Overview

Principal legislation

Identify the principal transfer pricing legislation.

The main provision addressing transfer pricing aspects in a cross-border context is section 1 of the Foreign Tax Act. It inter alia provides for the application of the arm’s-length principle and the general methods of determining transfer prices.

In addition, section 8(3) of the Corporate Income Tax Act, which applies with respect to cross-border but also domestic transactions, stipulates that hidden profit distributions (constructive dividends) do not reduce, and that hidden contributions do not increase the taxable income of a corporate entity unless - in case of a hidden contribution - such contribution reduces the taxable income at the level of the contributing shareholder. The fiscal courts have elaborated generally accepted principles and requirements for the assumption of hidden profit distributions and contributions. For example, a hidden profit distribution requires, inter alia, an economic disadvantage (suffered loss or unrealised profit) of a corporate entity that is caused by the relationship to a shareholder which is regularly assumed if a prudent and conscientious business manager would not have accepted such economic disadvantage with respect to a third party who is not a shareholder of the corporate entity (arm’s-length principle). In relation to a controlling shareholder, a hidden profit distribution may also be assumed if the conditions of the relevant transaction are not clearly and validly agreed in advance or if the transaction is not actually carried out as agreed (special formal conditions). According to rulings of the Federal Fiscal Court, these special formal conditions are, however, not covered by article 9 of the OECD Model Tax Convention and may not lead to an adjustment if the agreed conditions comply with the arm’s-length principle.

The aforementioned provisions are accompanied by documentation and reporting requirements, in particular in sections 90(3) and 138a of the General Fiscal Code.

Secondary legislation complements the aforementioned regulations and provides additional details - for example, the Ordinance on the Allocation of Profits between a Business and its Foreign Permanent Establishment. Finally, the Federal Ministry of Finance has issued a number of circulars addressing transfer pricing aspects, which outline its interpretation of the relevant provisions and are binding for the tax administration at a federal and local level, but are, as a rule, not binding for fiscal courts.

Enforcement agency

Which central government agency has primary responsibility for enforcing the transfer pricing rules?

There is no government body that specifically enforces transfer pricing rules, as these rules are part of the general tax legislation and its application in the tax assessment procedure. The administration and collection of tax is the responsibility of the respective tax authorities. At a federal level, the Federal Central Tax Office is, inter alia, the competent authority with regard to advance pricing agreements and mutual agreement procedures.

OECD guidelines

What is the role of the OECD Transfer Pricing Guidelines?

The OECD Transfer Pricing Guidelines are not binding and generally not applied directly in Germany, but the guidelines have a substantial influence on legislation regarding transfer pricing and its interpretation (at least by the tax authorities). For example, according to the relevant circular of the Federal Ministry of Finance issued in 2018, Chapter VIII of the OECD Transfer Pricing Guidelines 2017 shall be directly applied in assessing cost contribution arrangements. On the other hand, there are still some differences between the application of transfer pricing rules in Germany and such guidelines (eg, in connection with the taxation of transfers of function).

Covered transactions

To what types of transactions do the transfer pricing rules apply?

In general, section 1 of the Foreign Tax Act applies to relevant business relationships as defined therein between the taxpayer and a relevant related party. In this context, a party is generally ‘related’ to a taxpayer in case of a (direct or indirect) participation amounting to a least 25 per cent or a (direct or indirect) exercise of a controlling influence or a third party having such participation in or influence on both parties.

In addition, the relevant provisions of the Foreign Tax Act also apply to dealings between a taxpayer’s headquarters and its foreign permanent establishment, which are deemed to be business relationships.

There is no specific limitation on certain kinds of transactions or participation thresholds with regard to the application of section 8(3) of the Corporate Income Tax Act.

Arm’s-length principle

Do the relevant transfer pricing rules adhere to the arm’s-length principle?

The arm’s-length principle is the core element of German transfer pricing legislation (see above).

Broadly speaking, the domestic understanding and interpretation of the arm’s-length principle corresponds to the principles outlined in article 9 of the OECD Model Tax Convention, with some modifications (eg, section 1(1)3 of the Foreign Tax Act, which stipulates that for the application of the arm’s-length principle it must be assumed that unrelated parties have knowledge of all relevant facts and circumstances of the business transaction (ie, information transparency)).

In a recent decision, the Federal Fiscal Court has overruled a former decision with regard to the interpretation of article 9 of the OECD Model Tax Convention and has now held that also the lack of collateralisation resulting in a write-off or partial write-down of a loan receivable is a condition in terms of this article. Thus, in the case decided by the court, an adjustment based on the arm’s-length principle under the Foreign Tax Act could be applied and its application was not blocked by the relevant tax treaty. This decision may lead to an extended scope of the application of the arm’s-length principle in Germany. However, further details are still to be seen, as the Federal Fiscal Court has announced that the new principles to be applied will be put into concrete terms in a number of other cases still pending.

The arm’s-length principle, in theory, also applies to domestic transactions (eg, as an element for the assessment of hidden profit distributions).

Base erosion and profit shifting

How has the OECD’s project on base erosion and profit shifting (BEPS) affected the applicable transfer pricing rules?

In recent years, German legislation has increasingly focused on transfer pricing and has incorporated principles outlined by the OECD, including many aspects of the BEPS project. This has led to a number of amendments - in particular to the Foreign Tax Act and the General Fiscal Code.

The German legislature introduced, in particular, country-by-country reporting in 2016 and certain limitations regarding the deductibility of royalty payments and similar expenditures between related parties in 2017.

Pricing methods

Accepted methods

What transfer pricing methods are acceptable? What are the pros and cons of each method?

In general, the transfer pricing methods used to establish the arm’s-length price are not restricted and all standard methods are applied, although the tax authorities prefer the transaction-based methods. In addition to the transaction-based methods, the transactional net margin method and the profit split method can be used, depending on the circumstances of the case (in particular, if no comparables are available). The pros and cons of these transfer pricing methods generally apply without German specifics.

Cost-sharing

Are cost-sharing arrangements permitted? Describe the acceptable cost-sharing pricing methods.

Cost contribution arrangements are, in principle, permitted under German tax law. Pursuant to the most recent administrative principles on auditing cost contribution arrangements between internationally related companies published in 2018, Chapter VIII of the OECD Transfer Pricing Guidelines 2017 shall be applied for the auditing of the income allocation between internationally related companies.

According to the administrative principles, when two or more companies in a multinational group act together in the common interest, assume joint risks and make contributions to jointly develop assets (development cost allocation) or to use services (allocation of service costs), the contributions shall be valued at arm’s length prices and remunerated on the basis of the expected benefits. The administrative principles published in 2018 are applied to fiscal years beginning after 31 December 2018. However, in a transitional period until 31 December 2019, cost contribution arrangements existing as at 25 July 2018 are still audited pursuant to the administrative principles published in 1999.

Best method

What are the rules for selecting a transfer pricing method?

According to section 1(3) of the Foreign Tax Act, the price comparison method, the resale price method or the cost-plus method must be preferentially applied in determining transfer prices if arm’s-length data can be determined that is - after appropriate adjustments in view of the performed functions, used assets and assumed chances and risks - unrestrictedly comparable.

If such arm’s-length data cannot be determined, the application of an appropriate transfer pricing method may be based on arm’s-length data that is restrictedly comparable and has been adjusted appropriately. If arm’s-length data that is restrictedly comparable cannot be determined, a hypothetical comparison based on the principles outlined in section 1(3)5 et seq. of the Foreign Tax Act must be applied by the taxpayer.

Within these limits, a taxpayer may use the method appropriate for the relevant business transaction.

Taxpayer-initiated adjustments

Can a taxpayer make transfer pricing adjustments?

The German tax authorities accept determinations or adjustments of the prices on an ex post basis after the conclusion of the business transaction only in exceptional cases. As outlined in the Administrative Principles - Procedures this is, for example, the case if the taxpayer is on the basis of records able to demonstrate that such an approach would have also been agreed between third parties. Generally, the tax authorities in this context inter alia require that all price determinants are agreed on an ex-ante basis and are not subject to subsequent influence of the parties to the business transaction. Specific statutory provisions with respect to ex post adjustment apply to the cross-border transfers of function (see question 39).

In the context of hidden profit distributions within the meaning of the Corporate Income Tax Act, the special formal conditions for controlling shareholders need to be observed (see question 1).

Safe harbours

Are special ‘safe harbour’ methods available for certain types of related-party transactions? What are these methods and what types of transactions do they apply to?

German tax law provides no safe harbour rules in connection with transfer pricing, and the tax authorities do not apply safe harbour rules.

Disclosures and documentation

Documentation

Does the tax authority require taxpayers to submit transfer pricing documentation? Regardless of whether transfer pricing documentation is required, does preparing documentation confer any other benefits?

Section 90(3) of the General Fiscal Code stipulates a general obligation of a taxpayer to prepare documentation on relevant business relationships within the meaning of the Foreign Tax Act. However, there is no obligation to prepare transfer pricing documentation for all cross-border business transactions on an ongoing basis. Only with respect to exceptional business transactions, the transfer pricing documentation must be prepared in a timely manner.

Generally, tax authorities shall, according to section 90(3) of the General Fiscal Code, request transfer pricing documentation only in the course of a tax audit.

Based on the Ordinance on the Kind, Content and Extent of the Documentation within the Meaning of Section 90(3) of the General Fiscal Code, the transfer pricing documentation, in principle, must provide inter alia the following information (local file):

  • general information on the corporate (shareholder) structure, business operations and operational structure;
  • details of the business transaction between the taxpayer and the related party;
  • a functional and risk analysis; and
  • a transfer price analysis.

The kind, content and extent of the transfer pricing documentation to be prepared must be determined on the basis of the circumstances of the individual case taking the applied transfer pricing method into account.

In addition to the local file, companies that are part of a multinational group must prepare a master file if the company turnover in the preceding fiscal year was over €100 million. The master file must inter alia contain an overview of global business activities of the multinational group as well as the applied systematics regarding the determination of transfer prices.

Transfer pricing documentation shall generally be prepared in the German language. The tax authorities may permit exceptions at the taxpayer’s request and preparation in the English language is often accepted.

In general, it is recommended that the relevant data for a fiscal year forming the basis of the relevant documentation is collected in a timely manner even where the transfer pricing documentation does not have to be prepared in a timely manner. This is because data collection in connection with a tax audit, which is mostly only carried out several years after the relevant fiscal year ends, is often difficult and the deadlines applying in case of a request by the tax authorities may otherwise be insufficient.

Country-by-country reporting

Has the tax authority proposed or adopted country-by-country reporting? What are the differences between the local country-by-country reporting rules and the consensus framework of Chapter 5 of the OECD Transfer Pricing Guidelines?

Germany has adopted country-by-country reporting standards in section 138a of the General Fiscal Code that are generally in line with the OECD recommendations and are generally applicable to fiscal years beginning on or after 1 January 2016. Pursuant to the law, country-by-country reporting is mandatory for enterprises with seat or centre of management in Germany. These establish consolidated group accounts or must establish consolidated group accounts other than for tax purposes if, and to the extent that an enterprise with a seat or centre of management outside of Germany or a foreign permanent establishment, is included in the consolidated group accounts, and the total consolidated turnover as shown in the consolidated group accounts in the preceding fiscal year amounts to at least €750 million. If a company is resident in Germany and is part of a foreign multinational group, it is only obliged to prepare or file a country-by-country report for the foreign multinational group in Germany if it is specifically requested to do so by the parent enterprise of the foreign group, or if specific cooperation obligations apply, since the German Federal Central Tax Office has not been provided with the foreign group’s country-by-country report. Deviating from the OECD recommendations, the wording of the law does not differentiate as to why the German Federal Central Tax Office has not been provided with the report.

Timing of documentation

When must a taxpayer prepare and submit transfer pricing documentation?

A taxpayer is not obliged to file transfer pricing documentation on a regular basis with the tax authorities. In particular, there is no obligation to submit all transfer pricing documentation with an annual tax return. The general transfer pricing documentation must be provided within 60 days after the respective request from the tax authority has been received. In case of exceptional business transactions, the transfer pricing documentation must be provided to the tax authorities within a reduced 30-day time frame after the respective request has been received by the taxpayer. In principle, it is possible upon application to extend the relevant deadlines based on the facts and circumstances of each individual case.

In general, country-by-country reports must be submitted to the Federal Central Tax Office within one year after the end of the fiscal year in question.

Failure to document

What are the consequences for failing to submit documentation?

Section 162(4) of the General Fiscal Code stipulates that a minimum penalty of €5,000 applies if a taxpayer does not provide transfer pricing documentation as defined under section 90(3) of the General Fiscal Code or if the provided transfer pricing documentation is essentially of no use. The penalty must be at least 5 per cent and at most 10 per cent of the additional income arising from required corrections, including estimates by the tax authorities due to the failure by the taxpayer to comply with the applicable cooperation obligations pursuant to section 90(3) of the General Fiscal Code if this amount exceeds €5,000. If the submission of sufficient transfer pricing documentation is delayed, a fine of at least €100 applies for each full day of delay and may amount up to €1 million.

In addition to the penalties set out above, if a taxpayer fails to comply with the cooperation obligations pursuant to section 90(3) of the General Fiscal Code, unless demonstrated otherwise it will be assumed that the domestic income of the taxpayer to which the respective transfer pricing documentation relates is higher than the income declared. If the tax authorities have to conduct an estimate and the relevant income can only be determined within a certain range (in particular a price range), the authorities may use the upper end of the relevant range to the detriment of the taxpayer.

Finally, taxpayers can be fined between €2,500 and €250,000 if certain documents requested in the course of a tax audit are not provided within a reasonable time frame.

Failure to submit the country-by-country report may qualify as an administrative offence and can result in fines.

Adjustments and settlement

Limitation period for authority review

How long does the tax authority have to review an income tax return?

The regular limitation period with regard to income tax is four years, starting at the end of the calendar year in which the respective tax return has been filed, and beginning, at the latest, at the end of the third calendar year following the calendar year in which the respective tax has been triggered. In the case of tax evasion, extended limitation periods of up to 10 years apply. The ending of the limitation period is suspended in case of certain events, in particular in the case of an ongoing tax audit.

Rules and standards

What rules, standards or procedures govern the tax authorities’ review of companies’ compliance with transfer pricing rules? Does the tax authority or the taxpayer have the burden of proof?

Taxpayers’ compliance with transfer pricing rules is regularly reviewed in the course of general tax audits, which usually cover three to four years. Tax audits are conducted by local tax authorities, which often have tax inspectors who specialise in transfer pricing. In addition, there are federal auditors who specialise in transfer pricing, some of whom have industry specialisms and may decide to participate in a tax audit. A tax audit involving local and federal tax auditors on transfer pricing can last for many years.

A taxpayer will be notified several weeks in advance of a tax audit. The audit will usually be concluded by a final meeting between the auditors and the taxpayer, in which the results of the audit will be discussed and an agreement sought for any outstanding issues. The results of the audit will be summarised in a written audit report, which can be commented on by the taxpayer before it is sent to the tax inspector responsible for the issuance of revised tax assessment notices reflecting the audit’s results.

The burden of proof regarding compliance with the arm’s-length principle lies, generally, with the tax authorities, which need to prove the facts and circumstances that lead to a higher tax liability. However, if the taxpayer has not complied with his or her duty of cooperation, the standards for providing proof for an adjustment of the tax liability of the taxpayer are lowered. Further, in cases where the taxpayer does not comply with the relevant documentation requirements, the tax authorities may either estimate the appropriate transfer price or choose the least favourable value within the relevant range.

Disputing adjustments

If the tax authority asserts a transfer pricing adjustment, what options does the taxpayer have to dispute the adjustment?

The taxpayer can file an appeal with the tax authorities against the relevant tax assessment notice containing the transfer pricing adjustment. Such an appeal is filed with the same tax office competent for the tax assessment and the entire case is then reviewed again by the tax office.

If and to the extent that an appeal is unsuccessful, the decision can be contested by filing a lawsuit with the lower fiscal court of the respective federal state. The fiscal court reviews and assesses all aspects of the case. It is not possible to limit the lawsuit to a certain legal question and the fiscal court is not obliged to assess the case based only on the arguments and facts presented by the taxpayer and the tax office.

If and to the extent that a party is unsuccessful in (lower) fiscal court proceedings, he or she can file an appeal against the fiscal court’s decision with the Federal Fiscal Court under certain circumstances. However, strict requirements apply for filing a federal appeal and the scope of the review by the Federal Fiscal Court is very limited.

Relief from double taxation

Tax-treaty network

Does the country have a comprehensive income tax treaty network? Do these treaties have effective mutual agreement procedures?

Germany maintains a comprehensive income tax treaty network, including treaties with all major trading partners. In general, Germany follows the OECD Model Convention with treaties regularly comprising effective mutual agreement procedures. Germany has also signed the Multilateral Instrument and the double tax treaties nominated by Germany (in case the other contracting state agreed to the changes) must be amended with respect to the provisions regarding mutual agreement procedures and arbitration in line with the provisions of the Multilateral Instrument.

Requesting relief

How can a taxpayer request relief from double taxation under the mutual agreement procedure of a tax treaty? Are there published procedures?

A taxpayer can apply to initiate a mutual agreement procedure (MAP) under the applicable double tax treaty with his or her local tax authorities or the Federal Central Tax Office. The double tax treaty may provide for a certain time frame in which the application for the initiation of a MAP must be submitted. With the application, the taxpayer must provide detailed information about the underlying facts and the respective tax assessments.

Details of the scope, content and procedure regarding a MAP or arbitration involving the tax authorities are outlined in explanatory notes published by the Federal Ministry of Finance in 2018.

When relief is available

When may a taxpayer request assistance from the competent authority?

According to the explanatory notes published by the Federal Ministry of Finance in 2018, a MAP should not usually be initiated until the tax authorities have taken measures that entail or will entail taxation contrary to the tax treaty. However, in specific cases a MAP may be initiated prior to such measure if the measure becomes concretely apparent. This may, for example, be the case if a tax authority announces certain adjustments during an audit.

Limits on relief

Are there limitations on the type of relief that the competent authority will seek, both generally and in specific cases?

There are no general limitations on the type of relief. However, it must be noted that according to the practice of the German tax authorities, the agreement reached in a MAP can only be implemented and result in amended tax assessments if the taxpayer has consented in writing and waived his or her right to appeal against tax assessments that correctly implement the agreement reached in the MAP or the results of the arbitration.

Success rate

How effective is the competent authority in obtaining relief from double taxation?

According to numbers given by the OECD (www.oecd.org/tax/dispute/2017-MAP-Statistics-Germany.pdf), 156 MAP transfer pricing cases could be closed. However, the overall number of pending cases regarding transfer pricing had still risen to 542 by the end of 2017.

Advance pricing agreements

Availability

Does the country have an advance pricing agreement (APA) programme? If so, is the programme widely used? Are unilateral, bilateral and multilateral APAs available?

The German tax authorities regularly conclude bilateral as well as multilateral APAs (unilateral decisions on transfer pricing with future effect are granted only under exceptional circumstances). APAs are an increasingly used tool, with 36 APA requests submitted to the German tax authorities in 2017 and 39 bilateral and multilateral APAs being in force at the end of 2017 (according to the EU Joint Transfer Pricing Forum, Statistics on APAs in the EU at the end of 2017 (24 October 2018)).

Process

Describe the process for obtaining an APA, including a brief description of the submission requirements and any applicable user fees.

The requirements and procedure regarding the application for an APA are outlined in detail in explanatory notes published by the Federal Ministry of Finance in 2006. The APA process usually starts with a pre-filing meeting between the Federal Central Tax Office, which is responsible for the negotiations with the other contracting country, the federal and state auditors, and the taxpayer. In the course of the pre-filing meeting, inter alia, the suitability of the case for an APA, the scope of the APA and the specific information and documentation to be provided in the course of the application are discussed.

After the APA has become effective (which also requires the taxpayer’s consent and waiver of the right to appeal) and on application by the taxpayer, the local tax office must grant a binding ruling reflecting the agreement reached in the APA.

Generally, the following fees apply with respect to bilateral APAs:

  • €20,000 for an APA application;
  • €15,000 for an extension; and
  • €10,000 for the amendment of an APA.

Fees are reduced for smaller enterprises and may in exceptional situations be reduced to zero.

Time frame

How long does it typically take to obtain a unilateral and a bilateral APA?

The time frame for the conclusion of an APA cannot be predicted and depends on the complexity of the case. The average time for APAs granted in 2017 has been 36 months with regard to EU APAs and 47 months for non-EU agreements (according to the EU Joint Transfer Pricing Forum, Statistics on APAs in the EU at the end of 2017 (24 October 2018)).

Duration

How many years can an APA cover prospectively? Are rollbacks available?

The tax authorities suggest a duration of at least three and a maximum of five years. Under certain conditions, a rollback into preceding fiscal years is possible.

Scope

What types of related-party transactions or issues can be covered by APAs?

In principle, any transfer pricing case with regard to internationally affiliated parties can be covered by an APA. Details of the specific case are usually discussed in the pre-filing meeting.

Independence

Is the APA programme independent from the tax authority’s examination function? Is it independent from the competent authority staff that handle other double tax cases?

APAs are handled by specially trained personnel at the Federal Central Tax Office (also competent for MAPs) who coordinate the cases with the competent local tax offices that are involved in the APA process and often prepare the technical analysis. This coordination may simplify future processes and audits and may, ideally, create an open and collaborative relationship between all parties involved. However, from the taxpayer’s point of view it should be borne in mind that under the general procedural rules the German tax authorities may utilise all information received in the course of an APA procedure to the detriment of the taxpayer - even if no APA is concluded at the end.

Advantages and disadvantages

What are the key advantages and disadvantages to obtaining an APA with the tax authority?

The key advantage of an APA is the creation of planning and legal certainty with regard to transfer pricing issues that may avoid future (cost-intensive) conflicts and simplify future processes and audits, and may also avoid the assessment of interest on late payment of taxes. From a taxpayer’s point of view, the downside of such planning certainty is, however, the restriction on business planning freedom, since the binding effect of the APA requires the actual implementation of the underlying facts and circumstances. Further disadvantages may be the initial costs of the request for an APA and the fact that this process takes a significant amount of time and may tie up internal and external resources.

Special topics

Recharacterisation

Is the tax authority generally required to respect the form of related-party transactions as actually structured? In what circumstances can the tax authority disregard or recharacterise related-party transactions?

Related-party transactions may be recharacterised under the general rules, for example as a hidden profit distribution or a hidden contribution, with the general tax implications applied to these recharacterised transactions (eg, a hidden profit distribution may trigger withholding tax). An implemented transaction may be disregarded by the tax authorities under the application of the general anti-avoidance provision (section 42 of the General Fiscal Code). An abuse within the meaning of this provision may in general be deemed to exist if an inappropriate legal structuring is chosen that - compared to an appropriate legal structuring - would result in a tax advantage not intended by the law. In the event of such abuse, the tax authorities may, under further preconditions, apply the tax consequences that would have applied if the appropriate legal structuring had been chosen by the taxpayer.

Selecting comparables

What are some of the important factors that the tax authority takes into account in selecting and evaluating comparables? In particular, does the tax authority require the use of country-specific comparable companies, or are comparables from several jurisdictions acceptable?

The applied comparables mainly depend on the facts and circumstances of the individual case. The tax authorities have issued explanatory notes on details of the comparability factors in which they have shown no preference for internal over external comparables. In practice, taxpayers widely use pan-European data for a tested party located in Europe. With regard to the use of databases, it may be noted that the tax authorities and relevant law require the taxpayer to document detailed information with regard to the database used and, for example (regarding search methods), the criteria used and the subsequent selection process in order to make the entire process as transparent as possible.

Secret comparables

What is the tax authority’s position and practice with respect to secret comparables? If secret comparables are ever used, what procedures are in place to allow a taxpayer to defend its own transfer pricing position against the tax authority’s position based on secret comparables?

According to the Federal Fiscal Court, the use of secret comparables (eg, the use of a database on licence fees that is maintained at the Federal Tax Office) is in principle allowed. However, in practice the probative value of such data is significantly reduced, as the Federal Fiscal Court has also emphasised that the quality of the used data must comply with a certain standard, which must be subject to review (eg, by tax courts) and which is a requirement generally being inconsistent with the character of a secret comparable.

Secondary adjustments

Are secondary transfer pricing adjustments required? What form do they take and what are their tax consequences? Are procedures available to obtain relief from the adverse tax consequences of certain secondary adjustments?

Secondary adjustments may be applied by the German tax authorities in line with the general rules that, for example, may result in the application of a withholding tax on a hidden profit distribution. With regard to relief from the potential adverse tax consequences and potential (economic) double taxation, the general procedures apply.

Non-deductible intercompany payments

Are any categories of intercompany payments non-deductible?

In principle, there are no specific categories of non-deductible intercompany payments, provided they are at arm’s-length terms. However, certain limitations may apply in this context. In particular, section 4h of the Income Tax Act in connection with section 8a of the Corporate Income Tax Act generally limits the deductibility of interests under certain conditions (interest-barrier rule). As a basic rule, the interest-barrier rule limits the deductibility of the net interest expenses (internal and external) up to an amount equal to 30 per cent of the EBITDA for tax purposes. However, certain exemptions to this basic rule apply. Certain limitations regarding the deductibility of royalty payments and similar expenditures between related parties have been introduced through section 4j of the Income Tax Act in 2017.

Anti-avoidance

What legislative and regulatory initiatives (besides transfer pricing rules) has the government taken to combat tax avoidance with respect to related-party transactions? What are the penalties or other consequences for non-compliance with these anti-avoidance provisions?

German tax law already included numerous provisions to combat tax avoidance schemes before the implementation of measures under the BEPS Action Plan. In addition to the general anti-avoidance provision (section 42 of the General Fiscal Code), there are a significant number of provisions addressing specific situations leading to tax avoidance (eg, anti-treaty shopping provisions, subject to tax provisions and provisions to avoid white income).

One recent example is the introduction of the limitation of the deductibility of royalty payments and similar expenditures in section 4j of the Income Tax Act (Action 5 of the BEPS Action Plan). If the limitation applies, payments are only deductible pro rata based on the ratio of the tax rate applied to the foreign income to a tax rate of 25 per cent.

Location savings

How are location savings and other location-specific attributes treated under the applicable transfer pricing rules? How are they treated by the tax authority in practice?

Location savings are recognised under the applicable transfer pricing rules. However, there is no clear guideline given by the tax authorities with regard to the general allocation of location savings. While the allocation question is subject to a controversial discussion among German tax literature experts, in practice the tax authorities seem to have a tendency to allocate location savings to the German principal. In a 2006 decision, a fiscal court held that a 50:50 division of the locations savings between a German manufacturer and a contract manufacturer was, under the given facts and circumstances, in line with the arm’s-length principle. With regard to specifically cross-border transfers of function, the transfer price must generally be determined within a settlement range that may often lead to a 50:50 split of inter alia location savings.

Branches and permanent establishments

How are profits attributed to a branch or permanent establishment (PE)? Does the tax authority treat the branch or PE as a functionally separate enterprise and apply arm’s-length principles? If not, what other approach is applied?

The authorised OECD approach regarding the attribution of profits to permanent establishments was implemented into German law in 2014 through section 1(5) of the Foreign Tax Act, which addresses the relationship between the headquarters and its permanent establishment and under which permanent establishments are treated as if they were functionally separate entities. According to section 1(5) of the Foreign Tax Act, the profits to be attributed to a permanent establishment should be the profits that the permanent establishment would have earned on arm‘s-length terms, in particular in its dealings with other parts of the company, if it were a separate and independent company engaged in the same or similar activities under the same or similar conditions. This takes into account in particular the functions performed, assets used and risks assumed by the company through permanent establishment and through the other parts of the company. Details on the application of the authorised OECD approach have been provided in the Ordinance on the Application of the Arm’s Length Principle to Permanent Establishments, which took effect in 2015.

Exit charges

Are any exit charges imposed on restructurings? How are they determined?

Apart from general exit charges for single assets, specific provisions apply inter alia with respect to the cross-border transfers of function (business restructurings). The rules on the taxation of such cross-border transfers of function (under section 1(3) of the Foreign Tax Act) were introduced in 2008. The valuation of the function is not only based on the tangible and intangible assets, but also on the implied profit potential. Further details are set out by the tax authorities in the Administrative Principles - Transfer of Function. Furthermore, an exit charge may be triggered in case of a relocation of a company outside Germany.

Temporary exemptions and reductions

Are temporary special tax exemptions or rate reductions provided through government bodies such as local industrial development boards?

Certain regional or specific investment incentive programmes exist. However, these do not specifically relate to taxation.

Update and trends

Tax authority focus and BEPS

What are the current issues of note and trends relating to transfer pricing in your country? Are there particular areas on which the taxing authority is focused? Have there been any notable legislative, administrative, enforcement or judicial developments? In particular, how is the OECD’s project on base erosion and profit shifting affecting both policymakers and tax administrators?

Tax authority focus and BEPS41 What are the current issues of note and trends relating to transfer pricing in your country? How is the OECD’s project on base erosion and profit shifting affecting both policymakers and tax administrators?

On 7 June 2017 Germany signed the Multilateral Instrument and submitted a preliminary list of its reservations and notifications in respect of the provisions of the Multilateral Instrument. National legislation is required for changes based on the Multilateral Instrument to become effective in Germany, and to date the Multilateral Instrument has not been ratified in Germany.

Apart from participation in various other initiatives at OECD level, Germany is also in the process of enacting legislation with regard to mandatory disclosure rules on cross-border tax planning, while in the political arena there is currently disagreement about whether domestic transactions should also become reportable.