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After a brief pause due to the government’s draft Growth Opportunities Act of August 30, 2023, the real estate sector can now breathe a sigh of relief after the Bundestag followed the Bundesrat’s corresponding recommendations and passed the law on November 17, 2023 without two questionable tightening measures. However, the danger has not yet been averted.
Although the originally planned “anti-fragmentation regulation” for the interest deduction and the interest rate barrier – which was critical in particular but not only for the real estate sector – was not introduced or included in the law; the basic idea of the latter point has shifted to amendments in Art. 1 AStG (German Foreign Transaction Tax Act). It was decided to extend Art. 1 AStG to include regulations for cross-border financing relationships.
The introduction of rules for determining the arm’s-length price for financing relationships and financing services had already been proposed earlier as part of the legislative process for the Act Implementing the Anti-Tax Avoidance Directive (ATAD Implementation Act) of June 25, 2021. At that time, the regulations, which essentially correspond to key aspects of the now adopted Art. 1 (3d) AStG and Art. 1 (3e) AStG, had ultimately not been adopted in Art. 1 AStG.
The transfer pricing regulations for financing relationships have now been newly included in line with the Bundesrat’s request, according to which the standardization, in contrast to the regulation envisaged then, is now not implemented as a comprehensive so-called “treaty override”, but is limited, according to the explanatory memorandum, to the fundamental issues compatible with the OECD transfer pricing guidelines for multinational enterprises and tax administrations. The new provisions of Art. 1 (3d) and (3e) AStG would be applicable for the first time for the 2024 tax assessment period.
On the one hand, the new regulations are intended to further specify the application of the arm’s-length principle in the case of cross-border financing relationships within a multinational group of companies that lead to income-reducing expenses for the recipient of the financing. On the other hand, they are intended to ensure the appropriate allocation of taxation rights:
- The term financing relationship is broadly defined and, in addition to loan relationships, also includes the use and provision of debt capital or debt-like instruments.
- The requirements for arm’s-length financing relationships pursuant to Art. 1 (3d) AStG are not primarily based on actual financing relationships between unrelated third parties, but on the taxpayer providing evidence to the contrary. In addition to the requirement that the taxpayer’s income has been reduced by the intragroup cross-border financing (inbound case), there is an income adjustment or a deduction of business expenses, including interest expenses, if one of the following two alternative conditions is met:
- The taxpayer cannot credibly demonstrate that it could have serviced the debt for the entire term from the outset (debt sustainability) and that the financing is economically necessary and used for the business purpose (financing requirement), or
- If the interest rate to be paid by the taxpayer exceeds the refinancing interest rate at which the company could obtain financing from unrelated third parties on the basis of the corporate group’s rating. If there is proof in individual cases that a rating derived from the corporate group rating complies with the arm’s-length principle, this must be taken into account when calculating the interest rate.
There is an increasing focus on determining appropriate transfer prices for intra-group financing relationships. If the taxpayer is unable to service the financing received from the start, it is to be deemed to constitute, in economic terms, an undisclosed contribution and not debt capital provided. Accordingly, business expenses, for example in the form of interest, are to be considered incompatible with the arm’s-length principle. The decisive criterion in this regard is the credibly expected “ability to service” the debt service on the part of the debtor, which can lead to increased documentation effort, in particular in the case of acquisition financing.
The deduction of business expenses will also be denied if intra-group external financing does not serve the company’s business purpose, i.e., the focus will be on the business relationship’s arm’s-length nature – here too, the documentation effort for proving the arm’s-length nature will increase significantly. The new regulations tend to restrict the freedom of financing within the group and will therefore be of great significance for multinational groups of companies.
The second part of the amendment to Art. 1 AStG relates in particular to treasury and financing services and provides for a special regulation for dealing with intra-group “sub-loans”. According to Art. 1 (3e) AStG, intermediary or pass-through financing functions are regarded as low-function and low-risk services which, according to the explanatory memorandum, are to be remunerated regularly according to the cost-plus method; the non-inclusion of refinancing costs in the cost base significantly restricts the potential realization of profits from such activities. Group companies that perform typical treasury functions such as liquidity management (borrowing and investing on the capital market, managing disbursements, financing corporate bonds, etc.), financial risk management (managing interest rate and liquidity risks, etc.) and currency risk management are to be particularly affected by the scope of the regulation. Classification as low value-added services can be waived by means of counterevidence.
At its meeting on November 24, 2023, the Bundesrat decided to request that the Conciliation Committee be convened with regard to the Growth Opportunities Act passed by the Bundestag on November 17, 2023, with the aim of fundamentally revising the law. It remains to be seen what changes the Conciliation Committee will agree upon. A date for the discussion of the law in the Conciliation Committee has not yet been set.