GERMANY- PROPOSE D CHANGES TO GERMAN TRANS FER PRICING LAW
The German Ministry of Finance has published a draft bill for tax law changes which will become effective on 1 January 2013. The draft is subject to discussion and revision by the Parliament and the Federal Council of Germany. The following comments focus on the most important envisaged changes in the area of Transfer Pricing.
The law aims at applying the arm’s length principle to all types of cross-border transactions irrespective of whether the transactions take place between corporations and/or partnerships and/or permanent establishments. Firstly, the law clarifies that the arm’s length principle also applies to partnerships. From a legal perspective, a German limited or unlimited partnership may conclude agreements with other entities. However, the income of a partnership for corporate or individual tax purposes is attributed to the limited or unlimited partner, and taxed at the level of the partners. Therefore, the law now clarifies that the arm’s length principle directly applies to the business transactions between the partnership and other entities or permanent establishments. In this regard the legislation will also cover partnerships which do not carry on a trade of business but limit their transactions exclusively to the administration and use of their assets (for instance, renting out real estate).
Furthermore, the amended legislation will replace the term ‘business relation’ (Geschäftsbeziehung) by the term ‘economic transaction’ (wirtschaftlicher Vorgang), in order to clarify that all legal contractual relationships as well as other transactions will be considered. In this regard, the law will include a rebuttable presumption that all business transactions, with or without evidence for contractual agreement, will be treated as if such agreements were available. In addition, economic transactions (“dealings”) between entities and foreign permanent establishments are regarded as economic transactions.
In this regard, the law will explicitly state that cross-border business transactions between entities and their permanent establishments (including branches) are subject to the application of the arm’s length principle.
Thus, the law wants to consider the new “Authorised OECD Approach”, which has been introduced by the revised OECD Transfer Pricing Guidelines in July 2010 and which treats permanent establishments as if they were independent enterprises. Hence, despite the fact that no contractual relationship is possible between an entity and its permanent establishment (in practice frequently so-called “pro-forma agreements” are made for purpose of evidence), the arm’s length principle has to be applied to transactions between head office and permanent establishment. This means that for the allocation of profits the permanent establishment is treated as an independent enterprise, unless international taxation principles require a different treatment (for instance, limited application for debt financing). In line with the new authorised OECD approach, the allocation of profits to a permanent establishment will be made in two steps, and should in the first instance consider the people functions.
These functions determine which assets, functions and risks have to be attributed to the permanent establishment. In a second step, the dealings between head office and permanent establishment then need to be considered.
The application of the usual transfer pricing methods results in the attribution of taxable profits to the permanent establishment.
The fiction of an independent enterprise may achieve the result that a permanent establishment can generate a profit although the enterprise as a whole suffers a loss, or the permanent establishment suffers a loss despite the fact that the whole enterprise generates a profit.
Partnerships and permanent establishments in Germany are subject to compulsory transfer pricing documentation in line with the rules that are applicable for corporations. This also means that the relief for small businesses may be claimed.
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