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Introduction to Germany transfer pricing
Transfer pricing rules
- In the German tax legislation, the arm’s length principle is defined in Section 1 of the Foreign Tax Act. Further, the following provisions of the national legislation are relevant from the transfer pricing perspective for companies operating in Germany:
- Constructive dividend, § 8 (3) Corporate Income Tax Act
- Hidden capital contribution, § 4 (1) Income Tax Act and § 8 (1) Corporate Income Tax Act
- Contribution or withdrawal, § 4 Income Tax Act, (eg, for partnerships)
- Section 1, Foreign Tax Act. Further clarifications to these legal provisions are provided in ordinances of the German Federal Ministry of Finance, eg Gewinnabrenzungsaufzeichnungsverordnung (ordinance on the documentation of profit allocation), Funktionsverlagerungsverordnung (ordinance on the relocation of functions), Betriebsstättengewinnaufteilungsverordnung (ordinance on the profit allocation of permanent establishments).
- In general, Germany follows the definition of the arm’s length principle stipulated in Article 9 of the OECD Model Tax Convention. Though, in intercompany transactions information transparency, which means that all parties involved in intercompany transactions dispose complete information about its circumstances, is presumed (§ 1 (1) Sentence 3 Foreign Tax Act).
- The TP rules apply to German taxpayers, including German branches of overseas companies. For permanent establishments basically, the Authorized OECD Approach applies, however, with some important particularities.
- Germany is a member country of the OECD. OECD Guidelines do not represent mandatory law in Germany, but the national tax legislation is generally considered – by German fiscal authorities – to be consistent with them. The OECD Guidelines are often referred to by taxpayers, tax authorities and courts, as far as domestic regulations contain no respective provisions.
- In several details German domestic legislation deviates from the OECD Guidelines (eg, documentation requirements, the application of transactional profit methods, and the treatment of transfers of functions). However, opposite examples do also exist. For instance, in its decree of 5 July 2018 regarding cost contributions agreements German Ministry of Finance immediately refers to the Chapter VIII of the OECD Guidelines.
Transfer pricing methods
- German tax law addresses what transfer pricing method should be applied with preference depending on the availability of third party data.
- Principally CUP, resale price, cost-plus (so-called standard methods) are the preferred methods. However, they are only applicable if fully comparable third-party data (after making appropriate adjustments with respect to the functions exercised, the assets used, and the associated opportunities and risks) is available. If several unlimitedly comparable prices are available, any price within the range is arm’s length.
- In case only limitedly comparable third-party data is available, all the above-mentioned transfer pricing methods are applicable, including TNMM and residual profit split (so-called transactional profit methods). However, the range of comparable prices must be limited using statistical methods.
- If no limitedly comparable third-party data is available, the taxpayer should conduct the hypothetical arm’s length test (§ 1 (3) Sentence 5 ) Foreign Tax Act) to determine the arm’s length transfer price in an intercompany transaction. Thereby the range of prices, which could be agreed between unrelated parties under comparable circumstances, is determined.
- The minimal price acceptable for the hypothetical seller and the highest price acceptable for the hypothetical buyer under consideration of functional analysis, their plan calculations as well as of the risk-adequate interest rate are to be determined. The midpoint of the range of possible prices is considered the appropriate arm’s length price, unless arguments are provided that support a more appropriate point within the range.
- No self-assessment-regime in relation to transfer prices.
Transfer pricing documentation
Preparation of transfer pricing documentation
- German transfer pricing regulations with respect to the preparation of master file and local file are stipulated in § 90 (3) General Tax Act. § 138a General Tax Act contains rules regarding the preparation of CbCR.
- With regard to CbCR, the regulation has been effective since 1 January 2016 for groups with revenues over €750m.
- According to § 87 (2) General Tax Act transfer pricing documentation is to be filed in the German language. However, the taxpayer can submit an application for filing of the transfer pricing documentation in another language. Such an application is to be submitted with the tax authorities immediately after receiving a request for submitting transfer pricing documentation.
- A taxpayer in Germany is not obliged to document ordinary intercompany transactions with its related parties immediately after the transaction has been conducted, but has to provide transfer pricing documentation within 60 days upon request of the tax authorities. Extraordinary transactions must be documented contemporaneously, which means at the latest six months after the end of the fiscal year, in which the transaction has been conducted. Taxpayers in Germany must submit transfer pricing documentation of extraordinary transactions within 30 days upon request by the tax authorities.
- There are no specific transfer pricing-related returns. In October 2014 German Ministry of Finance released a decree on the attribution of profits to permanent establishments ('Betriebsstättengewinnaufteilungsverordnung'). According to the decree profits between the head office and the permanent establishment are to be allocated following the arm’s length principle like between unrelated parties ('functionally separate entity approach'). The decree contains provisions on the attribution of assets, capital, liabilities, revenues, and expenses to the permanent establishment of a company. The attribution is to be conducted based on an 'Auxiliary Calculation', which is to be prepared annually and until the filing of the tax return of the respective year. The decree is applicable for fiscal years beginning after 31 December 2014. Apart from that, taxpayers must file no specific transfer pricing returns in Germany
Master and German local file
- Germany has implemented BEPS Action 13 'Guidance on Transfer Pricing Documentation and Country-by-Country Reporting'. The new transfer pricing documentation requirements apply in Germany as of January 2016. Regulations of the German domestic legislation with respect to the information, which should be contained in the transfer pricing documentation, deviate slightly from the international provisions stipulated in the BEPS 13 report by OECD.
- A master file must be prepared by a German entity if its revenue in the preceding fiscal year exceeded EUR 100 million.
- A local file must be prepared if the total intercompany supply transactions exceed EUR 6 million or if the total amount of all other transactions exceed EUR 600 thousand. Different from this there is no transaction-specific threshold. Please note transactions pertaining to entities that belong to the same group (in the meaning of sec. 18 of the German Stock Corporation Act) are looked at as being aggregated in this regard.
Some risk factors for challenge
- Companies facing (long-term) losses
- Companies being involved in a business restructuring
- Companies that have intercompany business transactions with related parties located in low tax jurisdictions
- (Brand) license charges
- Financing transactions
- Management Fees.
- In case a taxpayer does not fulfill the requirements of § 90 (3) German General Tax Code with respect to the provision of transfer pricing documentation to the tax authorities, a disprovable assumption applies, that the transfer prices in intercompany transactions were not set in accordance with the arm’s length principle and that the tax base of the taxpayer in Germany has been consequently inappropriately reduced. Therefore, the tax authorities can adjust the tax base of the taxpayer accordingly, provided the taxpayer does not disprove the assumption.
- If a taxpayer violates its obligation to cooperate with the tax authorities and provides no or insufficient transfer pricing documentation, or if extraordinary transactions have not been documented in the stipulated manner and within the deadlines determined in § 90 (3) German General Tax Code, tax authorities can estimate the tax base of the taxpayer. The same applies if a related party of the taxpayer violates its cooperation obligations with the tax authorities according to § 90 (2) German General Tax Code or violates its disclosure obligation according to § 93 (1) German General Tax Code. According to § 162 (3) Sentence 2 German General Tax Code, if the tax authorities can estimate the basis of taxation within a certain range only, they are allowed to exploit this range to the disadvantage of the taxpayer.
- In case a taxpayer does not submit transfer pricing documentation or the submitted transfer pricing documentation is unusable, a penalty fee in the amount of 5%-10% of a potential income adjustment in the tax audit but a minimum of EUR 5,000 is to be charged. In case a taxpayer files usable transfer pricing documentation beyond the deadline stipulated in § 90 (3) German General Tax Code, the penalty surcharge amounts up to EUR 1 million, at least EUR 100 for every day of delay.
- If a taxpayer does not provide the tax authorities with a CbC report a penalty charge in the amount of up to EUR 10,000 can be raised.
Economic analysis and how to demonstrate an arm’s length result
- An economic analysis basically must be prepared for each intercompany transaction independent of the transaction volume. However, the law does not require a benchmarking study or database analysis to be prepared if the arm’s-length nature of the transfer prices can be evidenced otherwise.
- For the economic analysis the circumstances at the time of the agreement of the transaction are to be considered. To this end, the taxpayer must determine all information available at that time that is necessary to determine the transfer price and take only this into account. The taxpayer may rely on external comparables that have later become known, insofar as these relate to the time of the agreement of the transaction. The same applies to the tax authorities.
- The economic analysis regularly leads to a range of comparable values. If after any comparability adjustments differences in comparability remain, this range must be narrowed. If the comparable values themselves do not offer any indications for a certain narrowing, the interquartile range must be used. The requirement to narrow the range applies in any case to benchmarking studies or database analyses.
- In benchmarking studies or database analyses local comparable companies are preferred, whilst European or regional comparable companies are usually accepted. Single-year analyses are preferred, but multiyear analyses are often accepted. Generally, the validity of benchmark studies is often challenged by the tax authorities.
- German tax authorities are not permitted to use 'secret comparables'.
- There are also no published “safe harbours” or norms in Germany.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- In Germany, Advance Pricing Agreements (APA) may be applied for based on § 89a of the General Tax Code if a double tax treaty exists containing an article on Mutual Agreement Procedures (MAP). Based on this law, APA are possible for transfer pricing questions as well as for non-transfer pricing-related matters. An APA refers to the tax treatment of precisely defined, yet unrealised circumstances for a specific period generally not exceeding five years.
- German tax authorities basically only grant bi- or multilateral APAs on transfer pricing questions. Exemptions to this rule may only apply in cases where there is no double tax treaty in place. Unilateral advance agreements, however, cannot guarantee the avoidance of double taxation.
- Upon request of the taxpayer, signed APAs may be extended beyond the originally specified period of validity. Upon request, APAs may also be applied to periods that precede the period of validity (roll-back). For rollbacks the time limits for mutual agreement procedures stipulated in the applicable double tax treaty must be heeded. Rollbacks are usually accepted by the German tax authorities if the taxpayer can evidence that the critical assumptions were adhered to, and facts and circumstances stated within the APA also applied during the roll-back period. Nevertheless, based on § 89a a roll-back is not automatically foreseen but rather an exception to the norm.
- The initiation of the APA process is subject to the determination and payment of a fee. The fee is EUR 30,000 for an APA application, and EUR 15,000 for an extension request. The fee shall be reduced by 75% if an application refers to the tax treatment of circumstances for which a coordinated bilateral or multilateral field audit has already been conducted at the time the application is submitted, and such field audit led to consensus regarding the circumstances and their tax treatment. The same reduced fee applies for non-transfer pricing-related matters. Reduced fees of EUR 10,000 for initial application and EUR 7,500 for extension request apply if the transactional volumes subject to the APA are below certain thresholds: intercompany tangible goods transactions below EUR 6 million and other intercompany transactions below EUR 600,000.
- If the case relates to the tax treatment by multiple contracting states, the initiation of multiple APA processes may be applied for (multilateral APA). In these cases, a separate fee for each bilateral APA procedure will be determined and must be paid.
- The German competent authority for APAs is the Federal Central Tax Office (Bundeszentralamt für Steuern, BZSt).
Mutual Agreement Procedures and EU Arbitration Procedures
- Mutual agreement procedures are available under a double tax treaty, or the EU Arbitration Convention (90/436/EEC) or the implementation of the EU Directive on Tax Dispute Resolution Mechanisms (EU-Doppelbesteuerungsabkommenstreitbeilegungsgesetz).
- The taxpayer must be eligible under one of these legal bases to request a MAP. The case must be presented to the tax authority within the deadlines prescribed by the relevant legal basis, in most cases three years from the first notification to the taxpayer of the actions giving rise to the MAP. A formal request includes a description of the facts and a legal assessment. MAP requests are accepted in the case of a taxpayer-initiated foreign bona fide adjustment.
- The German competent authority for Mutual agreement procedures is the Federal Central Tax Office (Bundeszentralamt für Steuern, BZSt). MAP applications can also be filed with the local tax office.
- The MAP application is not subject to a fee.
- The German tax authorities may participate in coordinated tax audits. The main aim of coordinated tax audits, which covers both simultaneous tax audits (simultaneous tax examinations) and joint tax audits, is to achieve consensus when determining the relevant facts with the participation of foreign officials during the audit.
- Coordinated tax audits are initiated by the tax authorities. The tax office responsible for the tax audit decides which cases to propose for a coordinated external audit and for what reasons, and also decides whether it will participate in a coordinated tax audit proposed by another state.
- The taxpayer must be consulted. The taxpayer may lodge objections to the proposed coordinated tax audit with the German tax office responsible for the tax audit, and in specific cases, with the Federal Central Tax Office (Bundeszentralamt für Steuern, BZSt). The taxpayer cannot apply for a coordinated tax audit. If the taxpayer wishes to initiate a coordinated tax audit, this would only be possible in coordination with and via the responsible tax office.
- The BZSt is the competent authority for administrative assistance in tax matters. The BZSt receives proposals for coordinated external audits from foreign tax administrations and sends the German tax administration’s audit proposals to foreign tax administrations. The BZSt reviews the legal permissibility of incoming and outgoing audit proposals.
- Moreover, the BZSt decides about objections of the taxpayer and communicates the outcome to the taxpayer and the competent tax office. If the BZSt considers the taxpayer’s objections to be justified, the coordinated external audit is not conducted. If the objections are considered unjustified, the taxpayer is informed in a timely manner.
German tax authorities and taxpayer behaviour
- German members of multinational enterprises face a high probability of a tax audit. Usually, a tax audit covers a three- to four-year period on a continuous basis. It is very likely that transfer pricing issues are scrutinised during a tax audit.
- Within the German tax authorities, we see a growing specialisation of transfer pricing tax auditors on areas of special interest, e.g. financial transactions. Tax auditors place a lot of importance on formal requirements, the economic analyses, and on the completeness of the underlying legal documents (agreements, policies etc.).
- In many cases transfer pricing methods and comparable values used are challenged during a tax audit. In these cases, the tax authorities usually claim income adjustments based on their own methodology and estimates. The probability of ultimately defending the taxpayer’s position depends on the circumstances of the individual case. We see an increasing number of cases ending up in national appeal procedures and / or mutual agreement procedures.
- Germany fully implemented reporting obligations according to COUNCIL DIRECTIVE (EU) 2018/822 (DAC 6) of 25 May 2018 into national law including the specific hallmarks concerning transfer pricing.
- There is no specific law, circular or guidance published in Germany on the transfer pricing implications of the COVID-19 pandemic. Basically, the OECD guidance of 18 December 2020 should apply. Accordingly, taxpayers should review their transfer pricing schemes for adverse effects not only from the pandemic but also from other shocks like interruption of supply chains and rising inflation. Non-arm’s length outcomes of controlled transactions due to these developments may be challenged in a tax audit.
- Regarding APAs (in particular critical assumptions) German tax authorities follow a case-by-case approach and examine the impact of the COVID-19 crisis on the particular industry the taxpayer operates in.
- Administrative actions of the tax authorities continue, although there may still be delays. More and more tax audits are conducted remote and tax audit meetings are held via video conferencing platforms.