Germany's Growth Opportunities Act and Its Impact on Transfer Pricing Regulations

Transfer pricing regulations are constantly in flux as tax authorities worldwide strive to keep their rules and regulations current. Their primary objective is to prevent non-compliant profit shifting and ensure that profits generated within their jurisdiction are appropriately taxed. Some transactions, by their nature, are inherently more challenging to assess accurately. For instance, intercompany royalty agreements have long been difficult to benchmark due to their intangible and subjective nature. Another area that demands significant attention from tax authorities is intercompany financing, as the free flow of cash can be a source of concern from a tax perspective.

Germany, among other nations, has been actively working to update its guidelines. The Growth Opportunities Act (Wachstumschancengesetz), passed by the German parliament in March 2024, aims to bolster Germany’s economy and enhance its business attractiveness. This act includes proposed changes to Germany’s transfer pricing guidelines on intragroup financing to align them more closely with OECD (Organization for Economic Co-operation and Development) standards. The draft guidelines, proposed by the German Finance Minister, seek to provide clarity for taxpayers and businesses looking to establish a presence in Germany while also aiming to reduce the risk of non-deductible interest on intercompany loans.

The draft guidelines come with specific requirements. Companies must demonstrate their ability to service the loan for its entire duration, establish an economic basis for the financing, and ensure it will be used for business purposes. Notably, refinancing within a company group is viewed as an arm’s length transaction, not requiring immediate proof of full repayment capacity. Borrowing for profit distribution is generally considered compatible with a company’s objectives, and short-term placement of excess funds or “capital buffers” in intra-group cash pools can be deemed reasonable under certain circumstances, such as when accumulating funds for acquisitions. Even high-risk financing scenarios, common in sectors like startups, are not automatically considered unfair or unreasonable.

The draft applies to financing agreements made after January 1, 2024, with rules for pre-existing agreements taking effect from 2025 if they extend beyond December 31, 2024. In cases of non-compliance, the draft clarifies that interest expenses are non-deductible only to the extent they exceed the arm’s length portion rather than being entirely non-deductible.

A key element in the draft is the explicit mention of the comparable uncontrolled price (CUP) method as Germany’s preferred approach to benchmark intercompany financing. The draft emphasizes that risk and the authority to control the financing transaction are crucial in determining which entity should receive the interest income. This marks a departure from current German rules, which broadly classify intra-group financing activities as routine functions with low associated risks, compensated using a cost-plus method (CPM) (an approach not aligned with OECD guidelines).

There are notable differences between Germany’s approach and that of the OECD, particularly regarding creditworthiness assessment. While the OECD focuses solely on the borrower, German legislature generally prefers to consider the entire group’s credit rating when determining the arm’s length interest rate. This discrepancy creates challenges for multinational entities operating in Germany and countries that adhere to OECD guidelines.

Transfer pricing remains a complex and dynamic function in international tax. Taxpayers face the challenge of adhering to both OECD and local tax authority guidelines. Germany’s case exemplifies this challenge, highlighting the need for ongoing surveillance in monitoring local updates and incorporating these nuances into transfer pricing studies.

Contact our Global Business Services team with questions on Germany’s updated transfer pricing regulations or any other international tax issue.