On the determination of the market interest rate for corporate loans

The amount of interest that one group company lends to another group company can serve as a means of artificially shifting profits between companies. Moreover, cross-border profits may be shifted to a state with low tax rates.

For tax purposes, loan interest should therefore only be recognized in the amount that would have been agreed between third-party companies that do not belong to the group - so-called third-party comparison - so-called "Arm's Length Principle". It has not yet been conclusively clarified which of the so-called transaction-related standard methods - the comparable uncontrolled price method, the resale price method or the cost-plus method - should be applied to determine the arm's length transfer price. In its ruling of 18 May 2021 (Ref. I R 4/17), the BFH (“Bundesfinanzhof” = Federal Fiscal Court of Germany) now considers the so-called comparable uncontrolled price as the most appropriate one.

In this dispute, a domestic group company had taken several loans from a Dutch group financing company. Tax authorities and tax court determined the arm's length interest used for comparison based on the cost-plus method by taking into account the refinancing costs and the equity ratio of the financing company. Consequently, the loan interest was excessive and should have been assessed as a hidden profit distribution in this respect.

The BFH did not follow this. It ruled that the arm's length nature of the agreed interest rate for a group loan must be determined primarily according to the comparable uncontrolled price method. Thus, the agreed interest rate must be compared with the interest rate used in similar transactions between independent third parties or between a group company and an independent third party. The prerequisite for the application of the comparable uncontrolled price method is therefore the at least limited comparability of the prices of the transaction in question and the comparable transaction.

According to the BFH, the comparable uncontrolled price method is the most appropriate method for determining appropriate transfer prices, as it leads directly to the determination of the comparable price. This is because the arm's length comparison, which is decisive for tax purposes, should, if possible, result from concretely defined comparable values. Thus, if a certain price for a certain service can be determined as customary in the business transactions of the respective company with third parties (internal comparable price) or in general business transactions (external comparable price), this price should be used for tax purposes. The OECD Transfer Pricing Guidelines also support the basic suitability of the price comparable uncontrolled price method for determining interest rates, since the transfer of money for a given term is essentially homogeneous and objectively comparable and there are many credit and loan markets with available information and analysis.

Only if such a price comparison is not possible the "cost-plus" method can be applied, in which the lender's costs are determined and increased by an appropriate profit mark-up.

The BFH once again remitted the case to the fiscal court for further investigation. In this context the fiscal court must clarify further aspects of the arm's length principle. Thus, the creditworthiness of the borrower, which is relevant for the interest rate, must always be based on the creditworthiness of the individual company and not that of the entire group. The financial capacity of the lender, on the other hand, does not play a decisive role in the appropriateness of the agreed interest rate.