A Greek company had borrowed a total of €18.5 million from related parties and applied an interest rate of 8.5% in FY 2017. The interest rate on the loans were documented using the CUP method with external comparables based on a stand alone credit rating.
The tax authorities carried out an audit and concluded that the company’s creditworthiness had been understated, as its membership of a financially stronger multinational group provided implicit support and enhanced its credit rating. Based on this, the arm’s length interest rate was determined to be 2.92%.
The company appealed, arguing that:
- the audit had unlawfully rejected its credit rating analysis and comparables;
- the CUP method had been misapplied because the specific features of the loans had been ignored, including their unsecured nature, low repayment priority, long maturity, fixed rate, and the credit rating of the individual bond issues; and
- the authorities had wrongly relied on group membership instead of the risk of the specific loans.
Judgment
The Administrative Tribunal rejected the appeal and upheld the tax assessment. According to the tribunal the creditworthiness of a group company must reflect the implicit support arising from its membership of a stronger group. As the documentation failed to take this into account, the 8.5% interest rate applied by the company was not considered to be at arm’s length.
Excerpt in English
“The term “incidental benefit” does not refer to the amount of the benefits, nor does it imply that these benefits must be small or relatively insignificant. Consistent with this general view of the benefits associated with membership of the multinational group, when incidental benefits or costs of membership of the Multinational Group arise solely and exclusively from membership of a Multinational Group and without the deliberate and coordinated actions of the affiliated companies of the Multinational Group or the provision of any intra-group service or other function by the associated enterprises of the multinational group, is that such incidental benefits do not need to be invoiced separately or allocated between the associated enterprises of the multinational group.
In fact, paragraph 1.164 [TPG 2017] gives an example of such benefits:
1.164 “P is the parent company of an MNE group engaging in a financial services business. The strength of the group’s consolidated balance sheet makes it possible for P to maintain an AAA credit rating on a consistent basis. S is a member of the MNE group engaged in providing the same type of financial services as other group members and does so on a large scale in an important market. On a stand-alone basis, however, the strength of S’s balance sheet would support a credit rating of only Baa. Nevertheless, because of S’s membership in the P group, large independent lenders are willing to lend to it at interest rates that would be charged to independent borrowers with an A rating, i.e. a lower interest rate than would be charged if S were an independent entity with its same balance sheet, but a higher interest rate than would be available to the parent company of the MNE group.”
This is because foreign rating agencies take into account the passive link and the ancillary benefits of a company’s membership of a group, increasing the credit rating of the company under review (……..).
Because equating the creditworthiness of the applicant (B) with the creditworthiness of the country (CCC) underestimates the creditworthiness of the applicant, because the applicant, as a member of the foreign group, may have access to financing on more favourable terms than the foreign group. Country risk overestimates the risk of default by the applicant, as it does not take into account the ancillary benefits that the applicant enjoys as a result of its participation in the foreign group.
Therefore, the audit correctly conducted a search using a credit rating criterion of B, including one grade above BB, in order to take into account the ancillary benefits to the applicant’s credit rating, its participation in the group, and one grade below CCC, which is the credit rating of the country, in order to take into account the country risk and the economic conditions faced by the applicant.”
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