Field report: Data centres in the focus of tax audits

The German tax authorities, in particular the Federal Central Tax Office (BZSt), have increased their focus on auditing the activities of intra-group data centres in Germany. The audit is focussed on two key aspects:

The German tax authorities, in particular the Federal Central Tax Office (BZSt), have increased their focus on auditing the activities of intra-group data centres in Germany. The audit is focussed on two key aspects:

In transfer pricing practice, the provision of computing capacity within a group is typically categorised as a routine activity to which no significant added value is attributed. This also applies to technology companies that require this computing capacity in order to provide their digital products or virtual services to customers. The required data capacities are seen as a hygiene factor of the business model; however, they do not represent a significant value creation factor. In our experience, intragroup data centres are generally remunerated on a cost-based approach with an appropriate mark-up for routine functions.

However, the tax authorities see a significant value contribution in intragroup data centres and regularly argue that intragroup data centres in Germany are of considerable importance to the business model itself and are not easily interchangeable. In their view, the location makes a significant contribution to market success, even if the personnel functions available on site (i.e. the number of data centre employees) are generally limited. Therefore, the tax authorities are of the opinion that the remuneration for the provision of computing capacity should also take into account the scalability of the business model operated with such capacity. This could be appropriately achieved, for example, by remuneration based on the external revenue of the content provider.

The challenge for both sides in these cases is that arm's length prices to justify the appropriateness of the remuneration are difficult to obtain. Intra-group data centres with their unique functional and risk profile are not comparable with those of third-party providers, as there is typically no market risk in the intra-group context due to the guaranteed purchase of capacity. Price information from third-party providers that might be comparable is generally not publicly available and therefore cannot be easily analysed for comparability.

Taxpayers that use domestic group-internal computing capacities should prepare for stricter transfer pricing audits by analysing and documenting the function and risk profile of their group-internal computing centres in more detail. The appropriateness of the chosen remuneration should also be analysed using alternative remuneration methods, such as return on assets employed or based on the volume of capacity used. If practicable for the taxpayer, it is advisable to have the double taxation eliminated by means of a bilateral mutual agreement procedure - if possible in the individual case - in the event of potential tax audit findings.

According to national law, as defined in Section 12 sentence 1 of the German Fiscal Code, and established case law, a permanent establishment requires a business facility or installation with a fixed connection to the ground that is of a certain duration. The business facility or installation must serve the activities of the company and the taxable person must have more than temporary control over it. Personnel are generally not required to establish a permanent establishment on the merits.

From an international perspective, it is crucial to assess the individual situation under the applicable double taxation agreements (DTAs) between Germany and the countries concerned (e.g. country of residence of the contractual partners of the intra-group agreements for data centre operations, e.g. content providers). The DTAs often do not differ significantly from the OECD guidelines with regard to the criteria for establishing a permanent establishment. However, a detailed review based on the specific circumstances of the individual case is advisable.

In the cases we have observed, the German tax audit assumes that the requirements for a permanent establishment of a foreign content provider are met even if the data centre is not owned by the foreign content provider but by a separate German legal entity and the foreign content provider only has virtual access to the computing capacities.

In our view, the assumption of a server permanent establishment should be critically examined on the basis of the individual facts of each case, in particular with regard to the extent of control over the fixed place of business.

If a permanent establishment of the content provider in the German data centre is indeed to be assumed, the next step is to assess the quantitative effects. These are derived from the Authorised OECD Approach, as set out in the 2010 OECD report on the attribution of profits to permanent establishments, the German principles on the allocation of profits to permanent establishments in accordance with Section 1 of the Foreign Tax Act (AStG) and the Permanent Establishment Profit Allocation Ordinance.

From an international as well as a national perspective, the essential personnel functions to be allocated to the permanent establishment are a decisive factor for the attribution of potential profits, with national law focussing even more on the physical presence of the essential personnel functions. In the case of server sites without a significant local physical personnel function, the quantitative effects should therefore be relatively low - at least under current national law.

If the tax audit assumes a permanent establishment of the foreign content provider in domestic data centres, we recommend that this assumption be critically questioned, as there are no clear guidelines under international and national law for the assumption of a permanent establishment in the context of virtual business models.

If the German tax authorities insist on the assumption of a permanent establishment for the foreign content provider in Germany, we recommend applying for a bilateral mutual agreement procedure in order to eliminate double taxation as far as possible and also to create international awareness of the German tax authorities' approach.

Our KPMG transfer pricing experts will be happy to answer any questions you may have.ung.

Publication date:27.03.2025