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German Tax and Legal News

New transfer pricing rules for intercompany financing contain tightened provisions

The business tax reform bill (“Growth Opportunity Act”) (see GTLN dated 03/27/24), which was signed by the president and published in the federal gazette on 27 March 2024, has tightened the transfer pricing rules in the Foreign Tax Act (FTA) regarding cross-border intercompany financing arrangements. The final version of the bill no longer includes the maximum interest barrier rule (see GTLN dated 10/17/23), although such rule was in the original draft bill that was introduced into the legislative process by the government (see GTLN dated 09/04/23). The newly introduced sections 1 (3d) and (3e) FTA are similar to certain transfer pricing rules that were proposed at the end of 2019 in the first draft of the EU anti-tax avoidance directive (ATAD) implementation law (see GTLN dated 12/12/19) but were not implemented at that time.

This article provides an overview of these new transfer pricing rules for cross-border intercompany financing arrangements, which include a three-prong test (i.e., debt capacity, business purpose, and maximum interest rate) and a description of “low-function” and “low-risk” services for purposes of the arm’s length principle and calculating an arm’s length remuneration.

Section 1 (3d) FTA

Section 1 (3d) FTA states that it is not in line with the arm's length principle if an expense resulting from a cross-border financing arrangement within a multinational group of companies has reduced the taxpayer's income and:

  • The taxpayer cannot credibly demonstrate that (i) they could have served the debt for the entire term of the financing arrangement from the outset and (ii) the debt is economically necessary and used for the purpose of the company; or
  • To the extent that the interest rate payable by the taxpayer for a cross-border financing arrangement with a related party exceeds the interest rate at which the company could obtain financing from unrelated third parties on the basis of the group rating. If it is proven in a specific case that a rating derived from the corporate group rating complies with the arm's length principle, this can be taken into account when calculating the arm’s length interest rate.

Debt capacity and business purpose tests

The fact that the borrower is able to serve the debt in order to qualify the arrangement as debt and not as equity for tax purposes should be in line with both the OECD transfer pricing guidelines (chapter X, paragraph 10.54) and with established case law from the federal tax court (BFH). There is, however, no additional guidance provided in the legislative materials or by the German tax authorities on how to apply this principle in practice. The only guidance provided in the legislative materials is that the ability to service the debt includes the ability to service both interest and principal payments.

The technical terms "economically necessary" and "used for the purpose of the company" also are not defined further. The only explanation provided in the legislative materials (as well as previous administrative guidance) refers to an example where cash borrowed by a company is subsequently deposited on a long-term basis into a cash pool. This is an arrangement that should clearly be caught by the new rule. It would be desirable for taxpayers if additional clarification were provided regarding the application of the business purpose test, as an overly broad interpretation might result in an argument by the tax authorities that debt financing is not necessarily required if equity financing is possible within the group. Such an interpretation would clearly undermine the taxpayer's freedom of deciding on how to finance its operations.

Maximum arm’s length interest rate test

According to new rules, the arm’s length character of the interest rate of a cross-border intercompany financing arrangement generally must be based on the group’s rating and external financing. The taxpayer, however, has the ability to demonstrate that a different rating is more in line with the arm's length principle. How such proof can be provided in practice is, unfortunately, not explained in more detail in the legislative materials.

The approach as described in the new rules not only deviates from the OECD approach, but also from previous case law of the BFH. Chapter X of the OECD transfer pricing guidelines and a decision dated 18 May 2021 from the BFH provide that the approach to determine the arm’s length character of the interest rate should be based on the stand-alone rating of the borrower. This approach was recently confirmed by a 2023 transfer pricing decree from the tax authorities. The new rules, however, seem to exclude a rating based on a stand-alone rating or a rating notched down from the group rating if the taxpayer is not able to provide sufficient documentation and reasons to justify such an approach. Again, it is not further clarified what kind of justification may be accepted for this purpose. In addition, this new approach is likely to result in a reversal of the burden of proof to the disadvantage of the taxpayer if a rating other than the group rating or an interest rate different from the rate where external financing for the group can be obtained is used.

Section 1 (3e) FTA

Section 1 (3e) FTA states that:

  • A low-function and low-risk service exists where a financing relationship is (i) arranged by one company with another company in a multinational group of companies or (ii) passed on from one company to another company within a multinational group of companies.
  • A low-function and low-risk service should generally be assumed, if a company in the corporate group takes over the management of financial resources, such as liquidity management, financial risk management, currency risk management, or is acting as a financing company, for one or more companies in the corporate group. The above should not apply, if based on a functional and risk analysis it can be proven that the service provided is not a low-function and low-risk service.

The rule can be seen as a continuation of the topic of a low-function and low-risk service company, as already discussed and included in two transfer pricing administrative decrees from the tax authorities in 2021 and 2023 and the proposed transfer pricing rule in the draft EU ATAD implementation law in 2019. Section 1 (3e) FTA, however, goes beyond mere administrative guidance and now includes the view of the tax authorities into its provisions.

According to the legislative materials, the low-function and low-risk services must be remunerated on a cost-plus basis (excluding financing costs). What is new, however, compared to previous draft provisions, is the fact that this approach not only applies to legal entities that provide cash pooling services, but also (explicitly) to group companies that provide cash pooling services internally.

The general nature of section 1 (3e) FTA comes as a surprise, as chapter X of the OECD transfer pricing guidelines makes it clear that financing companies can certainly have the profile of an in-house bank and that their functional and risk profile might clearly go beyond the profile of a pure (routine) service provider. It seems that the legislator wanted to take this into account by allowing the possibility of providing counter-evidence, as the rule should not be applicable if a functional and risk analysis is provided in order to establish that, in the specific fact pattern, the activities of the foreign entity do not qualify as a low-function and low-risk service provider.

Compared to the exemption clause in section 1 (3d) no. 1 FTA, the reliance on the conter-evidence in sections 1 (3d) no. 2 and (3e) FTA requires a different standard. Whereas, in section 1 (3d) FTA, the taxpayer must "credibly demonstrate" that certain conditions are met, but in section 1 (3e) FTA, it must be “proven” that certain conditions are fulfilled. The requirement of proving that a specific set of facts is given is certainly higher than just credibly demonstrating that certain conditions are met. There are no objective reasons for applying a different standard in these provisions. In this respect, it should be a reasonable assumption that the legislator intentionally wanted to set the hurdles particularly high for a financing function to qualify as a (high) value-creating function.

In this regard, it also should be noted that the areas of "financial risk management” and “currency risk management" as provided in section 1 (3e) FTA contain a significant element of risk control and management and should generally not qualify as low-risk services. Qualifying risk management functions to be routine services by law seems not to be justified and to contradict the OECD approach, both in terms of the risk control approach and the explicit emphasis on a case-by-case approach.

From an overall perspective, it seems that the sections 1 (3d) and (3e) FTA, contrary to the explicit statement of the legislator, are not in line with chapter X of the OECD transfer pricing guidelines and that the latest decisions of the BFH also were not reflected in the new rules. It remains to be seen how the application of these rules by the tax authorities will transpire in this regard.


The newly introduced provisions in the FTA are applicable starting from calendar year 2024 (i.e., for loans introduced after 31 December 2023); a retroactive application is not included in the law. The tax authorities have, therefore, some time to specify the rules and to provide further guidance regarding their interpretation (hopefully to align closer with the OECD transfer pricing guideline and previous decisions of the BFH). Taxpayers should still have time to consider the new rules and to determine how they should be applied in a specific fact pattern.

Summary and conclusions

Sections 1 (3d) and (3e) FTA seem to establish a significant departure from welcomed and previously established principles in administrative guidance from the tax authorities, as well as case law from the BFH. The new rules seem to establish a departure from the harmonization of the German transfer pricing rules with OECD transfer pricing principles and internationally accepted best practice. It can be expected that this is likely going to lead to a significant increase in disputes with the tax authorities and the potential for double taxation. This trend also is being reinforced by the fact that, in most cases, the burden of proof is shifted to the taxpayer, which is going to result in increased documentation requirements. This should then result in increased documentation costs and a significantly higher risk (and higher intensity) of disputes with the tax authorities.

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