Borrowers seek to optimise their weighted average cost of capital and to have the right funding available to meet both short-term needs and long-term objectives. When considering the options realistically available to it, an independent business seeking funding operating in its own commercial interests will seek the most cost effective solution, with regard to the business strategy it has adopted. For example in respect of collateral, in some circumstances, assuming that the business has suitable collateral to offer, this would usually be secured funding, ahead of unsecured funding, recognising that a business’s collateral assets and its funding requirements may differ over time, e.g. because collateral is finite, the decision to pledge collateral on a particular borrowing precludes the borrower from pledging that same collateral on a subsequent borrowing. Therefore, an MNE pledging collateral would take into account its options realistically available regarding its overall financing (e.g. possible subsequent loan transactions) ...

In the case of a loan from the parent entity of an MNE group to a subsidiary, the parent already has control and ownership of the subsidiary, which would make the granting of security less relevant to its risk analysis as a lender. Therefore, in evaluating the pricing of a loan between associated enterprises it is important to consider that the absence of contractual rights over the assets of the borrowing entity does not necessarily reflect the economic reality of the risk inherent in the loan. If the assets of the business are not already pledged as security elsewhere, it will be appropriate to consider under Chapter I analysis whether those assets are available to act as collateral for the otherwise unsecured loan and the consequential impact upon the pricing of the loan ...

“HQ Lender GmbH” is the sole shareholder and at the same time the controlling company of A GmbH. The latter held 99.98% of the shares in B N.V., a corporation with its seat in Belgium. The remaining shares in B N.V. were held by HQ Lender GmbH itself. A GmbH maintained a clearing account for B N.V., which bore interest at 6% p.a. from 1 January 2004. No collateralisation was agreed in regards of the loan. In the year in dispute (2005), the interest rate on a working capital loan granted to the plaintiff by a bank was 3.14%. On 30 September 2005, A GmbH and B N.V. concluded a contract on a debt waiver against a debtor warrant (… €). The amount corresponded to the worthless part of the claims against B N.V. from the clearing account in the opinion of the parties to the contract. Although it was deducted from the balance sheet of A GmbH to reduce profits, the tax authorities neutralised the reduction in profits with regard to the lack of collateralisation of the claim in accordance with section 1 (1) of the German Income Tax Act (AStG) through an off-balance sheet addition. An appeal was filed by HQ Lender GmbH. Judgement of the BFH The BFH allowed the appeal of HQ Lender GmbH and referred the case back to the FG Düsseldorf. The FG has to determine whether there is a loan that can be recognized for tax purposes at all or whether this “clearing account” is more of an equity transfer by the shareholder. The distinction between loans occasioned by business and contributions occasioned by the company relationship is to be made on the basis of the totality of the objective circumstances. Individual criteria of the arm’s length comparison are not to be accorded the quality of indispensable prerequisites of the facts. The lack of collateral for a loan is one of the “conditions” within the meaning of § 1, para. 1 of the German Income Tax Act (AStG) which, when considered as a whole, can lead to the business relationship being unusual; the same applies to Article 9, para. 1 of the OECD Model Convention (here: Article 9 of the DTC-between Germany and Belgium 1967). Whether an unsecured intercompany loan is in conformity with the arm’s length principle in the context of an overall consideration of all circumstances of the individual case depends on whether a third party would also have granted the loan under the same conditions – if necessary, taking into account possible risk compensation. If an unsecured group loan would only have been granted at a higher interest rate than the one actually agreed, an income adjustment must be made primarily in the amount of this difference. In the context of arm’s length determinations, the granting of unsecured loans by third parties to the group parent company is not suitable to replace the assessment of the loan granted to a (subsidiary) company on the basis of the standard of an arm’s length granting of a loan. Click here for English translation Click here for other translation ...

Diligentia was the parent company of a Group active in real estate. After a take-over of Diligentia by another Group, Skandia Liv, external loans in Diligentia were terminated and replaced with intra-group loans from the new parent company, Skandia Liv. The new loans had an interest rate of 9,5 percent compared to the interest rates before the take over where the average rate was 4,5 percent (STIBOR added with 0,4 percent). Skandia Liv was a life insurance company (tax free under Swedish law) The tax authorities stated that the interest rate level exceeded a marked interest rate level and that the excess rate constituted deemed dividends. The Administrative Court established that an arm‟s length rate can be determined by looking at a wide range of interest rate levels since an interest rate is determined by a number of elements such as the borrower‟s credit worthiness, collateral, term to maturity etc. The court set the interest at 6,5 percent. The Court claimed that the loans should be compared to loans with collateral, due to the ownership structure. The Supreme Administrative Court stated that, when pricing a loan it was vital to be aware of the risk that a borrower will not be able to carry out the payments and the possible need for a security. When a parent company is granting a loan to its subsidiary different conditions apply. While a parent company exercises control over its subsidiary, an external lender only has limited insight. The external lender can also be unsure of the intentions of the parent company, i.e. the will to support the subsidiary financially in case of default. The Court claimed that loans from parent companies to subsidiaries have characteristics that influence the credit risk, hence the interest rate. These characteristics are absence when lenders and borrowers are independent parties. With the same conditions in general, the interest rate could not, without further, be settled to what would have been considered a market price if the lender had been external. Finally, the Court stated that the credit risk in this case was lower than if the loan agreements would have been concluded between independent parties. Based on the information submitted in the proceedings concerning the interest rate and other conditions, the Court did not see a reason why Diligentia should deduct a sum higher than 6,5 percent. Click here for translation ...