Transfer pricing agreements - new challenges due to Section 153 (4) AO

German taxpayers have a legal obligation to report incorrect or incomplete tax returns to the tax authorities immediately if they become aware of them and to correct them if a tax reduction has occurred (Section 153 (1) AO). With the introduction of Section 153 para. 4 AO, taxpayers are faced with new challenges, as this regulation extends the obligation to notify and correct.

Transfer pricing is not an exact science and transfer pricing disputes often end with a compromise in a final meeting. It is not uncommon for tax auditors to explicitly enquire at the beginning of the follow-up audit whether an agreement reached for the previous audit period has been continued in the tax returns for subsequent years. The provision of Section 153 (4) AO therefore raises the question of whether an agreement reached in the tax audit may entail an obligation to make corrections or updates in future tax periods. Is it still possible to reach an agreement with the tax audit on certain transfer pricing issues and can such an agreement be legally limited to the current tax audit period?

This article provides an overview of the new requirements and highlights practical aspects of the application of Section 153 (4) AO to transfer pricing issues.

According to Section 153 (1) AO, taxpayers who subsequently realise that a submitted declaration is incorrect or incomplete and this leads to a tax reduction must report this to the tax office immediately and correct it.

With the aim of speeding up external audits, the legislator has now extended the obligation to make corrections to include the provision in Section 153 (4) AO: According to this, the obligation to notify and make corrections now also exists if the audit findings of an external audit have been implemented in a tax assessment notice in an incontestable manner and the underlying facts also lead to an amendment of other tax returns submitted that were not the subject of the external audit. In other words, the correction obligation now also applies if the original declaration was correct and complete, but the external auditor takes a different view on a particular matter and has made adjustments on this basis.

The provision of Section 153 (4) AO applies to all taxes arising after 31 December 2024 and to all tax periods for which an audit order is issued from 1 January 2025. This means that tax periods prior to 2025 are also affected by the regulation.

a. Incontestable implementation of audit findings

The audit findings of the external audit must have been implemented incontestably in a tax assessment notice, assessment notice or partial final assessment notice, i.e. the notice can no longer be contested with a legal remedy. The notification and correction obligation in accordance with Section 153 (4) AO therefore does not apply if and for as long as an objection is lodged against the assessment notice, which suspends the final judgement.

As a rule, transfer pricing disputes are either ended by an agreement with the tax audit or continue after the conclusion of the external audit in court proceedings or by conducting an international mutual agreement procedure. The agreement with the tax audit usually requires a waiver of further legal remedies. In the event of an agreement, the requirement that the audit findings have become incontestable within the meaning of Section 153 (4) AO is thus fulfilled.

The situation is different in the case of an objection or appeal. In these cases, the audit findings only become incontestable with the decision on the objection or through a legally binding judgement, unless they have been amended in the objection or legal action. Therefore, if these proceedings have not yet been concluded, they do not become final and therefore the legal consequence of Section 153 (4) AO does not even occur.

The incontestability of a tax assessment in a mutual agreement procedure essentially depends on whether taxpayers have lodged an objection; without an objection, incontestability occurs, but can be cancelled again by certain regulations and thus the incontestability of the audit assessment can ultimately be influenced by the outcome of the mutual agreement procedure.

b. Significance of the underlying facts

The facts underlying an audit finding are of particular importance in the context of Section 153 (4) AO: The obligation to notify and correct only arises if these facts lead to a change in the tax bases in other (non-statute-barred) returns.

As explained at the beginning, the focus for transfer pricing issues is on a possible obligation to update audit findings into subsequent years, so that the requirement that the declaration must be one that was not the subject of the current external audit is always fulfilled for the declarations of subsequent years. This raises the question of how the term "underlying facts" is to be understood that give rise to a change in the tax bases in subsequent years.

At this point, it is still unclear whether Section 153 (4) AO only refers to completely new and unrecognised facts or also to facts that have already been recognised. The latter should already have been processed in subsequent declarations and should therefore not lead to any changes. The question then arises as to whether the regulation only covers "circumstances with a permanent effect", i.e. circumstances with a one-off justification and ongoing tax impact (e.g. long-term intra-group lending at a fixed interest rate), or whether it also applies to "circumstances with a permanent recurrence", i.e. similar circumstances that arise periodically (e.g. share of non-offsettable shareholder costs). If only "circumstances with a permanent effect" are covered, the scope of application of the new regulation is very narrow.

In the current discussion about the obligation to update audit findings in transfer pricing, it is questionable whether the regulation also applies to subsequent years. The main reason for this is that transfer prices must be reassessed annually due to constantly changing market conditions (e.g. macroeconomic factors). Furthermore, the transfer pricing maxim applies that a transaction-related appropriateness analysis must be carried out. Therefore, the concept of the facts of the case should be interpreted rather atomically, so that it ends at the latest at the end of the assessment period, even if the business relationship between the related parties continues. An interpretation of the term "underlying facts" is therefore decisive for the assessment of whether an update obligation could exist.

The application of Section 153 (4) AO to transfer pricing issues is questionable due to the dynamic nature of transfer prices and can probably only be applied in individual cases, as issues must be considered atomically for each assessment period and, moreover, transfer prices must be reassessed at each point in time against the background of the respective market conditions.

It is advisable to proactively address the provisions of Section 153 (4) AO, in particular the potential obligation to update, in the final discussion of a tax audit. Both parties should determine how far the agreement extends in terms of time. Taxpayers should document the results in meeting notes and it is advisable to take minutes of the final meeting.

Failure to comply with the duty of disclosure and correction in accordance with section 153 para. 4 AO is - as with para. 1 - punishable by law if taxpayers have not complied with their duty despite being aware of it. In order to fulfil tax obligations and minimise risks under criminal and fine law, taxpayers should always check whether the underlying findings may affect declarations already submitted in periods that are not time-barred.