With its decision of 27 February 2019 (I R 73/16, I R 51/17 and I R 81/17), the German Federal Fiscal Court (“Bundesfinanzhof” – BFH) changes its principles of jurisdiction that were previously believed to be firmly established and realigns the tax regulations for intercompany financing. In legal terms, the BFH has expressed itself identically in all three rulings mentioned above, only minor differences exist with regard to the facts of the case. The following discussion of the judgements will therefore only deal with the proceedings I R 73/16 in more detail.
Underlying case (abbreviated)
The claimant, a domestic limited liability company (A-GmbH), was the sole shareholder and at the same time the fiscal unity parent of the domestic A-GmbH. A-GmbH itself held 99.98% of the shares in B-NV, a limited liability company with its seat in Belgium. The remaining shares in B-NV were held by the claimant. A-GmbH maintained a clearing account for its Belgian subsidiary, which bore interest at 6% p.a. In 2005, A-GmbH agreed a debt waiver in return for a debtor warrant in connection with the clearing account maintained for its Belgian subsidiary in an amount which, according to the parties to the agreement, corresponded to the worthless portion of the existing receivable. A-GmbH then accounted such waiver as a write-off of the receivable in accordance with section 6 (1) no. 2 of the Income Tax Act. However, the German tax authorities treated the loss as non-deductible for tax purposes pursuant to section 1 (1) Foreign Taxation Act , taking the lack of a collateral security with regard to the claim into account.
Arm’s length discussion
The BFH justifies its correction in accordance with section 1 no. 1 Foreign Taxation Act with the fact that the claim on which the clearing account is based on does not fulfil the arm’s length requirements. Due to the fact that it had no collateral security, the BFH assumes in its decision that this corresponds to a circumstance that is sufficient for an arm’s length comparison. The reason given for this is that a third party lender would have insisted on a standard bank security for the claim. According to the BFH, no other information could be taken from the topos of the so-called group retention (see below).
According to the concept of so-called group retention (“Rückhalt im Konzern”), which has been advocated by the courts and the administration to date, the mere intercompany relationship between two companies already constitutes sufficient security for a loan relationship. In the past, this meant that in the case of an intercompany loan without explicit collateral security, such loan fulfilled the arm’s length principle and no additional risk surcharge on the interest rate was necessary.
In its current decision, however, the BFH states that the unsecured claim existing between the two companies cannot be assessed as being at arm’s length for the purposes of section 1 (1) Foreign Taxation Act, simply because such security can be dispensed with in intercompany loan relationships due to the group retention. This is based on the opinion that the group retention “without the addition of a legal obligation to be responsible for the repayment of the loan, merely expresses the legal and economic framework of the intercompany relationship and the customary practice of not securing loan claims within the group as is the case with third parties”. As far as divergences can be inferred from previous rulings of the BFH on group retention, these rulings no longer apply.
No blocking effect according to section 9 no. 1 OECD-Model Tax Convention
After the tax courts of the previous instance had still invoked the blocking effect of section 9 no. 1 OECD-Model Tax Convention, the BFH abandoned its previous case law in connection with the blocking effect in cases of an expense-relevant write-down to the fair market value of an unsecured claim against a related party.
According to previous case law, section 9 no. 1 OECD-Model Tax Convention only has a blocking effect to the extent that transfer price adjustments are only permissible “in terms of amount” (so-called price adjustment). According to the previous legal opinion, non-standard terms and conditions were only to be corrected to the extent that they affected the amount of the performance conditions. In its current case law, the BFH states that the term “agreed condition” is not only limited to the amount of the agreed interest rate, but now also includes the collateralisation of the loan relationship, so that corrections “on the merits” are possible and are no longer blocked by the norm.
Compatibility with ECJ case law (Hornbach-Baumarkt)
The result of the BFH described above was also in line with Union law, with the BFH referring in particular to the ruling of the European Court of Justice (ECJ) of May 31, 2018 (Case C-382/16, Hornbach-Baumarkt). According to the ECJ ruling, the taxpayer should be able to provide evidence that any deviations from the arm’s length principle have been agreed for economic reasons, especially in terms of the position of the shareholder.
The BFH makes it clear that the ECJ ruling does not lead to an automatism which consistently displaces the territorial taxation rights of the member states. Rather, the national courts must weigh up the weight with which the respective deviation from the standard of what is customary in the foreign country to be assessed intervenes in the allocation of taxation rights.
According to the remarks of the BFH, the present case is not comparable with that of the ECJ ruling, since in the present case the waiver of the claim was aimed at a transfer of capital and this had direct effects on the financial and liquidity situation of the parties concerned. In the case to be assessed by the ECJ, however, the guarantee or letter of comfort issued did not result in such a change in the asset and liquidity status of the companies concerned.
Effects on existing intercompany financing
The above-mentioned rulings of the BFH may have considerable practical effects on existing intercompany financing. For example, interest rates on outbound loans may be qualified as inappropriately low if the risk premium for unsecured loans, which was previously not necessary due to group retention, is missing. In addition, there is a risk that – as in the cases of judgements – the write-down to the fair market value of loan receivables, which is recognised as an expense, can no longer be recognised for tax purposes and that in these cases an argument based on group retention or the blocking effect of section 9 no. 1 OECD-MA is no longer applicable.
Groups should therefore examine their entire intercompany financing relationships to determine whether they have not previously waived corresponding collateral or risk surcharges on the basis of the group retention, as otherwise they run the risk that any write-downs at fair market value can no longer be claimed for tax purposes due to the new BFH jurisdiction or that the interest rates have simply been set too low.
This article was first published in: Handelsblatt online, Steuerboard, 8 November 2019
Read more about current decisions of the Federal Fiscal Court:
Federal Fiscal Court decides on right of taxation in the absence of DTA
Federal Fiscal Court clarifies open questions regarding distributions by a foreign family foundation
Tax neutral repayment of contributed equity by non-EU-corporations