Germany vs Lender GmbH, June 2021, Bundesfinanzhof, Case No IR 4/17

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Applicable method for determining the arm’s length price in the case of a loan granted by a sister corporation domiciled abroad:

(1) Are the three recognised methods for determining arm’s length prices (price comparison method, resale method and cost plus method) equally applicable?
(2) Should the price comparison method be used if a comparable price can be determined on the basis of identical service relationships and conditions, and the cost-plus method if there are no comparable service relationships within or outside the group?
(3) is an estimate of the appropriate transfer pricing to be made if the domestic borrower which receives a loan from the foreign sister corporation, in breach of its obligations to cooperate under section 90(2) sentence 1 AO, is unable to provide all the evidence necessary to determine a transfer pricing in accordance with arm’s length principles?

Background
In the specific facts of the case (I R 4/17), a domestic limited liability company (plaintiff) is held by a Dutch holding company. The holding company is also the sole shareholder of the plaintiff’s sister company, which is also domiciled in the Netherlands. The Dutch sister company acts as a financing company within the group. It extended various loans to the plaintiff. The interest rate was determined with the help of an external price comparison.

In these appeal proceedings, the tax office (defendant) also doubted the applicability of the selected transfer price method and the appropriateness of the interest rate. The tax office determined the interest rate on the basis of the cost-plus method. The tax office qualified the difference as a hidden profit distribution (vGA). In its ruling of 7 December 2016 (13 K 4037/13), the Münster Regional Tax Court ruled in favour of the tax office on the merits, arguing that there was no hierarchy between the standard methods. Rather, it was up to the tax office to determine the most suitable method in each individual case. The cost-plus method was applicable in the present case. Only in the case of essentially identical service relationships could the price comparison method be the most appropriate method.

Statements of the Court

Dr Brandis was also the presiding judge in these appeal proceedings. He commented on the question of the appropriate transfer price method to the extent that the Münster Regional Court may have been “too hasty” in directing its attention to the cost-plus method. Furthermore, it was not convincing that the application of the external price comparison method failed due to the fact that the underlying group rating was not exactly comprehensible by mathematical calculations. In this context, the BFH referred to price determination on stock markets, which was also not entirely comprehensible. The First Senate thus took up the arguments of the plaintiff. Furthermore, the presiding judge commented on the specific application of the cost-plus method by the tax office and the Münster Regional Court, which has not been widely used in practice to date. It was unusual for an appropriate interest rate to be recalculated annually by including variable parameters (here: equity ratio), so that the interest rate changed annually. This, as argued by the plaintiff, was contrary to the fixed interest rate.

The question of the consideration of the group retention was, among other things, also a point of contention in these proceedings. With reference to the statements of the Federal Ministry of Finance (BMF), which was involved in the appeal proceedings as a third party, the BFH pointed out that the group as a whole had to be taken into account. However, neither a holistic group view nor a complete “stand-alone view” was to be used. Rather, it required a case-by-case consideration. A referral back to the Münster Regional Court could be considered. However, the senate did not comment on the defendant’s violation of the plaintiff’s duty to cooperate, which made possible the tax office’s power to estimate tax under § 162 para. 2 sentence 1 of the German Fiscal Code (AO).

Outlook
The oral proceedings suggested that the BFH would tend to follow the plaintiff’s arguments on the decisive question of the appropriate transfer pricing method for shareholder loans. The BFH would thus confirm the view of the Federal Ministry of Finance. At the same time, however, it would also rule in line with international practice and the prevailing opinion in the literature. In this case, too, the BFH’s supreme court decision is eagerly awaited, because the use of the price comparison method to determine an arm’s length interest rate is widespread in practice.

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BUNDESFINANZHOF Urteil vom 27-2-2019, I R 81-17

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