On 3 December 2020, the Administrative Principles 2020 were published in a circular of the German Federal Ministry of Finance. Over 25 pages, the Administrative Principles 2020 concretise the views of the tax authorities on the obligations of taxpayers to cooperate regarding the examination of profit allocation between associated companies pursuant to section 90 of the German Fiscal Code (“Abgabenordnung”, hereinafter “AO”) and on estimates and penalties pursuant to Section 162 AO. The Administrative Principles 2020 partially replace the Administrative Principles Procedure of 12 April 2005 with a focus rather on procedural aspects.
In cross-border cases, the German taxpayer has an increased obligation to cooperate. Specifically, the taxpayer has to clarify the facts of the case, obtain evidence and take precautions to be able to provide evidence. The new Administrative Principles 2020 specify that the taxpayer cannot claim inability to clarify the facts or to submit evidence when the taxpayer could have had the opportunity to do so in structuring the circumstances. According to the Administrative Principles 2020, potentially relevant evidence now explicitly includes “emails, messenger messages or messages by means of other electronic communication media, insofar as these include business content with tax relevance” in addition to, as previously, e.g. expert opinions and statements on transfer prices.
The taxpayer has to demonstrate the arm’s-length nature of the transfer prices. According to the Administrative Principles 2020, it is no longer sufficient to justify the adequacy of the transfer pricing method actually applied; it now must be explained why the transfer pricing method chosen is the most appropriate method from the taxpayer’s point of view. Furthermore, when applying the hypothetical arm’s-length test, an explanation of the underlying assumptions applied as well as a sensitivity analysis on the effects of alternative assumptions on the valuation method is now also considered necessary.
According to the Administrative Principles 2020, the tax authorities are given the right to choose the correct transfer pricing method. If the transfer pricing method chosen by the tax authorities differs from that selected by the taxpayer, the taxpayer must provide the necessary information required by the tax authorities for the application of the transfer pricing method selected by the latter.
The Administrative Principles 2020 now also refer to the most recent version of the OECD Guidelines as of 2017. The official language remains German. Upon the taxpayer’s request, the German tax authorities may accept documents in foreign languages, which may have to be translated upon the German tax authority’s request.
Traditionally, German tax authorities have preferred a price-setting approach instead of an outcome-testing approach. Therefore, the economic and legal circumstances at the time of the conclusion of the contract or at the time when adjustments would have been made by third parties are decisive for the records. According to the Administrative Principles 2020, data that has subsequently become known may be used, provided that it refers to the time of the conclusion of the contract; it is irrelevant as to whether the contract was concluded in writing, verbally or by implied action.
Furthermore, the new Administrative Principles 2020 include further formal questions concerning transfer pricing documentation: regarding the local file, sample information on functions, assets and risks that may be relevant for the documentation of the facts and circumstances is provided in tabular form. Regarding the master file, clarification on the preparation, on the request for submission as well as on the submission deadline is presented.
If the taxpayer does not fulfil the obligations to cooperate, the tax authorities are allowed to estimate the tax base and to impose penalties pursuant to section 162 AO. This includes instances where the German taxpayer provides no transfer pricing documentation or a transfer pricing documentation that is non-usable. Records are non-usable if they do not enable a third-party expert within a reasonable period of time to determine and verify which facts the taxpayer has realised and whether the arm’s-length principle has been met. According to the Administrative Principles 2020, records are deemed to be non-usable, for instance, in the following cases: (i) documentation of facts is missing or inaccurate, (ii) the arm’s-length analysis is missing or does not match the function and risk profile, (iii) the arm’s-length analysis does not offer a sufficient justification on the comparability of external data or (iv) the application of transfer pricing method chosen is not presented. In case of non-usable records, the taxpayer should be given the opportunity for amendments.
According to the Administrative Principles 2020, the submission of usable records does not exclude income adjustments by the tax authorities. Generally, the tax authorities shall now be allowed to make income adjustments, even in the case of submission of usable records, if the transfer prices applied by the taxpayer are highly unlikely to be at arm’s-length and the transfer price determined by the tax authority is at least more likely.
In general, the new Administrative Principles 2020 contain (i) adjustments to the updated legal situation since 2005, (ii) further information on mainly formal questions concerning transfer pricing documentations and (iii) amendments on procedural aspects. It is also expected that the remaining parts of the Administrative Principles Procedure of 12 April 2005 and the Administrative Principles of 23 February 1983 will be revised soon. Above and beyond the new Administrative Principles 2020, changes on German transfer pricing rules as embodied in section 1 Foreign Tax Act will soon be enacted, which will likely include a legal implementation of DEMPE and intangible values, as well as further amendments to the existing transfer pricing rules.
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