The Transfer Pricing Law Review: Germany


In Germany, the adjustment of inappropriate transfer prices is based on Section 1 of the Foreign Tax Act. In addition, the Federal Ministry of Finance has issued a detailed decree on the adjustment of transfer prices, the Administrative Guidelines (Verwaltungsgrundsätze) and extensive guidelines on transfer pricing documentation (BStBl. 2005 I, at 570). On 3 December 2020, the German Ministry of Finance published a revision of this guidance, now known as the Administrative Guidelines 2020. The revised guidance focuses on taxpayers' obligations to cooperate with German tax auditors, the burden of proof of arm's-length transfer prices and the assessment of potentially more appropriate transfer prices. Although such administrative guidance does not bind either taxpayers or the tax courts, it acts as an interpretation of German tax law, to which German tax auditors are bound. The legal transfer pricing framework is also supplemented by various directives and administrative guidelines, such as the Statutory Ordinance on cross-border relocations of business functions. Moreover, the Federal Ministry of Finance released on 14 July 2021 new Administrative Guidelines (Verwaltungsgrundsätze) on Transfer Pricing and Income adjustments (BStBl. I 2021, 1098). These Administrative Guidelines focus on the application of the arm's-length principle to different types of intercompany cross-border transactions such as use of intangibles, product supplies, provision of services and financing. In particular, the German tax administration illustrates its view on the impact of recent OECD transfer pricing developments as well as transfer pricing-related Federal Tax Court rulings.

Section 1 of the Foreign Tax Act stipulates that related parties must deal with each other on an arm's-length basis. An arm's-length price is determined based on what a prudent and diligent business manager would charge by considering all material facts related to the business transaction. A transfer pricing adjustment can be made only if the contracting parties are related. According to Section 1(2) of the Foreign Tax Act, this is the case if:

  1. a person directly or indirectly holds at least 25 per cent in another party;
  2. a person directly or indirectly controls another person;
  3. a third person has a participation of at least 25 per cent or controls the taxpayer and the other contracting party; or
  4. one of the parties can exercise a major influence on the conditions during the negotiation of the agreement or one party has an interest in the income generated by the other contracting party.

The income of the German taxpayer is adjusted to reflect arm's-length conditions, if a prudent and diligent business manager would not have accepted certain conditions in relation to an unrelated party. This provision applies to all business transactions between related parties. Examples are inter-company sales and services, loans or guarantees and intellectual property (IP) licensing arrangements, as well as the transfer of functions between related parties.

With effect from 1 January 2013, the scope of the transfer pricing rules contained in Section 1 of the Foreign Tax Act was extended to also apply to dealings between a resident company and its foreign permanent establishment and to dealings between a non-resident company and its domestic permanent establishment. These amendments aim to implement the Authorised OECD Approach, as set out in Article 7 of the OECD Model Convention 2010 and the respective OECD Commentary, to allocating profits between permanent establishments and headquarters, in domestic law.2 For the purpose of the application of the transfer pricing rules, a permanent establishment is treated as a separate legal entity. Therefore, significant people functions and assets connected with the functions carried out by the permanent establishment and related risks must be attributed to the permanent establishment. Moreover, an appropriate amount of free capital must be attributed to the permanent establishment. Subsequently, on the basis of the aforementioned attributions, the arm's-length price for the dealings between the head office and its permanent establishment must be determined.

Germany has already implemented some of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project Final Reports, such as the BEPS 2015 Final Report on Action 13 on transfer pricing documentation and country-by-country reporting. However, as long as OECD guidelines are not passed into law, neither the German tax administration nor the German tax courts are legally bound by them. This also applies to the OECD Commentary on the Model Convention and to the OECD Transfer Pricing Guidelines. Nevertheless, in practice, both the German tax courts and the German tax authorities use the OECD guidance when dealing with transfer pricing issues.

Filing requirements

In 2016/2017, Germany implemented the master file and local file concept, as recommended in Action 13 of the OECD/G20 BEPS Project and this applies to fiscal years starting on or after 1 January 2017. The local file requires four items of information to be presented by a German company:

  1. general information on shareholding percentages, business operations and organisational structure;
  2. documentation of transactions with foreign-related parties;
  3. functional analysis; and
  4. transfer pricing analysis.3

The purpose of requiring this information is for taxpayers to provide credible evidence of compliance with the arm's-length principle when determining their transfer prices. Moreover, information about the timing of the determination of transfer prices must be presented. Furthermore, the local file requires further information to be included on a case-by-case basis, such as foreign tax rulings, records relating to price adjustments by the taxpayer, records on the reasons for permanent losses, details of intentional set-offs, or records of ongoing research projects in the case of changes in function and risk profiles.

Transfer pricing documentation relating to the attribution of income between the head office and its permanent establishment must also include the reasons for the allocation of the company's people functions, assets and transactions, and the reasons for the existence of internal dealings.4

The preparation of a master file is also required. This requirement affects only German taxpayers who belong to multinational groups and had revenue of at least €100 million in the previous fiscal year. The purpose of a master file is to give the tax authorities an overview of the nature of the global operating activities of multinational groups and their undertakings, and the methodology that they apply for the purposes of determining transfer prices.

No obligation is required to prepare transfer pricing documentation until the tax return is filed. However, there is an exception for extraordinary transactions with foreign related parties. Extraordinary transactions include:

  1. the conclusion and amendment of significant long-term agreements having a significant impact on the amount of income generated from the business with related parties;
  2. asset transfers during business restructurings; and
  3. the transfer or provision of assets or benefits connected to a change of functions and risks within the group.

Transfer pricing documentation for extraordinary transactions is prepared contemporaneously, if it is prepared no later than six months following the close of the fiscal year during which the transaction was carried out. In practice, German tax authorities apply a rather broad definition of an extraordinary transaction.

With effect from 2022, business transactions conducted by taxpayers will trigger defensive measures if the transactions are conducted with residents from a non-cooperative tax jurisdiction that are included in the EU list of non-cooperative jurisdictions and territories for tax purposes, also known as blacklisted jurisdictions. Increased transfer pricing documentation obligations generally apply to all those business transactions and the documentation has to be prepared no later than one year after the end of the calendar or fiscal year in question and submitted to the German tax authorities.

If a foreign company has a German permanent establishment or a German company has a foreign permanent establishment, the company must prepare auxiliary and ancillary accounts for the permanent establishment at the beginning of a fiscal year, updated during the fiscal year and closed at the end of the fiscal year.5 These accounts include the result for the permanent establishment. The auxiliary and ancillary accounts must have been prepared at the latest on the date that the company files its required tax return.6

The auxiliary and ancillary accounts include all items that are to be attributed to the permanent establishment due to its people functions. This includes the attributable assets, free capital and debt, as well as the operating income and operating expenses related to these items. Moreover, the auxiliary and ancillary accounts also include deemed operating income and deemed operating expenses that arise as a result of internal dealings.7 The transfer pricing documentation that must be prepared and submitted at the tax authorities' request must show the reasons for the attribution of all items that are to be attributed to the permanent establishment due to its people functions, and the reasons for the existence of internal dealings.8 Once a permanent establishment has closed, the auxiliary and ancillary accounts are to be closed as of that date. The deemed transfer of assets between the permanent establishment and the head office gives rise to internal dealings.9

In 2016, Germany implemented country-by-country (CbC) reporting in its domestic law. Groups are now required to prepare annual CbC reports and file these reports with the Federal Central Tax Office in electronic form before the end of the following fiscal year. Hence, firms located in Germany that prepare consolidated financial statements or are required to do so under provisions other than tax law must prepare a CbC report for each fiscal year. This duty applies only if the consolidated revenues shown in the group financial statements for the previous fiscal year are higher than or equal to €750 million and the domestic parent company's financial accounts are not included in the consolidated financial statements of a foreign ultimate parent company. A foreign parent entity may delegate responsibility for the submission and filing of CbC reports to a domestically controlled company (surrogate parent entity). Furthermore, each individual domestic constituent entity or permanent establishment must also file a CbC report before the end of the following fiscal year, if the competent Federal Central Tax Office has not received a report from the foreign ultimate parent entity.

The information to be included in CbC reports can be broken down into three categories:

  1. an overview must be provided to show how the operating activities of the group are allocated among the countries covered by the CbC report;
  2. several indicators must be provided for each tax jurisdiction. Another overview shows the various tax jurisdictions for all constituent entities and permanent establishments, along with information about their main operating activities; and
  3. a third overview contains explanatory information for understanding the information provided in the first two overviews.

Germany has implemented the amendment of the European Directive on Administrative Cooperation 2018/822 (DAC6), which took effect on 1 July 2020. The Directive refers to the introduction of a new reporting obligation for cross-border tax arrangements that may potentially be regarded as aggressive and politically undesirable. A tax arrangement is reportable, if it is a 'cross-border tax arrangement', and certain hallmarks as stipulated in Annex IV of DAC6 are fulfilled. The hallmarks, which are grouped into five categories (A–E), aim to cover generic and specific characteristics as well as certain consequences of tax planning. Category E, among other things, deals with selected transfer pricing matters, such as the transfer of hard-to-value intangibles and the use of unilateral safe-harbour rules. The reporting obligation is limited to those intermediaries who are resident or have a permanent establishment in an EU Member State, in particular. An intermediary is any person who designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border tax arrangement.

Presenting the case

i Pricing methods

A transfer price is established as a matter of priority by employing the comparable uncontrolled price (CUP) method, the resale price method and the cost-plus method. The choice of one of these methods requires uncontrolled transactions that are either fully or to a limited extent comparable, taking into account functions exercised, assets employed and risks assumed, and that appropriate adjustments are made to account for differences between the inter-company transaction and comparable transactions. For the resale price method, the transfer price must be calculated as the resale price reduced by an arm's-length markup reflecting the functions and risks of the reseller. For the cost-plus method, the costs incurred by the related supplier in an inter-company transaction are determined by using its cost accounting concepts employed in its pricing policy towards independent parties. The costs must be increased by an appropriate markup. The German tax authorities seem to agree with the comments of the OECD Transfer Pricing Guidelines.

Moreover, German transfer pricing statutes stipulate the hypothetical arm's-length test, which a taxpayer is required to employ whenever it is not possible to identify comparable transactions. When applying the hypothetical arm's-length test, the taxpayer establishes a range of prices, which, in turn, are derived from the profit expectations (profit potentials) of the parties involved. Unless the taxpayer provides evidence to the contrary, the mid-point of the range determines the transfer price. The hypothetical arm's-length test has no similarities with the transactional net margin method (TNMM). In fact, this method involves a comparison of the profitability of a related person with the profitability of unrelated parties. The hypothetical arm's-length test looks at the profits of either party to the tested transaction and resembles the OECD profit split method. To split the profit, the hypothetical arm's-length test advocates a rebuttable 50/50 split rule.

Determining arm's-length transfer prices for the assignment (i.e., transfer of beneficial ownership) of intangible assets, such as trademarks, patents and customer bases, also requires an appropriate pricing method. Therefore, in practice, both the application of economic valuation techniques and the valuation through income-based methods to derive hypothetical comparables represent the norm. The German tax authorities accept the use of economic valuation techniques and the underlying principles of the German Standard for Chartered Accountants (IDW) to derive hypothetical arm's-length prices.10

German transfer pricing statutes prioritise traditional transactional methods over profit methods and other viable methods. This priority is subject to the requirement of available data from comparable transactions with or between unrelated parties. Where this requirement is not fulfilled, the use of the hypothetical arm's-length test is mandated.

Application of the arm's-length principle in Germany requires a thorough comparability analysis. This is best achieved by undertaking a functional analysis that identifies and compares the economically significant functions undertaken, assets employed and risks assumed by the independent and related company to determine the comparability of the uncontrolled and controlled transactions.

If a taxpayer uses benchmark studies for the demonstration of arm's-length prices, the taxpayer must comprehensively disclose the search process, including the definition of the applied search strategy to identify potential comparable companies, the search result and the selection process. The entire search process must be transparent and, at the time of a tax audit, verifiable. Moreover, the configuration of the database with which the search process has actually been conducted must be comprehensively documented.11

ii Authority scrutiny and evidence gathering

Tax auditors have little formal guidance on how to examine transfer pricing issues. As a standard procedure, the tax auditor requests the taxpayer's entire transfer pricing documentation covering all inter-company transactions. Afterwards, the tax auditor selects those transactions that may require an in-depth examination at the discretion of the individual auditor. German tax auditors are likely to examine in detail the following situations:

  1. when the profitability of foreign subsidiaries has increased significantly (e.g., usually EMIT – marginalised over 8 per cent);
  2. when the German taxpayer has entertained a transfer of functions involving substantial operations;
  3. when the German taxpayer's income has declined sharply or the German taxpayer has suffered permanent losses;
  4. when the German taxpayer has carried out inter-company transactions with related parties situated in low-tax countries;
  5. when the German taxpayer has applied the TNMM and year-end adjustments; and
  6. when the taxpayer has carried out corresponding or secondary adjustments.

From a transaction perspective, German tax auditors often focus on the following types of controlled transactions:

  1. services;
  2. licensing;
  3. financing transactions;
  4. transfer of functions; and
  5. distribution and procurement activities.

Tax audits of German subsidiaries typically involve a review of the taxpayer's compliance with formal requirements for the deductibility of payments to foreign-related parties. This entails requesting written inter-company agreements, in particular concerning loan, licence and service arrangements. German tax auditors normally check the contracting parties' adherence to the terms of their contracts.

Tax auditors are increasingly focusing on transfer pricing related issues, such as withholding taxes, tax-efficient inbound transactions with German partnerships, creation of permanent establishments and the general anti-abuse rule (GAAR).

In German transfer pricing audits, the intensity and level of aggressiveness have significantly increased over the past years. Nevertheless, German tax audits can still be successfully managed by avoiding international double taxation during the tax audit. Taxpayers are well advised to think strategically when responding to information requests for specific audit issues. They are also recommended to respond to audit findings often lacking any detailed legal analysis by presenting counter arguments and negotiating with tax auditors.

Intangible assets

Recently, the German legislator implemented BEPS Actions Item 8-10 into German tax law. In particular, Section 1, Paragraph 3c of the FTA was introduced according to which the adjustment of transfer pricing results will be based on the value added by each entity of a multinational group of companies.

For the attribution of income from the exploitation of IP, BEPS Action Item 8 introduces for transfer pricing purposes – and possibly in divergence from civil law and economic ownership – the 'functional property' of IP according to the development, enhancement, maintenance, protection and exploitation (DEMPE) concept. This concept focuses on the individual value-added contributions of individual group companies to the DEMPE functions of the IP concerned. Hence, it is possible that risks of legal or economic allocation (for accounting, prosecution and compensation purposes) are falling away from the allocation for transfer pricing purposes. As a result, the German tax authorities assume that capital-rich but functionally weak or functionless companies (cash boxes) should only be entitled to a risk-free interest rate and not to the residual profit. Consequently, the group companies performing solely financing or legal protection functions (or both) related to IP shall be entitled to cost-based routine remuneration pursuant to the newly introduced Section 1, Paragraph 3c, sentence 5 of the FTA. However, group companies in charge of development, enhancement, maintenance and exploitation shall receive arm's-length part of the residual profits generated from the respective IP.

In addition to the general application of the OECD DEMPE concept, Section 1 of the FTA contains specific rules on the transfer of business functions. The tax rules on the transfer of business functions to a foreign-related party are stipulated in Section 1, Paragraph 3b of the FTA in conjunction with the Decree Law on the Relocation of Functions dated 12 August 2008 (DLRF) and with consideration of the Administrative Guidelines on the Relocation of Functions (Federal Tax Gazette Part I 2010, p. 774; AGRF). Accordingly, the requirements for a taxable transfer of business functions within the meaning of Section 1, Paragraph 3b of the FTA are as follows:

  1. the existence of a business function performed the transferring entity;
  2. the transfer of this function to a foreign-related party; and
  3. the transfer of associated assets and other benefits to a foreign related party.

If these requirements are met, the transfer of a business function is also assumed even in the case that the acquiring company assumes the function only temporarily.

A function is defined as a business activity consisting of a bundle of similar operational tasks performed by departments or positions of an enterprise (cf. Section 1, Paragraph 1 of the DLRF). A business function is therefore an organic part of an enterprise, if it presents itself as a purposeful, definable activity using certain assets (especially intangible assets) and other benefits to generate a value contribution. The AGRF specifies the meaning of a 'business function' by providing several examples such as production, packaging, sales, assembly, processing and refining of products (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 15).

A business function can be constituted by activities involving third parties or affiliates, or both. Individual functions are the result of the separation of tasks within a company, whereas the respective tasks do not necessarily have to include all elements that are essential for the added value (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 14). The classification takes place with focus on the activity and the objective based on the assets employed and benefits as well as the opportunities and risks connected with the specific activity (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 16). Hence, the tax authorities have an extremely expansive understanding of the term 'function'.

A transfer of a business function is assumed if a German company (the transferring company) either transfers or concedes the right of use of assets and other (economic) benefits, including the opportunities and risks involved to an affiliated foreign company (the acquiring company). As a result, the acquiring company takes over the function that has been thus far performed by the transferring company, thereby limiting the transferring company in executing this function (cf. Section 1, Paragraph 2 of the DLRF). Against this background, the taxable transfer of functions requires the termination or at least the restriction of functions performed by the transferring company.

Pursuant to Section 1, Paragraph 6 of the DLRF, a duplication of functions triggers a taxable transfer of business functions, only if the function exercised by the transferring entity is restricted by the establishment or extension of the same function exercised by acquiring entity within a five-year period, unless the taxpayer can credibly explain that the restriction of the function is not directly linked to the duplication of the function. The German tax authorities do allow for a bagatelle arrangement where a taxable relocation of a business function is not assumed, if a duplication of function merely results in a minor restriction for the transferring enterprise. In this regard, a restriction is substantial (i.e., not minor) if, within the five-year period, the sales resulting from the function that the transferring company generated during the last complete business year prior to the change of the function decline in one business year by €1 million (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 49).

The rules on the transfer of business functions require the transfer of assets and other benefits associated with the relocated business function, as well as the risks and opportunities involved to an affiliated foreign company (cf. Section 1, Paragraph 2 of the DLRF; AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 19). However, pursuant to Section 1, Paragraph 3, sentence 10 of the first alternative FTA, the tax rules on relocation of business functions do not apply if the taxpayer shows credibly that no essential intangible assets and benefits were part of the relocation of functions. Intangible assets and benefits are essential, if they are required for the transferred function and their transfer price amounts to more than 25 per cent of the total of all individual prices of all assets and benefits of the transfer package (cf. Section 1, Paragraph 5 of the DLRF; AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 71).

The term 'asset' includes not only goods and rights but also conditions and concrete business opportunities; in other words, all benefits for which an enterprise would pay a compensation and that can be separately valued (cf. e.g., Federal Tax Court of 6 December 1990 – IV R 3/89, Federal Tax Gazette Part II 1991, p. 346; Federal Tax Court of 26 August 1992 – I R 24/91, Federal Tax Gazette Part II 1992, p. 977). Benefits not meeting these requirements might be classified as 'other benefits'. These include good customer relationships or qualified employees. The corresponding 'chances and risks' must be transferred together with the assets and other benefits to the acquiring enterprise.

If a transfer of functions, within the meaning of Section 1, Paragraph 3b of the FTA, is given, it will be necessary to determine the value shift associated with a transferred function through valuation of a 'transfer package'. Subsequently, the value of the transfer package would be subject to exit tax (i.e., corporate income tax plus solidarity surcharge and trade income tax) at the level of the transferring entity.

The value of the transfer package will be equal to the net present value of the transferred earnings potential from the transferring entity to the acquiring entity. In other words, the net profits after tax to be expected from the relocation of the function, both from the perspective of the transferring entity and the acquiring entity, have to be discounted with an appropriate capitalisation rate reflecting the risks and opportunities linked to the respective function (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 84). The valuation of the transfer package also includes the time frame over which future profits will accrue. According to the German tax authorities, an 'eternal rent approach' has to be regularly applied, meaning that the economic lifetime of a transfer package shall not be limited (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 109). However, the taxpayer can provide credible evidence for a limitation of the time frame of capitalisation (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 110).

The German tax authorities assume that the transfer of a routine function also leads to a taxable transfer of business functions but allow for the application of the escape clause pursuant to Section 1, Paragraph 3b, sentence 3 of the FTA in connection with Section 2, Paragraph 2 of the DLRF. Accordingly, if an acquiring enterprise performs a function exclusively for the transferring enterprise and if it is appropriate to calculate the remuneration for the performance of the function by using the cost-plus method, it is assumed that no material intangible assets and economic advantages are transferred or conferred for use against payment. In the view of the German tax authorities, this is also applicable if an acquiring enterprise applies TNMM based on costs to determine its transfer prices, or if such enterprise receives a commission fee considering the minor risk (cf. AGRF, Federal Tax Gazette Part I 2010, p. 774, recital 67).

An immediate exit tax can be avoided if the transfer package is licensed out by the transferring entity to the acquiring entity pursuant to Section 4, Paragraph 2 of the DLRF. However, from a practical perspective, a legal certainty for the acceptance of the licence agreement by the tax authorities (instead of assumption of taxable transfer) can be obtained only by requesting a binding tax ruling. In addition, the licence fee has to be at arm's length.

The transfer of a business function constitutes an extraordinary business transaction. Pursuant to Section 90, Paragraph 3, sentence 8 of the General Fiscal Code, a documentation of the relocation of the business function shall be prepared within six months following the business year in which the relocation has been conducted.


To obtain legal certainty for the future, taxpayers may request different types of tax rulings on transfer pricing issues. Ruling requests or binding factual agreements on matters that have already been subject to a tax audit can be instruments for obtaining legal certainty on transfer pricing issues. In principle, the German tax authorities are rather hesitant to issue unilateral advance tax rulings on transfer pricing issues. In practice, however, they have granted advance tax rulings under which the prerequisites of a taxable transfer of functions (business restructuring) are not met, for example.

Arguably, a unilateral ruling is of more value if the foreign tax authority that is also affected is also involved in the ruling procedure. This can be achieved by seeking legal certainty for transfer pricing issues by means of advance pricing agreements (APAs). There were 89 applications requests for APA procedures and 25 completed APAs in Germany in 2019, for instance. The typical process for a bilateral APA procedure has the following stages:

  1. pre-filing meetings are held in both countries;
  2. the taxpayer files a formal request for the initiation of an APA procedure;
  3. the German competent authority liaises with the foreign competent authority to prepare and exchange a position paper; and
  4. the competent authorities draft an agreement on the agreed APA terms and conditions, once they have concluded negotiations, which must be approved by the taxpayer.

In fiscal year 2021, Section 89a of the General Tax Code was introduced, dealing with the availability and access to APA proceedings, the resolution of APA cases, and implementation of APAs reached, all of which are in line with international best practices. The German APA programme also enables taxpayers to request rollbacks of APAs to past years and is no longer limited to transfer prices but also covers other matters.


Corporate income tax returns of relatively large companies are under audit almost permanently. Defining the audit programme falls under the competency of local tax offices. International tax auditors and industry specialists from the federal tax authorities often assist a local tax office. Simultaneous tax examinations and joint audits can be observed more often. The main objective of such coordinated tax audits is to achieve agreement with foreign tax authorities when determining the relevant facts during the tax audit to avoid international taxation conflicts and competent authority proceedings. In practice, Germany has initiated coordinated tax audits with Austria, Italy and the Netherlands, in particular.

If the basis for a transfer pricing adjustment is the taxpayer's non-compliance with formal requirements, the taxpayer is well advised to counter the adjustment as a violation of an income tax treaty.

If a transfer pricing audit results in an adjustment to the company's income, the local tax office will prepare a revised tax assessment notice. Within one month of having received the notification, the taxpayer may appeal the reassessment notice.12

The taxpayer may also initiate competent authority proceedings with respect to a disputed transfer pricing adjustment. In principle, competent authority proceedings and administrative appeal procedures can be initiated simultaneously. Typically, one of both proceedings will be suspended and will not be actively pursued while the outcome of the other pursued proceeding is given. The taxpayer should give reasons for an administrative appeal in writing. The tax office may set a deadline for the submission of further evidence. Normally, the appeals officer follows the arguments of the tax auditors. Initiating an administrative appeal procedure does not, in principle, relieve the taxpayer from paying the disputed taxes.13 The taxpayer may, however, request the suspension of the payment until after a decision has been rendered on the appeal, which is normally granted in transfer pricing cases.

If the taxpayer's administrative appeal is rejected, as often is the case in transfer pricing disputes, the taxpayer may take recourse to a lower tax court. The legal action must be filed with a competent lower tax court no later than one month after having received the notice rejecting the taxpayer's administrative appeal.14 The lower tax court has the right and duty to review all factual and legal aspects of the case.15 The party disagreeing with the lower tax court's decision may take recourse to the Federal Tax Court within one month after notification of the decision.16 The Federal Tax Court in the final instance will not review the facts of the case again but will make its decision based on the facts and circumstances as established by the first instance. Decisions rendered by the Federal Tax Court are generally not appealable. On average, in court proceedings, decisions take three to five years to be reached. In practice, both tax auditors and taxpayers, however, prefer to reach a compromise during the tax audit.


i Procedure

The regular period for the statute of limitations is four years, starting at the end of the year in which the tax return for the respective tax year was filed, at the latest, three years after the respective tax year. After this period, tax assessments may no longer be changed. The period is extended to 10 years for wilful tax fraud and to five years for negligent tax fraud. The running of the four-year period is stopped by certain events, the most important one being the start of a tax audit.

In recent years, the German tax authorities have taken an increasingly aggressive stance over transfer pricing matters. In the past, transfer pricing discussions were limited solely to tax audits; nowadays, however, the tax authorities are increasingly launching tax fraud investigations on transfer pricing matters.

Generally, the taxpayer can file administrative or court appeals. The local tax court (first instance) investigates both the facts and the legal issues at stake. The Federal Tax Court focuses only on a revision of questions of law (second instance). Where questions of European law are critical for a decision on the case, local tax courts may, and the Federal Tax Court is obliged to, refer the case to the European Court of Justice. Once legal court instances have been exhausted, the taxpayer may raise a complaint with the Federal Constitutional Court for violation of constitutional rights. The Court decides whether to admit the complaint.

However, transfer pricing issues are regularly subject to MAPs and arbitration procedures pursuant to double-tax treaties or the EU Arbitration Convention. This is due to the fact that MAPs usually result in avoidance of double taxation while there is a risk that an unfavourable decision by the tax courts may leave the taxpayer with double taxation. Furthermore, a litigation process running through both instances may take several years where the improvement of the MAPs practice allows for a quicker conclusion of the transfer pricing issues at stake.

ii Recent cases

The following are some of the most important transfer pricing rulings that have been issued by German Tax Courts since 2000.

  1. Several decisions have been ruled on whether or not a group subsidiary should pay royalty fees for a licence to use a corporate brand. In 2000,17 the Federal Tax Court ruled that royalty charges for the use of the corporate brand are appropriate, if it is a protected trademark or brand name that may result in valuable benefits to the licensee. In a case18 in 2016, the Federal Tax Court decided that the use of name rights does not establish a business relationship within the meaning of Section 1(4) of the FTA, if the right to use is given to the subsidiary at a corporate level. New administrative regulations on the use of group names, trademarks and logos were published on 7 April 2017.19 These administrative regulations apply to all pending cases and largely disregard the Federal Tax Court decision.
  2. In a landmark decision of the Federal Tax Court in 2001,20 the court clarified important procedural aspects of transfer pricing rules, in particular on the burden of proof, transfer pricing documentation, the taxpayer's duty to cooperate with the tax authorities and the use of secret comparables. As a reaction to the ruling, the German legislature introduced important changes in German transfer pricing law (transfer pricing documentation, penalty rules and refinement of the arm's-length principle in Section 1 of the FTA).
  3. In 2005,21 the Federal Tax Court confirmed the principles established in prior rulings that losses incurred by a distribution entity over a certain period trigger a rebuttable presumption that the transfer prices are not at arm's length.
  4. In 2012, 2014 and 2015,22 the Federal Tax Court decided on the prevalence of double-tax treaty rules over Section 1 FTA. Accordingly, based on double-tax treaty rules similar to Article 9 of the OECD Model Tax Convention, the arm's-length analysis should be restricted to the testing of the transfer price applied by the parties involved. On 30 March 2016,23 the Federal Ministry of Finance issued a 'non-application decree' stating that Article 9 of the OECD Model Tax Convention does not refer to a transfer price adjustment but to a profit adjustment instead.

In 2013,24 the Federal Tax Court ruled that the obligation to prepare, and upon request submit, transfer pricing documentation is in line with EU law. In particular, these obligations do not breach the freedom of establishment.

In 2016,25 the Lower Tax Court of Münster confirmed that standard transfer pricing methods (CUP, resale minus, cost-plus) are, in general, equal to one another. It is up to the taxpayer and the German tax authorities to determine the most appropriate method for each individual case. To determine arm's-length interest rates on loans within the group, according to the court's assessment of the case, cost-plus shall be the best method. This ruling is currently subject to revision by the Federal Tax Court.

In 2017,26 the Lower Tax Court of Cologne confirmed its position that an EU Member State's requests to another Member State for administrative assistance is in line with the law, if the requested information is foreseeably relevant to the administration and enforcement of the domestic laws of the requesting Member State. The Lower Tax Court further clarified that 'foreseeably relevant' means that, at the time of the request, there was a reasonable possibility that the requested information could be relevant for tax purposes. The standards recognised by the Lower Tax Court are very low and therefore nearly anything could be deemed foreseeably relevant.

On 31 May 2018, the ECJ ruling in C-382/16, Hornbach case considered the compatibility of Section 1 of the Foreign Tax Act (AStG) with European law. Although Section 1 of the AStG restricts the freedom of establishment, it is not contrary to European law if the taxpayer is given the opportunity to present 'economic reasons' justifying transfer prices deviating from the arm's-length principle. In this context, the Federal Ministry of Finance released administrative regulations27 on the application of the ECJ judgment in the Hornbach case. These regulations restrict the criterion of economic reasons to actions related to near insolvency situations. The taxpayer must, in particular, prove the related party's or the group's need and capability for recovery. The regulations are effective as from 6 December 2018 and apply to all open cases.

In 2019,28 the Federal Tax Court changed its prior case law according to which Section 9 of the OECD Model Tax Convention limited the scope of application of Section 1 FTA to price adjustments. The Court authorises corrections not only in amount (price adjustments) but also on grounds of principle, such as the neutralisation of a profit-reducing write-off of a receivable. In addition, the Court revised its case law on passive integration within the group. Consideration of the benefits of passive group integration in the arm's-length analysis may violate the arm's-length principle. Finally, the Court interprets the ECJ Hornbach decision (C-382/16). Even if the taxpayer can prove economic reasons and the chosen structure does not qualify as purely artificial, a transfer price adjustment may still be required.

In 2019,29 the Federal Tax Court decided that the provisions for income adjustments (hidden profit distributions, hidden capital contributions and Section 1 FTA) are equal to one another. Consequently, the tax authorities are free to select the provision that applies to income adjustments.

Recently, in 2021, the Federal Constitutional Court (2 BvR 1161/19 from 04 March 2021) ruled that the Federal Tax Court had not met its obligation to refer the case to the European Court of Justice. The Federal Constitutional Court stated that the Federal Tax Court did not reasonably justify its decision that the case should not be referred to the ECJ against the background of the ECJ Hornbach decision (C-382/16).

On 18 May 2021,30 the Federal Tax Court issued two decisions confirming that the comparable uncontrolled price method (CUP) method should take priority when determining intra-group interest rates. Among other interesting aspects, the Federal Tax Court stated that a borrower's creditworthiness should be derived from a stand-alone rating rather than a group-wide rating. Moreover, it reaffirmed that the burden of establishing that the agreed interest rate is not at arm's length lies with the tax authorities if the taxpayer fulfils the requirement of sound transfer pricing documentation.

Currently, pending transfer pricing disputes comprise both procedural and substantive issues, including the following:

  1. determination of arm's-length service fees between related parties;
  2. the valuation of IP post-acquisition (purchase price allocation); and
  3. transfer of functions of a production 'function'.

Secondary adjustment and penalties

Secondary adjustments are made automatically under Germany's transfer pricing statutes. The transfer pricing adjustments based on the concept of hidden profit distribution entail a constructive dividend and the hidden capital contribution a constructive capital contribution. In contrast, transfer pricing adjustments based on Section 1 of the Foreign Tax Act are not accompanied by a secondary transaction.

Any failure to provide complete transfer pricing documentation in time can trigger two types of penalties:

  1. if a taxpayer does not prepare transfer pricing documentation at all or if the documentation prepared is unusable for the most part, the tax authorities will presume that the German taxpayer has under-reported the amount of taxable income from inter-company transactions. If the taxpayer is able to rebut the presumption, tax authorities impose a minimum penalty of €5,000. If the taxpayer is unable to rebut the presumption, the penalty amounts to 5 per cent to 10 per cent of the income adjustment; and
  2. if a taxpayer is late in making the complete transfer pricing documentation available to the tax authorities, the penalty amounts up to €1 million, irrespectively of any income adjustment.

Any failure to provide information or documents within an appropriate time frame that has been requested by the tax authorities during a tax audit can trigger a penalty of up to €250,000.

A taxpayer claiming deductions for expenses must establish that the expenditure is appropriate, while the burden of proof that an upward income adjustment is appropriate under the arm's-length principle lies with the tax authorities. As income adjustments are often legally based on the provisions governing the hidden profit distribution, the tax authorities have the burden of proof for an income adjustment in many transfer pricing disputes.

If the taxpayer does not fulfil its legal obligations to cooperate, however, the tax authorities must estimate the taxable profits. This also means that any failure to provide sound transfer pricing documentation creates the rebuttable presumption that the taxpayer has under-reported his or her taxable profits. In such cases, the tax authorities are allowed to estimate the taxpayer's income, including its transfer prices within an arm's-length price range, which is most disadvantageous to the taxpayer. This effectively shifts the burden of proof for arm's-length prices to the taxpayer.

Broader taxation issues

i Diverted profits tax and other supplementary measures

A diverted profits tax is not applicable under German domestic tax law.

In principle, royalties and similar expenses are also deductible. However, taxpayers may deduct only royalties if, and to the extent that, the corresponding income is not subject to a harmful preferential tax regime at the level of the recipient.31 The royalty barrier rule may only apply if the recipient is a related person and, thus, the rule primarily targets inter-company licensing. For the royalty barrier rule to apply, the foreign recipient of the corresponding income must be subject to a harmful preferential tax regime. This is the case if the received income is subject to a lower taxation regime than standard taxation, in which case the effective tax rate is determinative. A preferential tax regime is, however, not seen as harmful to the extent that it meets the prerequisites of the OECD nexus approach, though the royalty barrier rule ignores the OECD's grandfathering rule for preferential tax regimes that were already in place in 2016 but do not comply with the nexus approach before 2021. If the royalty barrier rule applies, the non-deductible share of the royalty expenses is equal to the difference between a standard tax rate of 25 per cent and the effective income taxes divided by 25 per cent.

ii Double taxation

Mutual Agreement Procedures (MAP) are a well-established instrument for resolving transfer pricing disputes between Germany and its tax treaty partners. Germany's MAP inventory is extremely large, with a substantial number of new cases submitted each year and significantly more than 1,000 cases pending, half of which relate to transfer pricing. In practice, transfer pricing MAP cases relating to other OECD Member States are resolved within 24 months. If taxpayers have achieved a suspension of the administrative appeal proceeding in parallel to the preparation of the request for the initiation of the MAP, the case can be taken back through litigation later on in the case of an unsatisfactory MAP outcome.

Germany has signed and ratified the EU Arbitration Convention, which applies between Germany and each of the other EU Member States. The purpose of the EU Arbitration Convention is to eliminate double taxation with transfer pricing adjustment at the level of companies that are resident in an EU Member States. Notably, the EU Arbitration Convention also applies to disputes over the attribution of income to branches.

The EU Arbitration Convention obligates the EU Member States to resolve transfer pricing disputes to relieve taxpayers from economic double taxation by imposing the duty to initiate arbitration proceedings. Should the competent authorities fail to reach an agreement that eliminates double taxation within two years, they must set up an advisory commission for deciding on how to eliminate the double taxation in question.

The Federal Ministry of Finance has issued administrative guidance on MAP and the arbitration procedure.

Germany has transposed the EU Tax Dispute Resolution Directive into domestic tax law. The mandatory dispute resolution rules apply to any double taxation of profits arising as of 2018. In practice, the new dispute resolution mechanism is particularly relevant for permanent establishment, tax residency and withholding tax issues.

iii Consequential impact for other taxes

Goods imported into Germany may be subject to customs duties and value added tax. The value of imported goods for customs purposes must be determined in accordance with the provisions of the Union Customs Code and the UCC Implementing Act. Their valuation principles conform to the customs valuation code of GATT. In essence, customs valuation rules are very similar to the income tax transfer pricing rules. However, there are some material differences that are caused by the fact that certain costs and payments must be excluded from, or added to, the dutiable value for customs purposes.

Outlook and conclusions

Transfer pricing and the documentation of arm's-length transfer prices are currently subject to aggressive tax audits in Germany. Taxpayers have to deal with increasing and complex documentation requirements.

The new Administrative Principles 2020 provide for an expanded obligation to submit documents and data, such as expert opinions, emails and messaging services. Moreover, the German tax authorities demand access to information located abroad allowing the scrutiny of transfer pricing.

In particular, the introduction of the best-method approach puts the burden of proof directly on the taxpayer. Furthermore, the taxpayer is obliged to document why he or she considers the applied transfer pricing method in each case to be the most appropriate method. The German tax authorities have also the discretion to choose an alternative transfer pricing method, if they consider it to be the most appropriate method.

It is highly doubtful that such an approach would be accepted by the tax authorities of the respective foreign-related party. This will result in an increasing number of double taxation cases leading to costly and time-consuming MAPs or litigations.

Consequently, taxpayers have to prepare thorough factual documentation and to treat the transfer pricing system as part of the tax compliance of the multinational group.

Finally, just recently German legislation has introduced more specific transfer pricing rules and implemented the OECD transfer pricing guidelines in German law.


1 Sven-Eric Bärsch is a tax partner and Vassil Tcherveniachki is a tax partner at Flick Gocke Schaumburg in Frankfurt and Bonn, respectively.

2 Further guidance on the application of the amendments, in particular on how to determine the amount of free capital of a permanent establishment, is set out in the ordinance on the application of the arm's-length principle to permanent establishments (Betriebsstättengewinnaufteilungsverordnung), which entered into force on 18 October 2014 as well as in the administrative guidelines on profit allocation to permanent establishments (Verwaltungsgrundsätze Betriebsstättengewinnaufteilung) from 22 December 2016.

3 Section 3.4 of the Administrative Guidelines on Procedures.

4 Section 3(3), Decree on the Profit Allocation of Branches.

5 Section 3(1), Decree on the Profit Allocation of Branches.

6 Section 3(1), Decree on the Profit Allocation of Branches.

7 Section 3(2), Decree on the Profit Allocation of Branches.

8 Section 3(3), Decree on the Profit Allocation of Branches.

9 Section 3(4), Decree on the Profit Allocation of Branches.

10 Federal Ministry of Finance, 13 October 2010, Federal Tax Gazette Part I 2010, 774, recitals 30, 63, 69 and 89.

11 Section 4(3), Decree on the Documentation of Income Allocation.

12 Section 355(1), General Tax Code.

13 Section 361(1), General Tax Code.

14 Section 47, Fiscal Court Code.

15 Section 76, Fiscal Court Code.

16 Section 120(1), Fiscal Court Code.

17 See Federal Tax Court from 9 August 2000, I R 12/99.

18 See Federal Tax Court from 21 January 2016, I R 22/14.

19 See Federal Ministry of Finance from 07 April 2017, IV B 5 - S 1341/16/10003.

20 See Federal Tax Court from 17 October 2001, I R 103/00.

21 See Federal Tax Court from 06 April 2005, I R 22/04.

22 See Federal Tax Court from 11 October 2012, I R 75/11; 17 December 2014, I R 23/13; 24 June 2015,
I R 29/14.

23 See Federal Ministry of Finance from 30 March 2016, IV B 5 – S 1341/11/10004-07.

24 See Federal Tax Court from 10 April 2013, I R 45/11.

25 See Lower Tax Court of Münster from 07 December 2016, 13 K 4037/13 K,F.

26 See Lower Tax Court of Cologne from 23 May 2017, 2 V 2498/16.

27 See Federal Ministry of Finance from 06 December 2018, Federal Tax Gazette Part I 2018, 1305.

28 See Federal tax Court from 27 February 2019, I R 51/17.

29 See Federal Tax Court from 27 November 2019, I R 40/19.

30 See Federal Tax Court from 18 May 2021, I R 4/17 and I R 62/17.

31 Section 4j, Income Tax Act.

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