The tax treatment of intra-group loans in a national or international context requires a high degree of judgment regarding arm's-length terms
When structuring loan relationships within national or international corporate groups, extensive tax considerations must be taken into account in addition to specific provisions under corporate, insolvency, and contract law. Essentially, intra-group loans—like loan relationships between close relatives—must comply with the arm’s-length principle and the principle of reasonableness in order to be recognized for tax purposes. In international capital transactions, the transfer pricing principles (transfer pricing at arm’s length) of the relevant national tax authorities must also be observed, which are based in part on OECD guidelines.
Tax recognition of intra-group loans is subject to the following requirements:
- Valid Conclusion of a Loan Agreement in Compliance with Formal Requirements Under Civil Law (Prior the Loan Disbursement)
- Actual implementation of the substantive terms of the contract (e.g., principal payments in accordance with the contractually specified due dates)
- Interest rates on the loan principal that are in line with industry standards and market conditions, depending on the borrower's credit profile
- Adequate collateralization of the loan principal through real property or standard alternatives
In the absence of specific guidelines for structuring and advisory practices, as well as for affected group companies, determining appropriate interest rates or requiring arm’s-length collateral measures during tax audits is highly contentious and a favorite area of scrutiny for group auditors. In Germany, the so-called price comparison method is the primary approach to be used to derive an appropriate interest rate for intra-group loans from the general interest rate market environment. The alternative method—the so-called cost-plus method from the lender’s perspective—should be used only as a secondary option. When applying the price comparison method, in addition to the loan amount, the stand-alone rating of the borrowing group company must be taken into account; the group’s overall rating should not be used per se—based on a potentially existing group backstop—to derive an appropriate interest rate (see BFH, judgment of May 18, 2021, Case No. I R 4/17).
Another key factor influencing the accurate determination of an arm’s-length interest rate is the size-dependent collateralization of a group loan. Subordinated collateral or rights to additional collateral alone, which are promised and granted to the lender in the loan agreement, but which must only be actually enforced in the event of subsequent doubts regarding the borrower’s creditworthiness, understandably have less influence on the interest rate than tangible collateral such as a real estate mortgage registered in the land registry, a security interest in physical assets, or a general assignment of the borrower’s short-term receivables from third parties.
As a result, however, Germany lacks specific guidelines for establishing loan terms that are definitively in line with arm’s-length principles, meaning that tax recognition can only be anticipated on a discretionary basis when drafting a loan agreement; there is no “right or wrong” or “black or white”—rather, there remains a certain “range of truth.” Unlike tax advisors, CFOs, or corporate treasurers, tax auditors can take a retrospective view and, thanks to the greater insight gained over time, present stronger arguments during tax audits.
In the specific context of the United States, intercompany loan arrangements must comply with the so-called “Best Method Rule,” under which the following three interest rate derivation methods may be used (U.S. Treasury Register):
- 1. Method: General Arm’s Length Interest Rate (similar to the price comparison method using interest rate databases)
- 2. Method: Funds Obtained at the Borrower's Location (similar to the cost-plus method based on the lender's external refinancing interest rates)
- 3. Method: Safe Haven Interest Rates (official interest rates for intra-group loans based on the so-called Applicable Federal Rates as the lower limit and 130% of that as the upper limit)
Interest rates for intra-group loans within Switzerland are determined in a similar manner; these rates must also be set based on government-prescribed safe-haven interest rates. The Swiss Federal Tax Administration (ESTV) publishes annual interest rates for this purpose to guide the setting of interest rates for intra-group loan arrangements.
If, under Swiss tax law, intra-group loans do not comply with the arm’s-length principle because the underlying interest rate is not at arm’s length (too low or no interest at all), such loan disbursements generally constitute, in essence, hidden profit distributions from the lender to the borrower, which typically trigger undesirable taxation. If the contractually agreed-upon loan interest rates fall within the guidelines set by the Federal Tax Administration, they are presumed to be at market rates or arm’s length, and the respective intra-group loan is recognized for tax purposes.
A comparable level of legal certainty regarding the issuance of intra-group loans—particularly with regard to the determination of market-based interest rates—would also be highly desirable in this country.
You can find the publication of the market interest rates for 2023 in Switzerland here.
