The German Ministry of Finance issued first draft legislation called “ATAD-Umsetzungsgesetz” on December 10, 2019, to implement the EU anti-tax avoidance directive (ATAD).
The draft law suggests changes to German tax law in the following areas:
- Anti-hybrid rules
- Cross-border intercompany financing
- Transfer pricing (TP)
- Controlled foreign corporation (CFC) rules
- Advance pricing agreements
- Exit taxation for individuals
From a TP perspective, the draft law includes the implementation of a revised interpretation of the arm’s-length principle, based on the OECD Transfer Pricing Guidelines. According to the draft, most of the measures will be applicable as of January 1, 2020. The key changes relevant for TP purposes are summarized below:
Cross-Border Intercompany Financing
To consider a financial transaction as arm’s length according to the draft law, companies need to demonstrate that:
- They are expected to be able to service the respective payments throughout the entire term of the financing period
- There was a business need for financing, and the borrowed funds were utilized for that purpose
Additionally, for intercompany loans, the draft law contains provisions asserting a rebuttable presumption that the interest rate at which the multinational group can borrow funds in the market (i.e., this assumes that the group’s credit rating needs to be adopted) should be used.
Interestingly, these specific rules are drafted for inbound transactions, and the tax authorities could adopt a different approach in assessing outbound transactions.
Financing Functions (For Example: Cash Pool and Treasury Functions)
The draft implements the German tax authority’s view that financial intermediaries perform only routine functions and bear only routine risks. The draft applies this default position to all financial transactions, allowing only limited room for any consideration of the individual transaction (based on functional and risk analysis). Accordingly, the prescribed remuneration for the financing function is a cost-plus return (typically cost plus 5% ‒ 10%). However, the remuneration is effectively limited to the current market return of government bonds with “highest” rating/solvency and corresponding maturity. This would have some interesting implications in times of negative yields on government bonds.
Method Selection and Arm’s Length Range
The draft proposes a few changes to the calculation and interpretation of the arm’s length standard.
- First, the draft clarifies that the comparable uncontrolled price method is no longer the preferred TP method, but taxpayers should adopt the most appropriate TP method for each specific case.
- Second, the draft states that taxpayers should always apply an interquartile calculation when narrowing a range of results/prices, and that adjustments should be made to the median if transfer prices fall outside the range. However, the draft also includes a refutable assumption allowing the taxpayer to demonstrate that another value better reflects the arm’s-length principle.
Intangibles and DEMPE Analyses
The draft law introduces the concept of development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE) as outlined in the OECD guidelines, under which functions performed in connection with the development, enhancement, maintenance, protection and exploitation of intangibles are to be analyzed. This is done to accurately identify the transaction and to determine transfer prices for intangible transactions.
Transfer of Functions, Assets and Risks
The draft widens the definition of transfer of function. The current law defines a Transfer of Function as the transfer of functions, the associated opportunities and risks, the transfer of assets—AND other benefits. The draft law replaces the AND conjunction with an OR conjunction. Further, the escape clause that allows for a single asset valuation instead of a transfer package approach (i.e. jointly valuing the transferred functions, assets and associated economic opportunities) has been deleted in the draft. Both these changes will likely increase the efforts for identification and valuation of exit charges when functions are moved out of Germany.
Price Adjustment Clause
Germany already has a price adjustment clause in its current TP regulations to ensure arm’s-length pricing of transactions involving intangibles, for which the valuation is considered highly uncertain at the time of the transaction. The draft embraces current hard-to-value intangible (HTVI) guidance, establishing a rebuttable presumption that intangible pricing based on forecasts may require adjustment, when there is a significant difference between the financial projections and actual outcomes (20% or more). The application of the price adjustment clause has been reduced in the draft regulations from the current term of 10 years to 7 years.
TP Documentation
TP documentation requirements are further extended. The revenue threshold for preparing a master file is reduced from EUR 100 million to EUR 50 million. Further, the master file needs to be submitted electronically to German tax authorities within one fiscal year after the end of the fiscal year to which the master file relates. The new contemporaneous documentation requirement for a master file is suggested to be applicable for all fiscal years beginning after December 31, 2020.
Advance Pricing Agreement
The draft law introduces a legal basis in Germany for the conclusion of advance pricing agreements (APAs). Under the draft law, taxpayers can also apply for an APA for all cross-border issues that are covered by the respective Double Tax Treaty, i.e. the scope of an APA is not limited to TP issues.
Key Takeaway
The planned changes to the German TP regulations result in additional analyses and documentation requirements for taxpayers. While it is unlikely that all the suggested changes will be adopted in the final law, Germany’s different interpretation of the arm’s-length standard (in particular regarding intercompany financing) significantly increases the double taxation risk for German companies. It is hoped that the recently published OECD TP guidance on financial transactions will be reflected in the final legislation, to avoid double taxation, mitigate uncertainty and limit documentation requirements for taxpayers.
Isa Ferber, Vice President in Duff & Phelps' Transfer Pricing practice, is a contributing author.
Read Transfer Pricing Times – First Quarter 2020
