German Federal Ministry of Finance: Administrative Principles 2021 published

On 14 July 2021, the administrative principles “Verwaltungsgrundsätze Verrechnungspreise” (Administrative Principles Transfer Pricing, in the following “administrative principles 2021”) were published. Although not binding for taxpayers and courts, the new administrative principles outline the tax authority’s view on the principles for the adjustment of income pursuant to section 1 Foreign Tax Act (FTA). The administrative principles 2021 are to be applied to all open cases.

In the first chapter, information is presented among other things on the relationship to other adjustment rules (e.g. hidden profit distributions), on the German controlled foreign corporation regime rules and on the terms “related party” and “business relationship”. According to the administrative principles 2021, conditions such as discounts, terms or securities agreed as part of a business transaction are also subject to the arm’s-length principle, so that reductions in income due to conditions not in line with the arm’s-length principle can be subject to a correction in accordance with section 1 FTA.

The significance of the OECD Guidelines 2017 for the analysis of cross-border business relationships is explained in the second chapter. In this context, the OECD Guidelines 2017 are explicitly referenced and included as an annex, thereby intended to serve as a guidance for the German tax authorities. It should be noted, however, that the administrative principles 2021 provide further concretizations which have priority over the OECD Guidelines 2017 and which, in the opinion of the tax authorities, are necessary to ensure equal taxation.

Furthermore, reference is made to the guidance of the EU Joint Transfer Pricing Forum and the Transfer Pricing Manual of the United Nations, which, however, are not included as an annex.

The third chapter provides further information e.g. on the arm’s-length principle, Transfer Pricing methods, comparability analysis, intangible assets, supplies of goods and services, cost allocations, transfers of functions, financing relations and international mutual agreement and arbitration proceedings. The administrative principles 2021 still refer to the administrative guidance on international mutual agreement and arbitration proceedings dated 9 October 2018. This guidance has meanwhile been replaced by a new administrative guidance dated 27 August 2021, which now also contains explanations on the dispute resolution procedure under the EU directive on tax dispute resolution mechanisms in the European Union.

Additionally, information on IC financing is provided. It is the opinion of the tax authorities that the first step is to check whether the financing represents debt or equity for tax purposes. For a loan to be qualified as debt for Transfer Pricing purposes, (i) the financing must be economically required by the borrower; (ii) an appropriate return on investment covering the financing costs would usually be expected by the borrower; and (iii) the use of the loan should be in line with the business purpose of the borrower.

The administrative principles 2021 also address the issue of implicit group support, stating that implicit group support merely describes the legal and economic framework of the corporate relationship and is therefore neither a legally enforceable security nor a proxy for it. Nevertheless, implicit group support is of significance in the assessment of the borrower’s subjective default probability and thus has a de facto effect on the credit rating. Therefore, the extent and impact of implicit group support shall be examined appropriately in each individual case. Secured loans are generally considered to be at arm’s length, whereas non-secured loans may be at arm’s length depending on the facts and circumstances of the case. According to the administrative principles 2021, this assessment should consider, among other things, the extent to which liabilities are secured in relation to third parties, the economic benefit of the security or options realistically available.

Due to the publication of the administrative principles 2021, several other administrative guidelines are repealed (a complete list can be found in point 6.1 of the administrative principles 2021). The administrative principles 2021 are to be applied to all open cases. Therefore, existing Transfer Pricing cases should be analyzed, taking into account the new guidance and the new tax law changes (please see our other article for the new tax law changes).

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