No True Grandfathering Protection for Financing Expenses from Existing Loans

The Growth Opportunities Act (Wachstumschancengesetz) of 27 March 2024 introduced significantly stricter requirements for recognizing expenses from cross-border financing relationships. This has led to a substantial increase in documentation. The Annual Tax Act 2024 of 2 December 2024 has now clarified that there will be no true grandfathering protection for existing loans. Instead, only transitional rules for the year 2024 are provided.

Overview of the Tightened Conditions for Deducting Financing Expenses

The introduction of Section 1(3d) of the German Foreign Tax Act (Außensteuergesetz) imposes stricter conditions for examining cross-border financing relationships within corporate groups (see Insight from 26 April 2024). To recognize financing expenses, taxpayers must credibly demonstrate that they:

a) could have serviced the debt for the entire duration of the financing relationship from the outset,

b) economically require the financing, and

c) the financing is used for its business purpose.

If the interest rate applied to a cross-border financing relationship with a related party exceeds the rate at which the company could obtain financing from unrelated third parties based on the credit rating of the corporate group, then this generally does not comply with the arm’s length principle under Section 1(3d) of the Foreign Tax Act. The only allowable deviation from the group rating is where it can be demonstrated in specific cases that a rating derived from the corporate group’s credit rating aligns with the arm’s length principle.

The new regulation significantly increases the documentation burden for domestic taxpayers. Alongside the expanded documentation requirements, its application to existing loans has been heavily criticized. In this context, there was anticipation that the Annual Tax Act 2024 might offer grandfathering protection for existing loans.

No True Grandfathering Protection Under the Annual Tax Act 2024

The Annual Tax Act 2024 does not provide true grandfathering protection for existing loans. The only exception to the new regulation of Section 1(3d) of the Foreign Tax Act are financing expenses incurred in 2024 from financing relationships that were legally agreed upon before 1 January 2024, and whose actual execution began before 1 January 2024. Additionally, the exemption applies only if the financing relationships were not substantially modified after 1 January 2024.

Need for Action on Existing Loans

Consequently, the tightened requirements for deducting financing expenses will apply in full by 2025 at the latest. Therefore, the arm’s length nature – both in principle and in amount – of existing loans should be documented as soon as possible. Waiting for a future tax audit is not advisable. Experience shows that decision-makers and information carriers may leave the company in the meantime, making retroactive documentation significantly more challenging.

Existing company documents and information can often be used for documentation purposes. These need only be properly classified. We are happy to assist you in this process as well as in preparing a template for documenting future loan relationships.