Transfer pricing in Germany.

• Author: Jarsch, Kerstin

In international business, most industrialized countries have adopted tax rules that require related parties to deal at arm's-length when transacting business with one other. Under Germany's rules, if a taxpayer conducts business with related parties, then the tax authority will usually examine whether it fully accounted for the income (i.e., whether the income is correctly allocated between the related parties). Along with Germany, other European countries, Great Britain, Luxembourg and the Netherlands, have strict laws or regulations for correctly allocating income between related parties, based on the Organisation for Economic Co-operation and Development's (OECD's) guidelines.

The German legislation on transfer pricing (TP) establishes the principle of arm's-length pricing for related-party transactions. The TP statutory rules are not found within one integrated section of the legislation, but in several provisions in different acts. The provisions include a definition of related parties and provide that when the assets or income of a German taxpayer are reduced by means of non-arm's-length transactions with related parties, that taxpayer's income may be adjusted accordingly.

Pricing Methods

Transactions between related parties should be evaluated for tax purposes according to whether those involved have acted like third parties independent of each other (i.e., under the arm's-length principle). The difficulty is how to find an appropriate transfer price that meets the arm's-length principle.

The OECD-accepted TP methods have been divided into two groups: the traditional transaction methods (which include comparable uncontrolled price, resale price and cost-plus) and the transactional profit methods (which include profit-split and transactional net-margin); see the exhibit at right.

German fiscal authorities have a clear focus on transaction-based methods; there is no order of priority of the standard methods for the examination of transfer prices. Profit-based methods are not formally accepted by the German tax authority--only profit-split is discussed as a method of last resort.

Written Contracts (Contractual Terms)

From a fiscal viewpoint, for transactions between a dominant shareholder and its subsidiary, a written agreement is almost required for the intercompany transactions to prove compliance with the arm's-length principle. Besides evaluating proper transfer prices and stipulating them in written contracts, another important...