On 31 May 2018, the Court of Justice of the European Union (CJEU) issued its judgment in Hornbach-Baumarkt (C-382/16). The case refers to German transfer pricing rules applying to transactions with foreign related parties and which do not provide the possibility for taxpayers to prove the existence of commercial reasons in case they conclude transactions not at arm's length terms.
What was the case?
In the case at hand a German company was an indirect shareholder of a Dutch group company and issued comfort letters free of charge in order to entitle its foreign subsidiaries (having negative equity) to receive bank loans. The German tax authorities increased the German company's taxable income by the amount of guarantee fees that third parties would have agreed upon.
The Court of Justice of the European Union (CJEU) found the German rules as infringing EU law (freedom of establishment). According to the CJEU, national law should basically give the opportunity to the taxpayer to prove that the (not at arm's length) terms were agreed upon for commercial reasons and the court clarified further that such economic reasons can also result from the status as a shareholder of the foreign group company. The CJEU ruled that in the situation at hand this requirement may be met, however leaves it to the referring German court to finally verify whether this is the case.
This judgment is of significant practical importance for cross-border transactions: the underlying doctrine is that transfer pricing adjustments infringe EU law if commercial reasons resulting from the status as shareholder can justify the deviation from the arm's length principle.
Although it is still open how such doctrine will concretely be applied by the German authorities & courts and also by other EU jurisdictions, multinationals with EU cross border activities should carefully monitor these developments.