In light of BEPS implementation, the current German transfer pricing landscape is characterized by a dynamically changing environment. Several issues resulting from the final BEPS reports are controversially debated in Germany. Some BEPS elements were already implemented in Germany through the first BEPS implementation tax law in December 2016 and the recently signed multilateral agreement on 7 June 2017 whereby other OECD BEPS recommendations are still evaluated in terms of necessity and/or overlap with already existing national tax regulations.
While the implementation process and the related discussions are ongoing, several German taxpayers are already facing German tax inspectors scrutinizing transfer pricing issues by referring to post-BEPS transfer pricing considerations. Hence, this transition period comes across with several uncertainties in the field of transfer pricing and thus poses a significant challenge for German taxpayers. Therefore, it is even more important to understand the current German transfer pricing environment, its developments and how to best manage the transfer pricing challenges.
Transfer Pricing Documentation
As part of the transparency initiative driven by the OECD BEPS project, Germany has implemented the BEPS Action Point 13 transfer pricing documentation concept through the first BEPS implementation law as of 20 December, 2016. The implementation of the three tier transfer pricing documentation concept in German tax law involves the following elements:
- Master file containing general standardized group information for fiscal year (FY) beginning after 31 December 2016, if local taxpayer's sales (intercompany as well as with third parties) amounted to at least EUR 100m in the previous FY.
- Local file covering information on the taxpayer's cross-border intercompany transactions (inter alia function and risk as well as economic analysis) for FY beginning after 31 December 2016, if either intercompany supplies of goods exceeds EUR 5m or services or other transactions exceeds EUR 500k per year
- Country-by-Country Reporting (CbCR) particularly involving country-specific key financials for FY beginning after 31 December 2015 with a filing deadline of 12 months after the FY end (i.e. for the first time until 31 December 2017), if the consolidated group sales of the previous FY amount to at least EUR 750m.
Subsequent to implementing the revised TP documentation landscape in German tax law, the German Ministry of Finance has already published a discussion draft on revisiting the underlying German TP documentation ordinance in February 2017. This draft has been intensely commented by the German industry, associations and consultants. The most critical items relate to a potential transgression of competences due to the fact that the draft TP documentation ordinance tries to anchor the price setting approach. However, such pricing considerations can conceptionally not be regulated in a documentation ordinance, but relate to the application of the arm's length principle itself. Further critical points consist in requiring the entire replication and archiving of benchmarking study, inconsistencies in local file elements and the highly regrettable fact that provision of TP documentation in English is not explicitly permitted (still requires discretionary decision upon application).
In turn, it is highly welcomed that the master file content is more or less in line with the OECD definitions.
In practice, the German taxpayer still has some time buffer to cope with the master and local file requirements as these two elements are both required only for FY beginning on or after 1 January 2017. Conversely, dealing with the CbCR, i.e. identifying data sources, setting up appropriate data gathering process, determine roles and responsibilities, define consistent format, evaluate technical tool support, analyse implications and monitor implementation process, is more time-sensitive as the CbCR needs to be filed in Germany for 2016 for the first time until 31 December 2017.
Revised Arm's Length Principle?
The BEPS Action Points 8-10 provide for revisions of section D of chapter 1 of the OECD Transfer Pricing Guidelines through revised guidance on the arm's length principle. One of the overriding principle is to ensure transfer pricing outcomes to be in line with value creation, i.e. taxation should occur where economic activity and resulting value creation takes place.
Against this background, the application of the revised chapter 1 is highly disputed in Germany with a particular focus on the allocation of risks through intercompany agreements. To date it has become common and well-established transfer pricing practice in Germany (as neither the relevant German tax law nor the German Administrative Principles provide for opposite regulations) that the arm's length test of cross-border intercompany transactions entails the analysis of relevant intercompany agreements in view of functions performed, risks borne and assets employed. Regarding the allocation of risks, the statements of the intercompany agreement regarding allocation of risks needs in principle to be respected.
In contrast to this established concept, the analysis of intercompany agreements should merely constitute the starting point of a transfer pricing analysis under the revised wording of section D of chapter 1 of the OECD Transfer Pricing Guidelines. More specifically regarding allocation of risks, this means that "contractual allocation of risk are respected only when they are supported by actual decision-making" . This approach would not be covered by current German tax legislation while the OECD Transfer Pricing Guidelines do not have a binding character, but – needless to say – reflect international transfer pricing standards. Consequently, this revised OECD concept focusing on transfer pricing in combination with value creation (driven by risk, control, substance and decision-making considerations) triggers potential for different point of views whereby the significant changes on OECD level enable tax administrations to explore new options to challenge transfer prices.
This development combined with the parallel transparency initiative on TP documentation requirements clearly follows the objective to identify any disconnect between transfer pricing and economic reality. In light of this development, it is controversially debated in Germany in how far the existing national legislation on the arm's length principle notably section 1 of the German Foreign Tax Act needs to be revised.
All in all, it remains to be seen in how far the international pressure resulting from the OECD BEPS initiative - to which also the German government committed itself - will lead to further implementations regarding the application of the arm's length principle in German tax law. It is currently expected that these aspects are going to be reflected in the planned German ordinance on the arm's length principle (expected to be issued end of 2017 / beginning of 2018).
German transfer pricing audit practice
In the context of internationally-driven and nationally implemented anti-tax-avoidance measures which are also put on the political and public agenda, the German tax administrations are exposed to considerable pressure. This pressure is intensified by non-governmental organisations and the non-negligible impact of respective tax news in the media causing a public debate on tax justice respectively tax fairness.
As a result thereof, the tax audit activity in Germany continuous on a very high level whereby one can even expect that the tax audit pressure even further increases. In accordance with this anticipated development, the German tax authorities steadily build up their tax audit resources in terms of numbers, but also in view of advancing transfer pricing competences. Meanwhile, it has become common practice in recent years that transfer prices are audited by special transfer pricing auditors. In case of larger taxpayers the Federal Tax Office often becomes in charge of the audit, in such cases the auditors have an industry specialization.
Transfer pricing is thus not only an issue for large multinationals, but mid-sized companies have to deal with transfer pricing in German tax audits more and more. In terms of hot topics, German transfer pricing audits particularly focus on high profits abroad or losses/low profits in Germany. In many cases license fees and the price for the supply of goods is under heavy scrutiny of the tax authorities. In recent years tax auditors became more familiar with financial transactions such as loans, guarantees, cash pooling and hedging. The German Ministry of Finance has also implemented comprehensive guidance to implement the authorized OECD approach. It is expected that the new regulation will be a focus topic for taxpayers involved in permanent establishments.
As a result, German taxpayers (e.g. a subsidiary of an internationally operating group or a German permanent establishment) should have prepared properly for the extremely high transfer pricing focus of German tax authorities. In terms of explicit actions to be taken, it seems very much recommendable to manage the following items proactively in view of the German transfer pricing developments:
- Ensure BEPS-compliant transfer pricing documentation setup
- Scrutinize existing transfer pricing model under revised BEPS thinking to create transfer pricing outcomes in line with value creation
- Establishing a sustainable and proper transfer pricing policy including the definition of roles and responsibilities across the transfer pricing process
A proactive management of transfer pricing topics is crucial to mitigate the various potential transfer pricing risks arising from the multiple areas of transfer pricing implications. The national tax audit practice will increasingly focus on transfer pricing as the international BEPS measures (i) are (partially) implemented in national tax law, (ii) are adopted in double tax treaties via the signed multilateral agreement and (iii) already (implicitly) applied by German tax auditors.