Tax authorities have amended controversial guidance regarding relocation of functions
The German Ministry of Finance (MOF) published an updated decree providing “Administrative Principles regarding Transfer Pricing” on 6 June 2023 (“TP principles”). The updated decree replaces not only two-year-old general transfer pricing guidance that was published in a decree dated 14 July 2021 (see GTLN dated 29 July 2021), but also guidance on the transfer or relocation of functions. This guidance was outdated in light of a new law that went into effect on 1 January 2022.
The TP principles introduced a few new concepts that may be relevant to a taxpayer planning a transfer of function or having completed one after 31 December 2021, as further discussed below:
Outsourcing: When outsourcing a routine function for a cost-plus remuneration, no transfer package (including the size and content of the function) was subject to a transfer valuation until 31 December 2021 because it was deemed that no significant intangible assets were part of the transfer. However, as from 1 January 2022, the tax authorities request to see a calculation demonstrating that the transferred function does not include intangible assets that constitute greater than 25% of all assets transferred. In addition, while in the past transferred advantages were to be included in the calculation of the 25% materiality threshold, they now have to be examined separately. If the transfer includes any advantage, then the whole transfer becomes taxable based on the transfer package valuation.
Substitution: The exchange of one function for another is deemed to be a transfer of a function as well. The TP principles provide several examples, including the following:
Loss situation: The TP principles also provide guidance regarding loss-making functions. When transferring such functions, the tax authorities distinguish between four basic cases:
Single intangible asset transfer: The single transfer of an intangible asset now must always be analyzed together with the shift of “control over risk” with respect to the associated DEMPE (development, enhancement, maintenance, protection, and exploitation) functions. Whenever a DEMPE function is active and controlled by the transferor and becomes part of the transfer of the IP, a transfer of a function together with a transfer package valuation has to be considered.
Stripping of function to routine: When stripping a full-fledged function to the routine level, if an arm’s length termination clause has been agreed, the valuation of the routine function must be based on an analysis of expected values that take into account both the financial surpluses in the event of the continuation of the function and the financial surpluses in the event of the termination of the routine contract (e.g., closing costs or compensation payments) in proportion to their respective probability of occurrence.
The updated TP principles are more restrictive than they were previously. The examples provided are welcome as they make the intent of the tax authorities easier to understand, although they are not completely aligned with German fiscal jurisprudence and fail to define what would constitute a partial transfer of a function.
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