Comprehensive German regulations require special attention for inbound and outbound cases
1. Introduction
It is common practice in multinational groups to restructure their business activities cross-border. In order to determine an arm’s length remuneration for the restructured business activities, most countries rely on the Organisation for Economic Co-operation and Development (OECD) regulations as stipulated in Chapter IX of the OECD Transfer Pricing Guidelines. According to the OECD Guidelines, not all cases in which profit potential is transferred lead to a compensation claim.
The German regulations on the transfer of functions, which apply for both inbound and outbound business restructurings, go far beyond the OECD regulations. With effect from the fiscal year 2022, the requirements for a transfer of function as defined in Section 1 of the German Foreign Tax Act (“FTA”) were tightened. A transfer of function can now already exist if a function is transferred, including the associated opportunities and risks as well as the transferred or provided assets or (previously: and) other benefits. Further concretization was introduced by the German 2022 Ordinance regarding the cross-border transfer of functions as well as by the Administrative Principles Transfer Pricing 2024. The tightened regulation indicates that a transfer of function does not necessarily require a transfer of assets, but that other benefits may also suffice, indicating a potential increase in cases where the German tax authorities assume functional transfers.
If the conditions for a transfer of function are fulfilled in principle, a two-sided valuation is to be performed to determine an arm’s length transfer price for the so-called transfer package.
This article provides information on the comprehensive German regulations regarding transfers of functions.
2. Definition of a transfer of function and escape clauses
A transfer of function shall be deemed to exist if:
- There is a partial or full relocation of a function ...
- ... including associated opportunities and risks ...
- ... as well as assets or other benefits transferred or made available for use ...
- ... so that the acquiring company can commence a new function or extend an existing function.
These conditions must be cumulatively fulfilled.
The transfer package consists of a function including the associated opportunities and risks as well as assets or other benefits. It does not necessarily have to be a separate legal entity or an operating unit.
Generally, the 2022 Ordinance points out that a function is a business activity consisting of an aggregation of operational tasks of the same kind that are performed by certain units or departments of an entity. It is an organic part of a business but does not need to qualify the conditions of a so-called Teilbetrieb, another specific concept under German tax law. Functions are, for example, business activities resulting from research and development (R&D), production, sales, assembly, etc. Also, risk control and DEMPE functions are considered as functions in the context of a transfer of function. In addition, the sale of certain assets or product groups could also be considered a transfer of function.
The following table provides a comparison of assets and other benefits that can be part of the transfer package.
The German regulations provide two escape clauses:
- Outsourcing: Provided that the remuneration of the transferred function is based on the cost-plus method and the transferred function is performed exclusively by the receiving company vis-à-vis the transferring company, a transfer of functions can be denied.
- Duplication of a function: Provided that there is no restriction on the performance of the respective function by the transferring company within five years of the function being assumed by the receiving company, although the other requirements of a transfer of functions are met, a transfer of functions can be denied.
3. Hypothetical arm’s length test
If the conditions for a transfer of functions are fulfilled, the taxpayer has to determine an arm’s length transfer price for the transfer package.
In the context of a transfer of functions, the valuation object is often unique. If no reliable third-party data is available, the taxpayer has to apply the so-called hypothetical arm’s length test (“HALM”) based on an economically recognized valuation method (e.g., net present value, discounted cash flow (“DCF”) method, relief-from-royalty method).
One characteristic of the German transfer of functions regulation is the requirement to perform a two-sided valuation. In this sense, the DCF method is regularly chosen to determine a minimum price from the seller's point of view and a maximum price from the buyer's point of view. The application of the HALM simulates the negotiation process between independent parties at the end of which the price at which both parties would agree to transact is determined.
As a result, a significant portion of the entire profit potential of the transferred function is taxed in Germany, i.e., the expected loss in profit potential in Germany but also typically half of the expected gain in profit potential in the receiving country.
The following figure illustrates the determination of the range of agreement.
4. Further Points to Be Considered in Case of a Transfer of Functions
Additional reporting and documentation obligations as well as consequences may result from a transfer of function:
- Conclusion of a Purchase and Transfer Agreement including a price adjustment clause specifying a review date of the two-sided valuation clause to avoid the review by the German tax authorities after seven years.
- Reporting of the transaction (according to DAC6 guidelines) within 30 days with the German Competent Authority.
- Preparation of a transfer pricing documentation for extraordinary business activities within six months after the end of the fiscal years in which the transfer of functions took place. Given the new regulations in Section 90, paragraph 3 of the German General Tax Code, such documentation has to be submitted to the German tax authorities within 30 days upon receipt of a tax audit announcement without further request.
5. Conclusion
The German regulations on transfers of functions contain many special features for the taxpayers which go far beyond the regulations stipulated in Chapter IX of OECD Transfer Pricing Guidelines and do therefore contain tripping hazards for many multinational groups with headquarters abroad.
Given that transfers of functions are a hot topic in German tax audits leading to controversial debates between taxpayers and the German tax authorities, it is important to carefully consider the aspects described above.
In our next newsletters, we will provide more insights into recent case law regarding transfers of functions, case studies as well as the special case of a transfer of a non-profitable function.
Our KPMG Transfer Pricing Experts would be pleased to assist you with any questions you may have.
Publication Date:
29 August 2025