In the present case, an intercompany loan was granted by a Dutch company to an affiliated GmbH (the plaintiff in the case) resident in Germany. The German tax office came to the conclusion that the interest rate agreed on for the intragroup loans was too high and did not comply with the arm’s length principle and that, therefore, the interest had to be treated in part as a hidden profit distribution. While the tax office used the cost-plus method to analyse whether the interest on the loan was at arm’s length, the GmbH used the comparable uncontrolled price (“CUP”) method.

The reasoning of BFH can be summarised as below and shows a clear orientation towards aligning with the OECD transfer pricing guidelines on financial transactions issued in February 2020.

(i) Precedence of the CUP method over the cost-plus method

With reference to the OECD transfer pricing guidelines, BFH describes the CUP method as the “basic method for determining appropriate transfer prices” that is to be preferred if several transfer pricing methods potentially are applicable.

As a justification, BFH states that the CUP method is frequently used to determine market interest rates because in the case of loans, homogeneous and unbiased comparable data from a number of markets are available. By contrast, the use of the creditor’s borrowing costs is appropriate only if no comparable data are available. BFH further states that both internal and external CUP can be applied, adding that the internal CUP cannot be excluded only because the transaction terms are different; instead, it should be analysed how the different terms affect the interest rate, whether this effect can be quantified and, if needed, eliminated by an appropriate adjustment. In case of the external CUP method, BFH states that corporate bonds are suitable for determining the market interest rate.

(ii) The debtor’s credit rating and consideration of group affiliation

BFH supports the differentiated approach. The determination of the market interest rate should primarily be based on the debtor’s individual rating, which may be adjusted, if needed, for potential effects arising from the group affiliation.

According to BFH, an adjustment of this individual rating and the consideration of the effects of the group support can be taken into account only if a lender outside the group would assign a higher credit rating to the borrowing group company due to the fact that it belongs to the group.

With these conclusions, BFH deviated from the position of the Ministry of Finance expressed in its opinion on the Administrative Principles of Transfer Pricing – i.e. a document on which the German tax authorities base their assessment of similar intragroup transactions.

The complete text of the judgment no. I R 4/17 in German is available on the BFH website.