EU Court upholds German transfer pricing law, says non-arm’s length loan guarantee may be justified

By Davide Anghileri, University of Lausanne

The Court of Justice of European Union on 31 May concluded that German transfer pricing legislation is consistent with EU concepts of freedom of establishment. Moreover, the Second Chamber ruled, in the case, C-382/16 Hornbach-Baumarkt, that a parent company’s position as a shareholder of a non-resident company may be taken into account in determining whether there is sufficient commercial justification for a non-arm’s length related-party transaction.

German transfer pricing challenge

In the case at stake, a German parent company guaranteed loans of two related companies for no remuneration. The German tax office corrected the amount of income allocated to the parent company as a result of the guarantee, taking the view that unrelated third parties, under the same or similar circumstances, would agree on remuneration in exchange for granting the guarantees.

The parent company challenged the decision saying that the German legislation was contrary to freedom of establishment because it leads to unequal treatment in cases involving domestic and foreign transactions since, in a case involving purely domestic transactions, no corrections to income would be made to reflect the presumed amount of the remuneration for guarantees granted to subsidiaries.

Moreover, the company argued that the legislation is disproportionate to achieving the government’s objectives because the law does not provide an opportunity for the company to present commercial justification to explain a non-arm’s-length transaction.

The German court requested a preliminary ruling from the ECJ.

The judgment

The ECJ stated that transfer pricing legislation constitutes, per se, a restriction to the freedom of establishment. However, this restriction can be justified, the court said, by the need to preserve a balanced allocation of taxing rights between the Member States.

In fact, the goal of the transfer pricing legislation is to prevent profit shifting via transactions that are not in accordance with market conditions, the ECJ said.

The issue at stake is to understand whether or not the German transfer pricing legislation goes beyond what is necessary to achieve the objective which it pursues, the ECJ, then said.

In its analysis, the ECJ stated that legislation does not go beyond what is necessary to attain the objectives relating to the need to maintain the balanced allocation of the power to tax between the Member States and to prevent tax avoidance if the taxpayer is given an opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction, and if the corrective tax measure is confined to the part which exceeds what would have been agreed between the companies in question under market conditions.

Regarding the second point, the ECJ stated that the income adjustment made by the German tax authorities was limited to the portion of the income which exceeded what would have been agreed between unrelated companies.

Commercial justification

Regarding proof of commercial justification, the ECJ pointed out that this concept may include economic reasons resulting from the very existence of a relationship of interdependence between the parent company resident in the Member State concerned and its subsidiaries which are resident in another Member State.

Regarding proof of commercial justification, the ECJ pointed out that this concept may include economic reasons resulting from the very existence of a relationship of interdependence between the parent company resident in the Member State concerned and its subsidiaries which are resident in another Member State.

In fact, in the opinion of the ECJ, contrary to the opinion of the German government, a parent company has sufficient commercial reason to provide capital on non-arm’s-length terms to a subsidiary when a subsidiary lacks sufficient equity capital to expand.

The ECJ said, as well, that no argument relating to the risk of tax avoidance had been advanced by the German government, nor had a wholly artificial arrangement had been identified, and no desire on the part of the applicant in the main proceedings to reduce its taxable profit in Germany was proved.

Therefore, the ECJ stated that comfort letters containing a guarantee free of any remuneration might be commercially justified because the parent company is a shareholder of the foreign group companies, which would justify the transaction at issue under non-arm’s-length terms.

However, the ECJ also that, in the case at stake, it is for the referring court to determine whether the parent company was in a position, without being subject to undue administrative constraints, to put forward elements attesting to a possible commercial justification for the transactions at issue in the main proceedings, without it being precluded that economic reasons resulting from its position as a shareholder of the non-resident company might be taken into account in that regard.

Davide Anghileri

Davide Anghileri

Researcher and lecturer at University of Lausanne

Davide Anghileri is a PhD candidate at the University of Lausanne, where he is writing his thesis on the attribution of profits to PEs. He researches transfer pricing issues and lectures for the Master of Advanced Studies in International Taxation and Executive Program on Transfer Pricing.

Anghileri, a Contributing Editor at MNE Tax, previously worked as a policy advisor to the Swiss government on BEPS issues.

Davide can be reached at danghileri@yahoo.it.

Davide Anghileri
Davide can be reached at danghileri@yahoo.it.


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