Taxing authority and tax law
Tax authority: German taxes are administered either by the German Federal Central Tax Office (Bundeszentralamt für Steuern) or by German state tax authorities
Tax law: German tax law is found in tax acts, executive order laws, double taxation treaties and supra-national norms
Relevant regulations and rulings
The German tax law assesses intercompany transactions by following the arm’s length principle (§1 Foreign Tax Act). The German interpretation of the arm’s length principle generally follows the definition in Article 9 of the OECD Model Tax Convention. However, a practically relevant exception, §1 Sentence 2 Foreign Tax Act, stipulates that for the interpretation of the arm’s length principle it is assumed that both parties involved in an intercompany transaction have full knowledge about all and the same facts and circumstances (information transparency).
Detailed transfer pricing regulations concerning the cross-border transfer of functions were incorporated into §1 Foreign Tax Act since 1 January 2008. An Executive Order Law providing details on how the new transfer pricing provisions relate to business restructurings and function transfers is effective from 2008 onwards.
In October 2010 new Administration Principles were released that include 81 pages of clarifications concerning the application of §1(3) of the Foreign Tax Act and the Executive Order Law on Transfer of Business Functions. The Administration Principles detail, for example, exemption rules due to which a business restructuring and function transfer does not lead to a taxable valuation of a so called “transfer package.” Such cases are, amongst others, cases where the receiving entity of a function exclusively performs the transferred function for the transferring entity and receives a cost-based remuneration (i.e., based on the cost plus method or a cost based TNMM), in accordance with the arm’s length principle. In such cases, it is assumed that the transfer package did not include any significant intangible property and other advantages that were transferred and, thus, a valuation of the transfer package is not required. This exception from examination of the transfer package basically affects the transfer of routine functions whose execution is connected with low risks which, as a consequence, are usually remunerated on the basis of the cost-plus method.
Other relevant provisions for transfer pricing issues in German tax law are:
- Section 8 (3) German Corporate Income Tax Act (hidden profit distribution)
- Section 4 (1) German Income Tax Act with Directive R40 of the German Corporate Tax Directives (hidden capital injection)
- Sections 90 (3), 162(3) and 162(4) German General Tax Code and the Executive Order Law to §90(3) German General Tax Code
To help interpret the above outlined provisions, the German tax authority issued a circular on the Principles Governing the Examination of Income Allocation between Multinational Enterprises in 1983, known as the Administration Principles. The Administration Principles do not constitute binding law for taxpayers or the courts but are binding for the tax authority and, thus, serve as an indication to taxpayers as to how the tax authority will treat specific intercompany transactions between related parties. The purpose of the Administration Principles can be interpreted as to provide a directive concerning the tax audit treatment of transfer pricing cases and to ensure the uniform application of rules and methods by the tax authorities.
In addition to the Administration Principles, administration circulars concerning income allocation with regard to cross-border secondments of personnel, costs contribution arrangements, permanent establishments and procedures have been published since December 1999.
OECD guidelines treatment
The tax authority considers its transfer pricing laws and regulations to be consistent with OECD guidelines. The OECD guidelines provide support for domestic use but do not constitute binding law in Germany; however, German transfer pricing regulations and practices differ with regard to certain issues (e.g., the application of transactional profit methods and documentation requirements, and the treatment of shifts of functions).
Priorities/pricing methods
Under the arm’s length principle, it is assumed that the taxpayers have acted in a manner comparable to unrelated parties. This assumes that all material information about the transaction (complete information about the counterparty) is available and that the parties acted as prudent and diligent business managers.
Under the new law (effective 1 January 2008), the application of transfer pricing methods is dependent on the availability and quality of third-party comparable data. Three different situations are distinguished: full comparability of the data, limited comparability of the data and non-availability of third-party comparable data.
When full comparability of third-party data exists, the new law stipulates the priority of the traditional transaction methods: CUP, Resale Price and Cost Plus. Any price within the full range of full comparable third-party data meets the arm’s length principle.
If limited comparability exists, Germany allows all OECD methods, i.e., the aforementioned traditional methods and the transactional profit methods TNMM and (residual) profit-split. In case of limited comparability, third party comparable data must be adjusted (i.e., by statistical procedures).
If no comparable data exists, the law stipulates that taxpayers have to conduct the hypothetical arm’s length comparison to derive arm’s length transfer prices. Accordingly, in compliance with the so-called prudent and diligent business manager principle, and based on the functional analysis and internal projections, the taxpayer has to establish an area of “hypothetical” arm’s length prices. The area of negotiation is defined by the minimum price of a hypothetical seller and by the maximum price of a hypothetical purchaser. The taxpayer must prove the value with the highest probability within the area of negotiation, otherwise the mean value is assumed to be the arm’s length transfer price for the transaction under review.
Transfer pricing penalties
If a taxpayer does not comply with its duty to document its transfer pricing to the extent outlined in §90(3) German General Tax Code, a refutable presumption applies according to which the income of the German company under review has been reduced by means of inappropriate transfer prices, which forms the basis of a transfer pricing adjustment by the tax authority.
Tax authorities may apply §162(3) of the German General Tax Code if the taxpayer submits no or only insufficient documentation or if exceptional transactions have not been recorded contemporaneously. In all three cases, the tax authority is authorized to estimate the income, provided that the taxpayer cannot rebut the presumption. This holds also true if a taxpayer does not disclose relevant data only available at foreign related parties.
The legislation takes into consideration that an appropriate single transfer price does not exist and that comparable third-party prices may vary within price ranges. However, it explicitly entitles the tax authority to make use of the full price range estimating the income, in case of insufficient documentation, to the detriment of the taxpayer.
If the taxpayer fails to submit transfer pricing documentation or if the documentation is unusable or insufficient, or if the documentation for extraordinary business transactions is not prepared contemporaneously, a surcharge of 5%-10% on the income adjustment will be applied, with a minimum surcharge of €5,000. For late filing, the taxpayer faces a penalty up to €1m (minimum penalty of €100 per day of delay). Penalties are imposed after the closing of a tax audit. The aforementioned penalties constitute non-tax deductible expenses.
Under the law effective 1 January 2008, in the event that the taxpayer’s transfer price falls outside the full range (in case of full comparability of third-party data) or the interquartile range (in case of limited comparability of third-party data) of arm’s length prices, the transfer price is adjusted to the median of the range.
Interest is assessed on tax payments (6% per annum, which is non-deductible for tax purposes).
There are also penalties for tax evasion.
Penalty relief
The taxpayer is required by law to present utilizable documentation to the tax authority. Accordingly, no penalty relief applies.
Documentation requirements
Section 90 of the German General Tax Code contains transfer pricing documentation requirements. For the documentation of transfer pricing issues, an Executive Order Law (effective 30 June 2003) prescribes general requirements and the documentation required in special circumstances. A circular (Administration Principles - Procedures) dated 12 April 2005 provides the tax authority’s interpretation of the requirements set out in the General Tax Code and in the Executive Order Law.
General documentation requirements:
- General information: shareholder relationships, organizational and operative group structure and operations
- Description of intercompany transactions: manner and extent of transactions, intercompany contracts and a list of important intangibles
- Functions and risks analysis: description of functions and risks the taxpayer bears within the intercompany transaction, contractual terms, business strategies and value chain
- Transfer pricing analysis: selection of the transfer pricing method, appropriateness of the method selected, calculation of the transfer price, list of comparables and documentation of adjustment calculations
Special documentation requirements:
The taxpayer has to document special circumstances which are used to substantiate the arm’s length nature of the price determined, including: special business strategies, business restructurings, cost contribution agreements, overview of APAs and mutual agreement procedures, information on transfer price adjustments, causes for losses from intercompany transactions, as well as countermeasures (if losses occur in more than three consecutive financial years).
Documentation deadlines
Contemporaneous documentation requirements exist only for exceptional business transactions. For extraordinary business transactions (e.g., legal restructuring within the group), the documentation must be contemporaneous (i.e., prepared within six months of the end of the business year in which the transaction has occurred). However, the preparation of contemporaneous documentation is strongly recommended for all cross-border transactions.
Documentation must be submitted within 60 days upon receipt of the tax authority’s request. In the case of extraordinary business transactions (e.g., transfer of functions), documentation must be submitted within 30 days of the tax authority’s request. In general, the request is made in the course of a tax audit.
Statute of limitations on transfer pricing assessments
There are no special time limit provisions applicable if intercompany transactions are involved. The general regime of the statute of limitations applies in accordance with the General Tax Code. Accordingly, each case has to undergo careful consideration to determine the specific statute of limitations. Most taxes are levied by way of assessment. Assessments can only be made within the statutorily prescribed assessment period, which is subject to the statute of limitations for assessments. The assessment period for taxes (§169 General Tax Code) is four years. For customs duties, it is shorter, and in case of grossly negligent evasion of taxes or tax fraud, it is much longer (10 years in the case of tax fraud). These periods commence at the end of the calendar year in which the tax liability arose. The assessment period, however, does not start prior to the end of the calendar year in which the taxpayer has submitted the tax return (but also does not start later than three years after the year the tax liability has arisen). There are a number of statutory exceptions to the statute of limitations for assessments (e.g., it should be kept in mind that the limitation period is interrupted when a tax audit begins).
Section 175a General Tax Code stipulates that tax assessments can be amended due to the result of a MAP/EU arbitration procedure up to one year after the effective date of such agreement irrespective of whether the aforementioned statutes of limitations have expired before.
Return disclosures/related-party disclosures
There are no specific disclosure requirements.
Audit risk/transfer pricing scrutiny
The risk of transfer pricing issues being scrutinized during a tax audit is high and continuously rising. Due to the documentation requirements, and in the light of the new stricter law effective 1 January 2008, it is expected that transfer pricing issues attract significantly more attention in tax audits than in the past. It is expected that transactions qualifying as exceptional business transactions under the documentation provisions, such as the transfer of functions and risks, particularly attract the tax auditors’ attention. Further, many tax audits increasingly focus on (brand) royalty charges and management services cost allocations into Germany.
APA opportunity
APAs are generally available. The German Ministry of Finance issued an APA circular on 5 October 2006 which defines the APA procedures and provides guidance with regard to the negotiation of APAs. Additionally, the Annual Tax Act 2007 introduced fees for APAs. The administrative competence for APAs is centralized in the Federal Central Tax Office. The APA process typically takes from one-and-a-half years to several years from application to conclusion. An agreement reached between two competent authorities will be made conditional in two regards: the taxpayer must consent to the intergovernmental agreement, and must waive its right to appeal against tax assessments to the extent that they are in line with the contents of the APA.
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