New regulations on financing transactions and Amount B

Changes to intra-group financing transactions within the meaning of section 1 para. 3d AStG

To deduct financing expenses for inbound transactions, the taxpayer must now substantiate the ability to service the debt (debt capacity test), the economic necessity of financing, and the business purpose of the debt (business purpose test).

In particular, the BMF specifies in its letter:

• Ability to service debt: A plausible explanation that sufficient assets or cash flows are expected from the outset of the transaction must be presented. This also includes assets acquired with the newly incepted intercompany debt.
• Business purpose: Acquisition financing with capital buffers or the holding of deposits in a cash pool is permissible. Taking out a loan for profit distribution is possible if it aligns with the usual distribution policy.
• Credibility: Taxpayers must provide ”prima facie evidence” (i.e., substantiate) for the economic circumstances. The BMF defines substantiation as “predominant likelihood”.
• Arm’s length interest: The interest is based on the credit rating of the corporate group, unless another rating (derived from the group rating) better complies with the arm’s length principle. 

The BMF recognizes the determination of the rating using both the Top-Down notching approach (a downgrade from the group rating) and the Bottom-Up notching approach (an upgrade from the stand-alone rating). In any case, the arm’s length nature must be transparent. 

Open questions regarding intra-group financing services according to section 1 para. 3e AStG 

The facilitation and on-lending of financing transactions within a corporate group are generally classified as routine functions or low-risk services. This primarily concerns pass-through loans and cash-pool structures. In our opinion, such a generalized view on partly very specific activities that are associated with certain risks are debatable, even though the BMF acknowledges that more functionally and risk-intensive profiles can be demonstrated on a case-by-case basis.

The VWG 2024 also clarify that the determination of the arm’s length price for the provision of debt capital between related parties must generally be carried out using the comparable uncontrolled price method. At the same time, the BMF states, that low-function and low-risk financing companies are only entitled to a risk-free return. If control over the functions or risk of the loan is excised by another company, an additional transaction may exist according to OECD principles, for which the remuneration must be examined.

The implications of the VGW 2024 on everyday practice

Generally, it is welcomed that the BMF aligns itself with the OECD transfer pricing guidelines. This ensures greater clarity in everyday practice, especially regarding the implementation of such structures across a number of countries. In addition, the BMF provides helpful clarifications and limitations regarding the criteria for debt service ability, the business purpose test, and credibility, which make the tax authorities’ position on the assessment of arm’s length nature fundamentally comprehensible. The explanations on determining the arm’s length interest rate, particularly the recognition of alternative rating methods, can also be helpful in practice. 

At the same time, key questions remain unanswered and new questions may arise in practice. A clear picture of the application of the new regulations on intra-group financing services cannot be identified. Additionally, it remains debatable to what extent supposedly simplifying regulations, such as the recognition of the Bundesbank rating in determining the arm’s length interest rate, will lead to a simplification in practical application.

First comments on the application of Amount B

In Chapter III of the VWG 2024, the BMF comments on the application of Amount B of the OECD transfer pricing guidelines for the first time. Amount B provides for simplification rules when determining the arm’s length routine remuneration for sales and marketing companies. 

The application of this simplified approach should not be objected to provided that the transaction is with an affiliated entity in a so-called “covered jurisdiction”. Further prerequisites is an existing double taxation treaty with the tax jurisdiction in question and that the tax jurisdiction is not classified as “non-cooperative” in accordance with the Tax Haven Defense Act. The final statement on Amount B and the list of covered jurisdictions are attached to the VWG 2024.

Conclusion & recommendation for action

The VWG 2024 offer companies greater clarity in the tax assessment of intra-group financing as well as the application of Amount B. However, implementation still requires detailed documentation and a well-founded justification of the economic necessity of financing measures.

Further information & advice: If you have any questions regarding the new regulations or need assistance with documenting your financing structure, please feel free to contact us!