The German Legislature has not worked out the fine details of the provisions governing a shift of functions. The term “function” is not yet clearly defined. Andreas Knebel—head of the German Tax Practice Group at White & Case and an authority in the field of German and international tax law—warns that the continuing risks regarding tax treatment will have a negative impact on entrepreneurial activity in Germany, especially now, during a global economic crisis.
Transfer pricing is a subject that becomes increasingly important for multinationals in the context of the continuing globalization, as a result of the sharp increase in competition. Given this development, new provisions were enacted in Germany on January 1, 2008, regulating business restructurings by way of a shift of functions (§1(3) sentence 9 of the German Foreign Transactions Tax Act—AStG). According to these new provisions, a shift of function occurs when a company transfers or leases assets or other benefits to a related company enabling such other company to exercise a function previously exercised by the transferring company. Thus, German law defines for the first time what the term “shift of function” means and how the transfer prices to be charged in this respect shall be determined. Germany has taken a go-it-alone approach and it is not clear whether and when other countries will follow its lead. At the most recent conference of the Organization for Economic Cooperation and Development (OECD) at the end of September 2009 in Paris, some observers commented as to whether OECD member countries may oppose adopting positions consistent with the German approach.
Criticism of Germany’s Go-it-alone Approach
Thus, German companies are faced with significant uncertainties regarding the tax implications of a shift of functions, both with respect to the interpretation of the new tax rules in German law and—for an unforeseeable period of time—how foreign countries will treat such a shift of functions as a principle of law currently not embedded in their national legal systems. The German fiscal authorities have made every effort to resolve uncertainties relating to interpretation of the new rules in German law. In addition to the regulation issued on August 12, 2008 with respect to transfer pricing, a 72-page draft has been prepared as well and, although this draft of July 17, 2009 leaves many questions unanswered, legal certainty at the national level has significantly increased. However, whether or not this will be of any value depends largely on how other countries will react towards Germany’s go-it-alone approach.
Treaty-Based Mutual Agreement Procedure May Be of Limited Assistance
In the event that the German tax authority imposes tax on a transferred package, the risk of double taxation arises depending upon whether the other country accepts this approach. At present, an apparent significant difference with the OECD principles is that the OECD focuses on the pricing of individual assets, rather than a “transferred package” that includes profit potential. Without a common approach, competent authorities in a mutual agreement procedure to avoid double taxation under a tax treaty may have great difficulty reaching a solution.
Contrary to EU Law?
The focus of tax audits of multinationals is more and more on transfer pricing given the stricter obligations regarding documentation, thus involving the risk of a reassessment of taxable profits, penalties and evidentiary disadvantages. Moreover, the question of whether the German tax rules are compatible with EU law remains unanswered. According to the decisions of the European Court of Justice (ECJ), tax rules which are likely to prevent, hamper or make less attractive the transfer of nonmonetary or monetary capital or the establishment of a branch office restrict the freedom of establishment and the free movement of capital. Under this aspect the German tax rules would present a problem.
Requests for Advance Pricing Agreements will Increase
It appears unlikely, particularly after the last OECD conference, that the OECD would quickly follow Germany’s lead and establish legal certainty any time soon (an idea which may have been entertained by the federal fiscal authority as well as German companies). Rather, the previously existing consensus among OECD countries at the international level seems to be put at risk by the tendency towards more detailed requirements and the need for coordination.
Thus, it can be safely predicted that companies will increasingly rely on advance pricing agreements. These agreements are made between tax authority and taxpayer; their purpose is to establish, prior to transactions, certain criteria for determining transfer prices. The tax authorities are legally bound by these agreements. It should, however, be noted that even today it takes, on average, 27 months to obtain an advance pricing agreement from the tax authorities, time which some companies simply do not have.