Germany: German Federal Tax Court rules disallowance of write-down for related-party debt violates OECD model treaty
The German Federal Tax Court (Bundesfinanzhof, BFH) issued a decision (case ref. I R 29/14) on September 9 2015, in which it held that the domestic transfer pricing rules may not be applied to disallow a write-down of an impaired related-party debt in a case where a relevant tax treaty includes the arm's-length standard provisions of Article 9 of the OECD model treaty.
Until 2007, German multinationals could claim a deduction for bad debts on loans granted to subsidiaries if the subsidiary did not perform as planned and the debt was impaired. As from 2008, write-downs of related-party loans are non-deductible under specific rules in the German Corporate Tax Act, unless it can be demonstrated that the loan was granted in line with (a very narrow interpretation of) the arm's-length principle.
In an effort to extend the general presumption of non-deductibility to the years before 2008, the German tax authorities challenged a 2002 write-down of a substantial unsecured debt owed by an undercapitalised UK subsidiary of a German entity of a Canadian group. The tax authorities argued that the German transfer pricing rules disallowed the write-down because either the loan was not granted on arm's-length terms, or the loan was not impaired because the subsidiary still could rely on the financial backing from its group, as long as it paid its third-party lenders.
The BFH confirmed a previous decision (case ref. I R 23/13) and emphasised that it may be in line with the arm's-length principle not to require collateral from a group subsidiary when granting a loan, and that it still may be possible to consider such a debt to be impaired if the subsidiary experiences financial difficulties. The BFH also confirmed that, where a tax treaty includes Article 9, paragraph 1 of the OECD model (as is the case with most German tax treaties), the domestic transfer pricing provisions may not disallow the write-down, since Article 9 permits only income adjustments relating to the conditions of the loan (for example, the interest rate); it does not permit the disallowance of a write-down. It is unclear if the same reasoning may be applied to years from 2008, where the deduction for a write-down is generally disallowed for reasons unrelated to the transfer pricing framework.
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