Introduction
Most company groups rely on shareholder and / or intragroup loans in order to manage the liquidity requirements within the group and easily transfer cash from one entity to another as and when needed.
While discussions about third-party debt can take days, weeks or months, shareholder and intra-group loans are at times documented and granted on short notice on the basis of inhouse templates.
However, based on latest publications of the German Ministry of Finance, we expect that (cross-border) shareholder and intergroup loans will be subject to more scrutiny by the German tax authorities in the future. When entering into new shareholder or intragroup loan arrangements, it is therefore recommended to check the latest legal publication from the German Ministry of Finance.
What does the German Ministry of Finance say?
The tax framework for shareholder and or intra-group debt financing in Germany is currently in flux. The current uncertainty is about the appropriate transfer pricing method and the basic question whether the tax authorities accept shareholder loans as debt for tax purposes or treat parts of the shareholder loans as equity.
The German Ministry of Finance published a decree on 14 July 2021 concerning inter alia the tax treatment of cross-border shareholder loans with some surprising statements regarding the recognition of a loan and the calculation of an arm’s length interest rate in cross-border situations between related parties:
Firstly, the financing will only be accepted for tax purposes as debt if it was economically required. A prudent and conscientious business manager will not borrow capital on the market if there is not at least a reasonable prospect of a return that covers the financing costs. The use of the borrowed capital should be in line with the purpose of the company. If these hallmarks are not met, the loan will be considered as equity.
Secondly, if the loan is considered as debt, the deductibility of interest expenses paid to an affiliated company without sufficient substance is limited to interest calculated on the basis of the cost-plus method capped at the “risk-free” interest rate. While there is no definition of a “risk-free” interest rate in the decree itself, in some statements it appears to be the interest on government bonds with the highest credit rating. No higher interest rate can be claimed for tax purposes as being at arm’s length, because in case of a financing company without sufficient substance, the financing company does not act as a lender but more as a servicer from a tax perspective and accordingly only the cost-plus method can apply.
What should be considered to consider debt for tax purpose?
While there are no clear statements from the tax authorities, the following aspects should be relevant in this context:
- economic rationale for the loan;
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- business and/or industry customs with regard to debt structuring;
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- use of the loan in accordance with the purpose of the company;
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- previous behaviour of borrower and lender towards third-party debt;
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- creditworthiness of the borrower;
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- interest rate, recognition of interest payments for tax purposes;
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- terms and conditions of the loan;
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- whether or not the loan will be secured/guaranteed;
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Altogether, when agreeing on a shareholder loan, the circumstances of the situation must be considered comprehensively, based on the due care and diligence of a prudent business man. Just as for any other business transaction, shareholder loans require an appropriate substantive consideration before they are concluded in order to avoid unwanted (legal) consequences.
Summary and additional points
The statements of the German tax authorities are with regard to intra-group financing structures highly difficult if the financing is provided by non-resident companies having low or no substance.
In particular, the potential for interest rate adjustment by the German tax authorities needs to be considered given that overly high interest rates can have significant tax compliance implications.
It should be noted that the German tax courts, in particular the German Federal Tax Courts, have recently decided that the cost-plus method should only be applied if it is not possible to determine an arm’s length interest rate based on the price-comparison method. While it appears more preferential in the case compared to a cap at the interest rate of governmental bonds of the highest credit rating, in the current low-interest market the actual effect may be low. Hence, it needs carefully be reviewed which entity in a group of companies is providing the debt financing to German affiliated companies in order to avoid substantial tax issues in Germany.
Authored by Bianca Engelmann, Carla Luh and Mathias Schönhaus.
