If a company maintains a permanent establishment in another country, the profits must be shared between the company and the permanent establishment. Under section 1 paragraph 5 of the German Foreign Tax Act (Außensteuergesetz) ("AStG"), the arm's length principle must be applied in this regard. Pursuant to this principle, such profits are to be attributed to a permanent establishment which it would have generated if it were an autonomous and independent company. This rule is based on the Authorized OECD Approach and the OECD Report on the Attribution of Profits to Permanent Establishments.
On 18 March 2016, the German Federal Ministry of Finance published a draft letter (Verwaltungsgrundsätze Betriebsstättengewinnaufteilung) ("BsGa") regarding the attribution of profits to permanent establishments and how to apply section 1 paragraph 5 AStG.
The draft letter states that section 1 paragraph 5 AStG will effectively apply to all cross-border cases of permanent establishments, irrespective of whether there is a double tax treaty. There are restrictions in particular in cases of double tax treaties with non-OECD countries which do not contain the Authorized OECD Approach. Moreover, the correlation between section 1 AStG and other regulations of the German tax law regarding the calculation of profits and corrections is confirmed, for example, section 1 paragraph 5 AStG should be applied without prejudice to other regulations. This in particular also emphasises that, in case of transfers or the attribution of assets between the parent company and the permanent establishment, the general provisions on disjunction and conjunction (Entstrickung und Verstrickung) must be applied.
In addition to that, the German Federal Ministry of Finance refers to the OECD Report on the Attribution of Profits to Permanent Establishments and provides numerous examples in order to clarify important questions regarding the interpretation of section 1 paragraph 5 AStG. Key points include the following:
- Cost allocations between the permanent establishment and the rest of the company can be accepted if certain requirements are fulfilled.
- No profits or only a small portion thereof are to be attributed to permanent establishments with no personnel (no HR function). This would exclude an allocation of profits in addition to the minimum amount to permanent establishments without any personnel (eg servers or pipelines as permanent establishments).
- Clarifications are provided with regard to the auxiliary calculation to be prepared for the permanent establishment at the beginning of the financial year. This statement contains the attributable assets which can be included in the balance sheet, the endowment capital as well as the remaining liabilities. It is clarified that sections 12 to 14 BsGa deviate from the national provisions regarding the calculation of profits for tax purposes and that there is therefore no balance sheet correlation to the auxiliary calculation. Within the framework of the obligation to keep records pursuant to section 90 paragraph 3 of the German Fiscal Code (Abgabenordnung), it must be ensured that the reasons for the attribution decisions are documented with reference to the respective parts of the auxiliary calculation.
- With respect to the attribution of intangible assets pursuant to section 6 paragraph 1 BsGa, refutable presumption rules will apply which are based on HR functions in connection with the establishment (first presumption rule) and the acquisition (second presumption rule) of the intangible asset. Intangible assets can, as an exception to all other assets, also be proportionately attributed to the permanent establishment as well as to the rest of the company.
- In case of an allocation of participating interests, it is explained as an example that a distribution subsidiary can be allocated to a production permanent establishment due to the functional correlation.
- Clarification that a financing function between the permanent establishment and the rest of the company is in general to be regarded as a service and not as the granting of a loan and therefore will not be subject to a cost-based remuneration. Additionally, the liabilities incurred due to the financing function of the permanent establishment will be allocated pursuant to the cost-by-cause principle to those parts of the company which received the financing and not to the permanent establishment performing the financing function.
The draft letter also contains important information for the preparation of the tax return for 2013 and 2014, in particular on how to apply section 1 paragraph 5 AStG to financial years which commenced between 31 December 2012 and 30 December 2014. It also specifies which provisions of the BsGa must be observed for financial years which commenced before 31 December 2014.
The draft letter of the German Federal Ministry of Finance will now be finetuned with the Tax Authorities of the German Federal States. It is expected that the Principles will be published in the second half of 2016.