Transfer pricing and the documentation of arm’s-length transfer prices are closely scrutinized and often disputed in tax audits. Germany has had administrative guidance in place since 2005, specifying German taxpayers’ obligations during a tax audit. On December 3, 2020, the German Ministry of Finance published a revision of this guidance, now known as the ‘Administrative Principles 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 apparently 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.
Overview of revised administrative guidance on transfer pricing
The key aspects of the Administrative Principles 2020 are the following:
- Expanded obligation to submit documents and data, such as expert opinions, emails, messaging services, etc.
- Clauses for the exchange of information between the contracting parties must be included when an intercompany agreement is finalized. This ensures the German taxpayer has access to information located abroad, allowing it to present it to the German tax authorities upon request. This will concern the determination of the costs incurred at the level of a foreign service provider if the cost-plus method has been applied.
- When certain regulations under foreign law clash with requests for information from the German tax authorities, it can result in a conflict of duties. The German tax authorities are granted the right to estimate the taxable income if the taxpayer complies with prohibitive regulations under foreign law, i.e. does not comply German information requests.
- The arm’s-length principle and required documentation shall be applicable for special business assets and special business income/expenses in a cross-border context. These are, for instance, incurred at the level of a foreign partner but allocated to the German partnership under general rules. The legal basis for this expansion of the arm‘s-length principle is, however, somewhat doubtful.
- Introduction of the best method approach. This means that the taxpayer is obliged to document why it considers the applied transfer pricing method in each case to be the most appropriate method. The legal basis for expanding the arm‘s-length principle is however very doubtful.
- The German tax authorities have the discretion to choose an alternative transfer pricing method if they consider it to be the most appropriate method. This alternative method may justify an income adjustment if the outcome (i.e. the transfer price being obtained from that alternative method) is more likely than the method actually applied by the taxpayer. The revised administrative guidance does not define the term “more likely” which is expected to cause additional disputes during German tax audits.
- Presentation of transfer pricing documentation outside of tax audits upon request (e.g. during WHT relief procedures).
- The revised administrative guidance makes references to rules concerning tax evasion procedures. This can be understood as a threat to taxpayers who stretch the interpretation of the arm’s-length principle too far.
That said, it is important to prepare correct transfer pricing documentation, which complies with the legal requirements. Otherwise, this may justify a change of the burden of proof of arm’s-length transfer prices to the taxpayer. Moreover, the tax authorities may be authorized to estimate transfer prices, i.e. by fully utilizing a range of self-elaborated comparables, normally to the detriment of the taxpayer. The now tightened administrative guidance underlines this even more. Taxpayers should always take care to comply with their documentation duties in a timely and complete manner.
Overarching implications for global businesses
The revised administrative guidance on transfer pricing has led to stricter rules, enhancing the position of German tax auditors. One must wait and see whether German tax courts will follow these broad compliance requirements.