In brief

The German Bundestag (parliament) on November 17 passed the ‘Growth Opportunities Act,’ submitted by the government. The Bundestag's legislative action foresees a new law introducing an investment grant for certain investments aiming to achieve energy savings, and making various adjustments to national and international tax law provisions. The Bundestag's legislative resolution differs in parts from the August 30, 2023 draft bill. This tax insight focuses on the significant changes with respect to the rules limiting the interest deduction. 

Observation: Next, the Bundesrat, the German legislative body that represents German Federal States must pass the draft law. However, this is not guaranteed as there might remain political disagreements on various aspects of the draft law. 

New: Adjustment of the rules for determining the arm's length price for financing relationships (instead of interest rate capping rule): 

The Bundestag's legislative resolution no longer contains the interest rate capping rule previously announced in the coalition agreement, which was envisaged as Section 4l Income Tax Act (ITA) in the draft bill. Instead, it includes a provision to amend the regulations for determining arm's length prices in Section 1 Foreign Taxes Act (FTA) from its statement on the draft bill. In this proposal, the Bundesrat included regulations that already had been proposed in the legislative process for the ATAD Implementation Act of 25 June 2021, but which were not included in the law at the time due to technical uncertainties. 

Under the new rules, the interest deduction for intra-group financing will be limited to an interest rate that is determined based on the group rating. However, the proposal contains the option to prove that the stand-alone rating (derived from the group rating) complies with the arm's length principle. If such proof can be provided, the derived rating must be taken into account when calculating the deductible interest rate. 

Observation: There is no escape from the aforementioned limitation even if the lender is a company with sufficient substance, as provided for in the draft law. Purely domestic constellations, on the other hand, are not affected by the proposal. 

In addition to a group interest rate limitation, the proposal would introduce increased compliance requirements to safeguard the deductibility of intra-group interest expense. According to these rules, the taxpayer must provide credible evidence that the so-called debt service (which includes interest and amortization payments) could be met during the entire term of the financing from the beginning. Furthermore, the financing must be proven to be economically required and used for company purposes. If these requirements are not met, the interest deduction would be denied. 

Finally, the proposal includes a provision that assumes that low-function, low-risk service activities are given for activities such as brokerage or the forwarding of funds within a multinational group of companies, for which the remuneration only can be determined on a cost-plus basis. The rule should apply as well if a company within the corporate group assumes the activities of managing financial resources for one or more companies in the corporate group, such as liquidity management, financial risk management, currency risk management, or acting as a financing company. 

The new proposal’s interest deduction limitations would apply from the 2024 tax period onwards. 

Observation: The new adjustment of the rules for determining the arm's length price for financing relationships which are again included in the Bundestag's legislative resolution were highly debated when originally proposed within the legislative procedure of the ATAD Implementation Act. The technical doubts and open questions with regard to these rules remain and might result in extensive discussions in the political process. Furthermore, the new draft law foresees further documentation requirements to ensure the deductibility of intra-group interest payments.