The German Federal Council on July 6 approved the 2008 corporate tax reform bill, which introduces significant changes to Germany’s transfer pricing legislation. The Federal Ministry of Finance has been authorised to provide further details on the application of the arm’s length principle to ensure consistency and legal certainty for taxpayers. Pursuant to this authorisation, the Federal Ministry of Finance recently distributed a draft decree law covering the relocation of functions, and asked trade organisations for their review and comments.
The first section of the draft decree law defines various terms used in the tax reform law, such as “function,” which is defined as the aggregation of similar operational tasks, including corresponding opportunities and risks, executed by certain departments of the enterprise. Accordingly, a
relocation of functions will be deemed to have taken place when a function performed by one entity is transferred to another entity, even if the transfer is partial or temporary.
Moreover, the term “relocation of functions” also includes the duplication of functions; that is, if a function is also performed by a second entity without changing the initial existing structure of the transferring company, the function will be deemed relocated. However, a mere sale or licensing of assets and the provision of services do not qualify as a relocation of functions. This is also true for employee secondments, unless a function is transferred with the seconded employee.
Because the relocation of functions is considered a comprehensive deal, the individual components transferred will be evaluated as one so-called “transfer package” comprising not only assets and intangibles but also opportunities, risks, and advantages. The new law assumes that a transfer of functions gives rise to a transfer of profit potential. So, the draft decree law stipulates that the value of the transfer package will be determined based on the expected after-tax earnings of the transferring company and the receiving company, taking into account the actual circumstances resulting from a functional analysis before and after the restructuring.
According to the new transfer pricing legislation included in the tax reform package approved on July 6, the “commensurate with income” standard applies to allow the tax authorities to retroactively adjust the taxpayer’s income if a significant change of circumstances takes place within 10 years after the relevant business transactions, and if the related parties did not agree in advance to an adjustment clause. Such an adjustment is permitted only once in the year following the year in which the changes occurred. The draft decree law defines the term “significant change,” which will be deemed to have occurred
if the transfer price determined on the basis of the actual profit development is outside the original range of potential agreement. Should a significant change occur, an appropriate transfer price will be established based on the supplier’s original minimum price and the recipient’s newly calculated
maximum price. The difference between the original and newly determined transfer prices is considered an appropriate adjustment.
The draft decree law contains various definitions and explanations; however, because those definitions and explanations are too broad and indefinite, they hardly clarify the scope of application of the new regulations concerning the relocation of functions. So, many questions are expected to arise from the application of the new transfer pricing legislation and the decree law on the relocation of functions in practice.
The Federal Ministry of Finance is expected to publish additional administrative guidance explaining not only the law, but also the decree law. The decree law will become effective from the 2008 assessment period.
Stephan Rasch (Munich)
Partner
Deloitte Touche GmbH
+49 (89) 29036 8722
srasch@deloitte.de
Susanne Hammerschmitt (Düsseldorf)
Consultant
Deloitte Touche GmbH
+49 (211) 8772 2503
shammerschmitt@deloitte.de