Standard market interest rates are an important aspect when setting financing conditions between affiliated companies
Definition of the foreign settlement principle
The foreign settlement principle, also known as the “arm's length principle” or “principle of customary foreign conditions,” is a fundamental concept in international tax law and is used to evaluate transactions between affiliated companies. It states that agreements between affiliated companies must be designed in such a way that they meet the conditions that would also be common between independent third parties. This means that the tax treatment of transactions between affiliated companies is based on market prices or market conditions and should therefore withstand a third-party comparison.
Relevance of the foreign settlement principle
The foreign settlement principle serves to prevent tax avoidance and profit shifting. It ensures that companies are taxed on a fair and objective basis. The application of the foreign settlement principle avoids distorting tax effects that may result from unreasonable pricing or conditions in transactions between affiliated companies. If companies comply with the foreign settlement principle, they also ensure that the agreements between affiliated companies are recognized for tax purposes.
Typical situations for applying the foreign comparison
- Sales of goods: When related companies trade goods among themselves, the foreign comparison method is used to determine the price of these transactions. The prices of goods that independent companies would agree on in comparable transactions are used as a benchmark.
- services: When providing services between affiliated companies, the third-party comparison method is used to determine the price of these services. This may include, for example, the provision of management services, IT support or consulting services.
- Intellectual property license fees: When affiliated companies license intellectual property, such as patents, trademarks, or copyrights, among themselves, the third-party settlement method is used to determine the appropriate license fee. The prices that independent companies pay for comparable licenses are used as a reference.
- Financing and loan arrangements: The cross-reference method is also used in the determination of >> normal market interest rates and conditions for financing and loan arrangements between affiliated companies. This compares the conditions that independent third parties would receive for similar loans or financing. Credit spreads serve as an important yardstick to take into account the additional interest rate premium that investors would charge for taking on credit risk. This contributes to the objective determination of transfer prices. An important example of the use of the price comparison method is the determination of customary foreign loan interest rates, as well as the >> Federal Fiscal Court in its landmark judgment Az. IR 4/17 clarified.
Guidelines on the foreign settlement principle
The foreign comparison principle is the basis of the price comparison method, which is used to determine transfer prices between affiliated companies. When using the price comparison method, the prices or price ranges of comparable transactions between independent third parties are used to determine a reference value for transfer prices between affiliated companies. The focus of this third-party comparison is on the search for comparable transactions that have similar economic conditions and risks. An internationally recognized and authoritative source for the use of the price comparison method in tax law is >> OECD transfer pricing guidelines. They provide clear guidelines for comparability analysis, selection of >> Comparison groups and documentation to enable a consistent and objective determination of transfer prices. Compliance with these guidelines helps companies to shape their transfer pricing policies in line with international standards and tax requirements.
Recommendations for action for tax advisors
- Comprehensive analysis of entrepreneurial structures: Tax advisors should carry out a thorough analysis of business relationships and transactions between affiliated companies in order to identify potential risks and deviations from the foreign settlement principle.
- Documentation of agreements: It is crucial that all agreements between affiliated companies are recorded in writing. The documentation should include the basis of the transactions, the market compliance of prices or conditions, and other relevant information.
- Comparative data and benchmarking: Tax advisors should access reliable sources of comparative data to verify the appropriateness of prices and conditions in transactions between affiliated companies. Benchmarking enables a comparison with similar independent companies and supports compliance with the foreign comparison principle.
- Expertise in international tax issues: Since the foreign settlement principle also applies to cross-border transactions, it is important for tax advisors to have sound knowledge of international tax issues. The complexity of international tax laws requires specialized expertise.If you want
- Regular review and adjustment: The foreign settlement principle is subject to constant changes and developments. Tax advisors should therefore regularly update their knowledge and monitor agreements between affiliated companies to ensure that they meet current requirements.
Conclusion
Through comprehensive analysis, the right documentation, the use of comparative data, sound expertise and regular reviews, tax consultants can ensure that their clients correctly implement the foreign settlement principle. Careful application of this principle helps to avoid tax risks and to ensure tax compliance.