Germany: “Transfer of functions” proposal to align arm’s length principle with OECD Transfer Pricing Guidelines

The German Federal Ministry of Finance on 5 July 2022 published a draft decree law regarding the transfer of functions. The aim of the draft decree law is to adapt and restructure the existing regulations on the arm's length principle with the current measures under the OECD Transfer Pricing Guidelines.

These new provisions are to be applicable retroactively to all cases of transfer of functions that begin after 31 December 2021.

Read a July 2022 release (German) and a detailed explanation of the draft decree (German) [PDF 174 KB] from the Federal Ministry of Finance.

The following key aspects are particularly relevant regarding transfer pricing for the transfer of functions.

• Broader definition of “transfer of functions”
  • According to the draft decree law, a transfer of functions exists if a function—including the associated opportunities and risks as well as (if applicable) assets or other benefits that may have been transferred or usage rights are provided—is transferred or relinquished in whole or in part so that the acquiring company can perform this function or expand an existing function. In addition, the phrase "and other benefits" would be replaced with "or other benefits.”
  • A restriction of function (at least at the time of the transfer) at the transferring company would no longer be part of the definition. However, there would be no transfer of functions if no restriction has occurred at the transferring company within five years after the transfer.
  • The draft also introduces an additional point in the definition—the expansion of the function at the receiving company. This could become problematic in instances when only an intangible asset (for example, the customer base) is transferred to the receiving company with an already existing sales function. The inclusion of the additional customer base could be treated by the German tax authorities as an expansion of the existing function.
• Materiality limit for intangible assets
  • Other benefits would be excluded from the materiality analysis and would be limited to intangible assets. Intangible assets are material in cases of the transfer of functions if they are necessary for the transferred function and the arm's length price exceeds 25% of the sum of the individual prices of all assets and other benefits of the transfer package. This is viewed as resulting in a significant restriction, in that a transfer of function could thus already be assumed if insignificant other benefits are transferred. Among other things, this could in particular affect transfers of routine functions. In order to prove that nothing of value has been transferred, a valuation of the entire transfer package could be required in such cases.
• Escape clause for so-called outsourcing cases
  • The “escape clause” would apply to situations when the function is outsourced to a company that is exclusively compensated for services provided, based on a cost-plus method. A valuation of the transfer package in accordance with § 2 would be required if the receiving company provides these services independently, in whole or in part, to other companies at higher prices than at cost-plus.
• Common valuation methods
  • In the future, common valuation methods, such as the discounted cash flow (DCF) method, would need to be used for a two-sided calculation to determine the value of the transfer package. In this context, the expected cash flows would be used instead of net profits after taxes. In this way, the drafters of the decree law want to allow the use of methods and parameters commonly used in business valuation.
• Capitalization period
  • The standard of proof for a period shorter than infinity would be tightened. There would be an obligation to provide concrete evidence when applying a shorter period than infinity. This could lead to considerable difficulties in practice because there is no guidance on how to provide such proof.

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice in Germany:

Svetlana Kuzmina | svetlanakuzmina@kpmg.com