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The latest developments in the real estate market are showing rising prices and larger numbers of international investors. In combination with the latest developments in the OECD BEPS publications regarding prices between related companies, the German tax administration is focusing more attention on the transfer pricing methods. The following article shows some facts which should be taken into account on the pricing of loans and management services.
First of all, the central feature of the pricing of loans is the dealing at arm’s length principle and an appropriate documentation. In general, there are two applicable transfer pricing methods for interest rates. On the one hand the cost-plus method, especially for back-to-back-financial transactions; and, on the other hand the price comparison method. The latter method is recommended by the OECD, due to higher reliability.
One way to obtain comparative prices is to analyze interest rates between two external third parties (external price comparison). Another way is to compare interest rates between the company and an external third party (internal price comparison).
Generally, real estate companies not only secure loans from affiliated companies but also from financial institutions. Therefore, an external price should be available. The German tax authority accepts interest rates which are comparable to interest rates a bank would have set. There are several circumstances a bank will take into account when it comes to pricing a loan.
The first step is to calculate a credit rating of the borrower by analyzing debt ratio, capital structure, cash flow, earnings, repayment modalities, market positioning and quality of investment assets. It is recommended to use either group- or stand-alonerating.
Thereafter, it is necessary to obtain comparable transactions through access to a specialized database. The database will compare specified properties. The guideline published by the German tax authority recommends comparing loan amount, duration, type, purpose, collaterals, credit rating, currency, currency risks, costs of exchange cover and other significant terms of the loan. The software or database will analyze similar transactions and provide a range of possible interest rates. Within this range small individual adjustments may be necessary. For example, it may be necessary to find a reasonable Loan to Value (LTV) rate. The higher the LTV ratio the higher the interest rate has to be. In some countries the LTV ratio is more important than in others.
Foreign shareholders of real estate companies often need fund and asset management services. If these services are done by affiliated companies, transfer pricing methods have to be taken into account. Generally, it is possible to use the comparable uncontrolled price method, cost plus method or profit split method. Similar to the pricing of loans, services can be priced by finding comparable prices. If there isn’t enough information the other methods could be applicable. Cost plus method is taken at low risk and minor value added services. For pricing all expenses plus an appropriate profit surcharge are taken. If the services have high risk and add a high value, the profit split method is more suitable.
The whole process of pricing should be documented in detail and proofed by evidence for tax audit purposes.
