Concept and Regulation in Germany
Transfer Pricing legislation in Germany is regulated in Section 1 of the Foreign Tax Law or “Außensteuergesetz.” In addition, the Finance Ministry issued a detailed decree on transfer pricing adjustment, the Administrative Guidelines, and extensive guidelines on transfer pricing documentation (BStBL. 2005 I, 570).
In 2020, the German Finance Ministry issued a revision of this guidance, now known as the Administrative Guidelines 2020. That Ministry published new Administrative Guidelines on transfer pricing and income adjustments on July 14, 2021 (BStBl. I 2021, 1098).
Arm’s Length Principle: Concept
This principle is defined in Section 1 of the Foreign Tax Act, including the concept of unrelated parties also knowing all relevant facts and circumstances of the transaction and acting as prudent and diligent administrators. This definition is complemented by the hypothetical arm’s length principle to be applied if the set of comparable parties does not meet the requirements of limited comparability.
Definition of Related Parties in Germany
According to Section 1, Numeral 2 of the Foreign Tax Act, related parties are the following:
- A person directly or indirectly owns at least 25% of another party;
- A person directly or indirectly controls another person;
- A third party owns an equity stake of at least 25% or controls the taxpayer and the other contracting party;
- A party can significantly influence the terms during the negotiation of the agreement, or a party has an interest in the income generated by the other contracting party.
Transfer Pricing Methodology in Germany
According to Numeral 3 of Section 1 of the Foreign Tax Act, in order to determine the market value of related party transactions, one of the following five methods may be used:
- Comparable Uncontrolled Price Method.
- Cost plus method.
- Resale price method.
- Profit split method.
- Transactional Net margin method.
Comparability Analysis in Germany
In order to determine whether two or more transactions are comparable, Paragraph 3 of Section 1 of the Foreign Tax Act points to the actual circumstances underlying the transaction in question. In particular, it must consider what business functions are related to the transaction it performs, which party is involved in the transaction, what risks are assumed in each case, and what assets are used for this purpose (functional and risk analysis). The circumstances described in the first and second sentences above serve as a benchmark for determining the comparability of the transaction to be assessed with transactions between unrelated third parties.
Transfer Pricing Documentation in Germany
During 2016 and 2017, Germany implemented the Local Report and Master File, based on Action 13 of the OECD BEPS Project.
The Local Report requires a German company to submit four reporting requirements:
- General information on equity stakes percentages, business operations, and organizational structure;
- Documentation of transactions with foreign related parties;
- Functional analysis; and
- Transfer pricing analysis.
Master File drafting is also required. This requirement affects only German taxpayers belonging to multinational groups with revenues of at least €100 million in the previous fiscal year. The Master File aims to provide the tax authorities with an overview of the nature of the global operating activities of multinational groups and their companies and the methodology applied to determine transfer prices.
Country by Country Report
On July 11, 2017, the BMF (Bundesministerium der Finanzen – Federal Finance Ministry) of Germany published a Circular providing administrative principles on the requirements for the Country-by-Country Report.
The Circular clarifies the requirements for the drafting and filing of such a Report under Section 138a of the German General Tax Code and Action 13 of the OECD BEPS project. The guidance is now applicable and effective for CbC reports to be filed for the fiscal years beginning after December 31, 2015, and due on December 31, 2017, of companies headquartered in Germany and entities headquartered abroad operating as “surrogate parent entities.”
Sanctions related to Transfer Pricing in Germany
Non-submission of complete transfer pricing documentation on time may result in two types of penalties:
- If a taxpayer completely fails to prepare transfer pricing documentation or if the prepared documentation is largely unusable, the tax authorities will presume that the German taxpayer has underreported the amount of taxable income from intercompany transactions. If the taxpayer can rebut the presumption, the tax authorities impose a minimum penalty of €5,000. If the taxpayer cannot rebut the presumption, the penalty amounts to 5% to 10% of the income adjustment; and
- If a taxpayer delays in making complete transfer pricing documentation available to the tax authorities, the penalty amounts to €1 million, regardless of any income adjustment.
Non-submission of information or documents within the appropriate time frame requested by the tax authorities during a tax inspection may result in a penalty of up to €250,000.