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Germany: Transfer pricing adjustments, involving non-resident related company relationships

Germany: Transfer pricing adjustments

The Court of Justice of the European Union (CJEU) on 31 May 2018 issued a judgment in a case concerning the German tax law rules providing that income of a German taxpayer resulting from its business relationships with non-resident related companies is to be adjusted when the relationships are not at arm’s length, but are not required to be adjusted when the business relationships are between German related companies. The CJEU judgment generally follows the opinion of the CJEU Advocate General that the German rules are not, in principle, contrary to the freedom of establishment.


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The case is: Hornbach Baumarkt (C 328/16)


A German parent company issued “comfort letters” providing financial guarantees to external creditors and banks, in respect of loans granted to two wholly owned Dutch subsidiaries. The parent company did not charge a fee for these comfort letters. Referring to section 1, paragraph 1 of the German Foreign Tax Act, the German tax authorities concluded that because of the associated liability risk, unrelated parties would have agreed to remunerate the provider of such comfort letters, and consequently the tax authorities adjusted and increased the parent company’s income for an amount that was equal to the notional liability remuneration.   

The taxpayer challenged the tax assessments, arguing that the German rules are contrary to the freedom of establishment because the adjustment is made only in instances involving cross-border business relationships. In a purely domestic situation and under otherwise identical conditions, there would have been no upward adjustment (at the level of the parent company). The taxpayer asserted that this difference in treatment would likely deter German parent companies from establishing subsidiaries in other EU Member States, and therefore, this reflected a restriction of the freedom of establishment. Lastly, the taxpayer asserted the German legislation was not proportionate because it excluded any possibility of putting forward commercial justifications for transactions that are not at arm’s length. 

CJEU judgment

The CJEU concluded that the German rules did not go beyond what was necessary to achieve the legislative objectives. Still, the CJEU considered that there may be commercial reasons for a parent company to agree to provide capital on terms that are different from market conditions. In particular, the gratuitous granting of comfort letters could be explained by the parent company’s economic interest in the continuation and expansion of the foreign subsidiaries’ business operations. 

The CJEU: 

  • Examined the application of the freedom of establishment and found that the German rules applied to situations when a resident taxpayer was able to exert a definite influence on a company established in another EU Member State 
  • Observed that a German parent company with a Dutch subsidiary would be treated less favorably than if it had a German subsidiary (no income adjustment would have been made if domestic subsidiaries) 
  • Agreed that the arm’s length principle was appropriate for preserving the allocation of the authority to tax among the EU Member States

KPMG observation

The CJEU decision sheds some light on the compatibility with EU law of national rules allowing for the adjustment of income from transactions between related parties, based on the arm’s length principle. In particular, the CJEU provided some clarity on possible commercial justification of a transaction that may differ from market conditions (for instance, the economic interests of the group as a whole with respect to the financial success of its foreign subsidiaries). It will now be for the German court that referred the matter to the CJEU to issue a decision, and it will be interesting to see if or how that court takes this finding into account in its decision. 


Read a June 2018 report prepared by KPMG’s EU Tax Centre 

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