Case Law Notes: Landmark Transfer Pricing Case on Applying the Arm’s Length Principle to Shareholder Loans in Germany

Abstract

This article examines the Federal Tax Court’s landmark decision of 27 February 2019 on the application of the arm’s length principle under German tax law. The Federal Tax Court reaffirmed that the mere absence of security/collateral does not justify re-characterizing a shareholder loan into equity. More importantly, the court held that German transfer pricing rules permit not only an adjustment of the price of a controlled transaction for the purpose of determining a taxpayer's income but allows, beforehand, the alteration of other terms or conditions that were made between the related parties, replacing actual conditions by arm’s length conditions. More specifically to the disputed case of an unsecured shareholder loan, an arm’s length loan must now be determined on the rebuttable presumption that the loan is deemed to be secured, even if no security has actually been provided or, presumably, the interest rate includes a risk premium. Arguably, the court denied the significance of implicit group support as a general rule. All this could further expand the reach of transfer pricing adjustments in Germany. In audit practice, it is expected that other terms and conditions of controlled transactions – apart from the price – will be now increasingly scrutinized in German tax audits.