I R 73/16), the Federal Constitutional Court reversed the ruling again, on 4.3.2021, and referred the case back to the BFH.
The lack of collateral alone is not a determinant, but rather ...
The BFH, in its ruling from 13.1.2022 (case reference: I R 15/21) now concluded that the lack of collateral for a group loan is not sufficient to allow for a finding of non-arm’s length. The Munich-based judges – unlike previously their BFH colleagues in 2019 – were of the opinion that the findings by the lower courts were not sufficient to assess whether or not the reduction in taxable profit, which was based on the write-down of the unsecured loan, had to be adjusted pursuant to Section 1(1) AStG. Collateral is indeed one criterion with respect to the question of the arm’s length nature. What matters however is whether or not an unrelated third party would have granted a loan on the same terms – where required, taking into account potential risk compensation. In the view of the BFH, the unrelated third party does not have to be a “traditional bank”.
The decisive criterion is that a market can be determined for the agreed loan that can then provide a benchmark for the arm’s length comparison that has to be performed. However, if one of the requirements cannot be met – in this case, the lack of collateral – this would not yet lead to an adjustment of the income. In this context, any group support may only lead to an improvement in the creditworthiness to the extent that an unrelated third party would take this into consideration. The case was referred back to the FG because the FG had not dealt with the issue of the arm’s length comparison.
... all the objectively discernible circumstances
In the grounds for its ruling, the BFH mentioned three criteria for the arm’s length comparison that have to be taken into consideration:
- capital commitment – a temporary or permanent commitment of capital
- collateral – an assessment as to whether or not third-party lenders would have insisted, ex ante, on collateral
- orientation towards the earnings situation
If an analysis demonstrates that an unrelated third party would have been willing to compensate for the increased risk of default, due to the absence of collateral, in return for a risk premium then a check should be performed to determine whether or not the interest rate that had been agreed complied with the arm’s length principle. The comparable uncontrolled price method is normally applied for the purpose of calculating arm’s length interest rates on loans.
No scope for adjusting the income under AStG
Irrespective of the outcome of the check, there is no scope for adjusting the income under Section 1(1) AStG if there is a market available for unsecured loans and if it can be verified. If the terms were consistent with the arm’s length principle then any adjustments to the income could no longer be considered. Even if the terms agreed were not consistent with the arm’s length principle, it would still not be possible to adjust the write-down, but instead solely for the amount of the difference between the interest income actually achieved and the amount consistent with the arm’s length principle. An adjustment to the write-down under Section 1(1) AStG would only be allowed if, under the special circumstances of a specific case, it was not possible to determine an appropriate market for unsecured loans.
Recommendation: Prior to the conclusion of a group loan, the respective market should be checked. You could make enquiries via a bank, for example. The interest rate for the group loan should then be set on the basis of this market assessment so that there would be a lower risk of an adjustment to the income.