2024 Growth Opportunities Act: New Transfer Pricing Rules for Financial Transactions

In November 2023, the Bundestag passed the Growth Opportunities Act aimed at strengthening Germany’s competitiveness as a business location.  The Bundesrat then approved it, after initially rejecting it.

The Growth Opportunities Act contains new transfer pricing regulations for financial transactions. They are intended to specify the arm's length principle for intra-group financing relationships and are to be applied for the first time in 2024. There are no grandfather rights for existing permanent arrangements. This means that the changes also apply to shareholder loans already in place and are not limited to shareholder loans newly concluded in 2024.

Formalization of the arm's length comparison in Sec. 1 (3d) of the German Foreign Tax Act (Außensteuergesetz – AStG): Debt sustainability and group rating

According to Sec. 1 (3d) AStG, there should be no compliance with the arm's length principle if, in certain cases, an expense resulting from an intragroup cross-border financing relationship has reduced the taxpayer's income (inbound case). In addition, one of the two alternative provisions must be met:

Regulation 1: The taxpayer is not able to credibly demonstrate that (a) they could have provided debt service for the entire term from the outset (debt sustainability) and (b) the financing is economically needed and used for the business purpose.

Regulation 2: The interest rate to be paid exceeds the interest rate at which the company could finance itself on the basis of the group rating, whereby it is possible to provide evidence to the contrary on the basis of an individual rating derived from the Group rating.

These transfer pricing requirements for financing relationships, which for the first time are being regulated by law, contain a large number of undefined legal terms and application issues. Since no grandfather rights are provided for permanent circumstances, it is questionable whether the ‘from the outset’ of Regulation 1 on debt sustainability is based on the time the loan was granted, which may well be several years ago.

The legal consequences of these regulations are also not very precise. However, contrary to the international standards of the OECD, the legislative materials for Regulation 1 indicate a complete denial of the interest deduction. In contrast, the interest deduction under Regulation 2 should only lead to a pro rata restriction of the interest deduction.

Further formalization of the arm's length principle in Sec. 1 (3e) AStG: Routine services

According to Sec. 1 (3e) AStG, a low-function and low-risk service is to be assumed as a rule (Regulation 3) if the company arranges only the financing relationship or if it is a matter of on-lending, which is also to be assumed in the case of an activity as an intra-group financing company. In most cases, the remuneration for performing the aforementioned activities is determined using the cost-plus method. However, it is unclear, for example, to what extent the refinancing costs of the foreign lender are to be taken into account when applying the cost-plus method for on-lending.

That said, by submitting a functional and risk analysis, it is possible to provide counter-evidence that the service is not a low-functioning and low-risk service after all.

Background: OECD Transfer Pricing Guidelines 2022

The aim of the new transfer regulations in Germany is to align tax laws more closely with Chapter X of the OECD Transfer Pricing Guidelines. This approach seeks to avoid adding an extra restriction on the deduction of business expenses to the Personal Income Tax (PIT) Bill. Originally, the Federal Government proposed an interest rate cap under Section 4l of the draft version of the Income Tax Act for the purpose of ensuring arm's length comparisons. While certain isolated statutory amendments in the past have aimed to align with OECD recommendations, the absence of the new transfer pricing regulations outlined in Secs. 1(3d) and (3e) AStG meant there was no legal specification of the arm's length principle for financial transactions. The OECD already made such a specification in Chapter X of the OECD Transfer Pricing Guidelines of February 2022. However, there is uncertainty regarding the extent to which the new offsetting regulations will align entirely with the OECD recommendations.

Recommendations for companies

From a business perspective, it is to be welcomed that the German transfer pricing regulations should increasingly comply with the internationally recognised OECD transfer pricing guidelines (now on financial transactions). Nevertheless, the explicit legal unequal treatment of inbound and outbound cases must be viewed critically. In addition, the regulation will lead to higher compliance costs and a higher documentation effort on the part of the companies. 

Companies would be, therefore, well advised to tackle the following:

Recording and reviewing intragroup cross-border financing relationships, such as intragroup loans and cash pools, with a view to the specifications of Chapter X of the 2022 OECD Transfer Pricing Guidelines. With regard to Sec. 1 (3d) and (3e) AStG, the following must also be undertaken:

Performance of a debt capacity test and financial requirements analysis for all affected financing relationships, the results of which must be documented.

Review and documentation of the financing interest rate, taking into account the group rating and, if necessary, derivation of individual ratings (notching down) of the borrowers concerned.

Review of the function and risk profile, particularly for on-lending loans and treasury/financing companies, and adjustment of their remuneration if necessary.

Please feel free to contact the authors or your usual FGS contact if you would like to discuss the legal developments on transfer pricing discussed in this blog post in more detail.