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    Thursday 27 June 2019

    The Double Taxation Treaty (DTT) arm's length principle has no blocking effect where a group loan is unsecured

    German's group loanIn a departure from its previous case law, the German Federal Tax Court ruled in its judgment on 27 February 2019 (Case No. I R 73/16) that Art. 9 (1) of The Organisation for Economic Co-operation and Development (OECD) Model Convention (or Art. 9 of the DTT with Belgium in the case being litigated) does not prohibit an income adjustment pursuant to section 1 (1) of the Foreign Tax Act (AStG) where an unsecured loan group is written off.

    The Court held a lack of collateral for the loan, which is not usual between independent third parties. This led to an income reduction that occurred at the time the receivable was written off and had to be corrected in accordance with section 1 (1) of the Foreign Tax Act. To the extent that in its previous case law (e.g. judgment of 21 December 1994, ref. no. I R 65/94) the Federal Tax Court had deemed the controlling shareholder's ability to exert influence on the borrower (a concept referred to as ‘group support’) to constitute arm's length collateral for the loan receivable, it expressly no longer adheres to this. The Federal Tax Court also abandoned its previous case law according to which Art. 9 (1) of the OECD Model Convention limits the scope of correction of section 1 (1) of the Foreign Tax Act to price adjustments. (Therefore, correction was expressly limited to the amount of the interest on the loan—see judgment on 24 June 2015, ref. no. I R 29/14.) Accordingly, the lack of collateral can also be a condition that is not at arm's length within the meaning of Art. 9 (1) of the OECD Model Convention and can thus lead to an income adjustment in accordance with § 1 (1) of the Foreign Tax Act.

    Note: In many cases where foreign subsidiaries are financed by domestic shareholders, this change in the Federal Tax Court's case law should lead to an income adjustment. If applicable, companies should examine whether, for such shareholder loans, arm's length collateral can be agreed in addition to an arm's length interest rate.

    Contributor:
    Christian Zimmermann - Partner
    Ebner Stolz, Germany
    E: Christian.Zimmermann@ebnerstolz.de

    In a departure from its previous case law, the German Federal Tax Court ruled in its judgment on 27 February 2019 (Case No. I R 73/16) that Art. 9 (1) of The Organisation for Economic Co-operation and Development (OECD) Model Convention (or Art. 9 of the DTT with Belgium in the case being litigated) does not prohibit an income adjustment pursuant to section 1 (1) of the Foreign Tax Act (AStG) where an unsecured loan group is written off. 
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