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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
- In general German tax authorities follow an ex-ante (so-called price-setting) approach, ie whatever analysis a taxpayer decides to use to prove the arm’s length nature of his intercompany transactions, it should be in place when the transaction takes place.
- Local comparable companies are preferred, whilst EMEA or regional comparable companies are usually accepted.
- There is no specific requirement that the interquartile range has to be used for narrowing down the bandwidth (however, it is the most common one and also the one the tax authorities make use of).
- German tax authorities are not permitted to use 'secret comparables'. There are also no published TP 'safe harbours' or norms in Germany, and the key is always the facts and circumstances of the specific case.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- Advanced Pricing Agreements (APAs) are written agreements between a business and the German tax authorities to govern the appropriate transfer pricing method for a forward-looking period.
- APAs are so far restricted to transfer pricing cases.
- The German regulations allow only for bilateral and multilateral APAs. Unilateral APAs are not possible for transfer pricing purposes.
- There is no charge for a MAP. The fee for an APA is EUR 20,000, if the request for an APA is changed, while the APA-negotiations are still ongoing an additional fee of EUR 10,000 will be due, the roll-forward fee for an existing APA is EUR 15,000. Reduced fees (50%) apply if the transactional volumes subject to the APA are below certain thresholds: intercompany tangible goods transactions below EUR 5 million and other intercompany transactions below EUR 500,000
- There is no automatic rollback procedure, but German tax authorities usually accept a rollback if the taxpayer can provide evidence that the assumptions, facts, and circumstances stated within the APA are also fulfilled in the previous year.
- The administrative competence for APAs is centralized in the Federal Central Tax Office.
- There are usually no 'secondary adjustments' or recharacterisation sought where a TP adjustment is made, but interest and penalties may well be.
- Germany has an extremely extensive treaty network, and the Mutual Agreement Procedure (MAP) will often be available when double tax occurs. In relation to EU member states also the EU Arbitration Convention can be applied. Further, Germany is about to ratify the OECD Multilateral Instrument that will further enhance the range of countries, for which an arbitration process will be available.
German tax authorities and taxpayer behaviour
- German tax authorities have been focusing increasingly on transfer prices and we see no end to this development. Within the German tax authorities, we see a growing specialisation of transfer pricing tax auditors on areas of special interest, eg financial transactions. Tax auditors place a lot of importance on the economic analyses but also on the completeness of the underlying legal documents (agreements, policies, etc.).