Key points for real estate clients

Key updates to the 2023 Administrative Principles were made covering the topics of relocations of functions (to take into account revisions to the Business Function Relocation Ordinance of 18 October 20223), secondments and price-adjustment clauses. Other chapters, e.g. relating to comparability analyses, group apportionments and documentation) remain largely unchanged.

Of particular importance to the real estate sector are statements concerning intergroup financing that in general, according to the 2023 Administrative Principles, should be applied in line with Chapter X of the OECD Transfer Pricing Guidelines (regarding financial transactions). Whilst a number of core principles remain unchanged (e.g. economic characterisation of loans as debt vs share capital, economic necessity of the financing, impact of implicit group support on a credit rating, statements on cash pools), some important changes are as follows:

Low-substance FinCos

In the 2021 Administrative Principles, the view was taken that a low-substance FinCo (i.e., an entity that receives funds and forwards these to another entity without controlling or assuming any of the related risks) should not receive an interest-rate above a risk-free one. Further, the return was to be determined on the basis of the cost-plus method. The critical inconsistency with OECD language was that an income correction was to be made at the level of the borrower of funds from the low-substance FinCo, i.e., in extreme cases, an interest rate deduction above the risk-free rate would have been denied.

The general view regarding the remuneration of low substance FinCos essentially remains in the 2023 Administrative Principles, although now not necessitating use of the cost-plus method. This appears in line with a recent German Federal Fiscal Court decision4, which is referenced, as well as the 2022 OECD Transfer Pricing Guidelines (attached to it as an appendix), which both give preference to the Comparable Uncontrolled Price Method over the Cost-Plus Method. However, it is no longer the case that any income correction necessarily takes place at the level of the borrower. Instead, there is acknowledgement that where there is a grant of a loan without the associated control and risks, it should be examined whether there are further transactions between the lender and the company that actually controls and bears the risks.

Nil or low-interest rate intercompany loans in lieu of capital injections

In the 2021 Administrative Principles, it was noted that in some countries, an interest-free or low-interest loan may be granted instead of an injection of equity capital, the reasons for which may lie outside of the borrower’s control. In such cases, the granting of such loans would not in itself constitute a partial write-down of the value of the loan. This provision has now been removed in the 2023 Administrative Principles, meaning that German tax authorities now have more scope to attack the arm’s length nature of such loans.

Collateralisation

In the 2021 Administrative Principles, it was contended that collateralisation is generally customary amongst third parties (and hence taken as the default position). Despite this, several factors were listed to support the non-collateralisation of loans, although it may have been difficult for taxpayers to demonstrate compliance with the arm’s length principle in the event of an uncollateralised intra-group loan.

In the 2023 Administrative Principles, the tax authorities now clearly recognise that collateralised and uncollateralised intragroup loans can be at arm’s length, whilst continuing to list factors to take into account when considering the appropriateness of the collateralisation (or lack thereof) of intercompany loans. However, it is now noted that when considering these factors, alternative options available to the parties (and whether such options would be advantageous to the borrower) should be considered.

Knowledge advantage resulting from corporate links

New in the 2023 Administrative Principles is that the extent and the effects of any knowledge advantage resulting from the corporate connections must be taken into account when pricing intercompany loans. This could potentially allow tax authorities to argue for a reduction in the interest rate (in the case of a German borrower), although details remain unclear at this point.

Services

The 2021 Administrative Principles contained a section on intra-group services, which broadly re-iterate principles outlined in the OECD Transfer Pricing Guidelines (i.e., when a service is eligible for cross-charging or not, including “on call” services). These statements appear to be unchanged in the 2023 Administrative Principles.

Our view

The 2023 Administrative Principles continue to address a number of key financing issues whilst now acknowledging some recent key German Federal Fiscal Court decisions on intragroup financing and therefore converge towards the OECD view. We expect more certainty for taxpayers in tax audit situations, in particular regarding collateralisation of loans. Above all, there appears to be less risk that an income correction at the level of the borrower will take place in the case of a low-substance FinCo as lender.

Given that a number of German tax audits were put on hold pending clarification of the recent German Federal Fiscal Court decisions, we can now expect German tax audit activity to resume.

Taxpayers should be familiar with the content of the 2023 Administrative Principles in order to anticipate how tax authorities will assess their cross-border dealings, in particular given that the 2023 Administrative Principles can in principle be applied to all open cases. Latest experience from German tax audits in the real estate (and other) sectors already shows that the focus of the German tax authorities is now moving towards details of rating analyses, including taking into account (the possibility of) collateralisation, consideration of implicit support, the choice of comparable transactions and lack of documentation in order to challenge the taxpayers’ interest deductions.