Article by Andreas Köster-Böckenförde and Alexa Clauss

I. Introduction

The development, transfer, and licensing of intangibles are part and parcel of cross-border transactions among related parties. The allocation of costs and revenues, risks and chances, has a fundamental impact on the tax liability of multinational companies. Therefore, enterprises should pay special attention to transfer-pricing strategies, particularly with regard to intangible assets. But determining adequate transfer prices is extremely difficult. And the national fiscal authorities closely examine how companies deal with this matter, paying particular attention to whether they comply with the documentation rules.

II. The Definition of "Intangible Property"

When determining transfer prices, the first step is to identify the intangibles. Since there is no universal, abstract definition of "intangible assets" in German legislation or administration, the identification of intangibles often presents serious difficulties. The applicable rules and guidelines comprise only enumerations of intangibles.1

Under Section 266.II.A of the German Commercial Code (Handelsgesetzbuch), "intangibles" are identified as concessions, industrial property and similar rights, the licenses referring to such rights, goodwill, and advance payments. Section 5 of the 1983 Administrative Guidelines lists industrial property and similar rights, design protection rights, copyrights, business secrets, and other rights and benefits not legally protected.2 The 2005 Administrative Guidelines discuss the transfer of intangibles without defining the term at all.3

In several judgments, the Federal Tax Court defined "intangibles" as "incorporeal objects."4 Nevertheless, in most cases the Court merely gives examples (the right to supply, options, concessions,5 software6) without providing a more general or abstract definition.

The literature tries to bridge this gap, holding that the lack of physical substance distinguishes intangible from tangible assets. Commentators further define "intangible assets" by explaining what they are not: neither material fixed assets nor financial assets.7 While financial assets obviously have no physical substance, they do have a monetary value and serve the enterprise in a financial respect, whereas intangibles are used in the operative group of goods and services.8 The criterion of physicality is not always determinative. Many assets, such as software or copies, have both corporeal and incorporeal features and are distinguished according to their ratio of tangible to intangible components.

The definition of "intangible asset" provided by Chapter 38 of the International Accounting Standards ("IAS") may be also indicative. According to IAS 38.8, an "asset" is a resource that is controlled by the enterprise as a result of past events (e.g., a purchase or self-creation) and from which future economic benefits (inflows of cash or other assets) are expected, while an "intangible asset" is an identifiable nonmonetary asset without physical substance. Thus, the three critical criteria of an intangible asset as listed by IAS 38.10 are control, identifiability, and future economic benefits. Pursuant to IAS 38.12, an intangible asset is identifiable when it is separable (i.e., capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or as part of a package) or arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. Additionally, IAS 38.21 requires an enterprise to recognize a resource as an intangible asset if it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise and that the cost of the asset can be measured reliably.

In summary, "intangible assets" may be understood as identifiable matters of potential benefit without physical substance which may be either legally protected or unprotected and which are used in the operation of a business.

III. German Generally Accepted Accounting Principles ("GAAP")

Long-term intangible assets that are acquired for a consideration have always been capitalized on the asset side of the German GAAP balance sheet. In contrast, companies were not allowed to account for self-made intangible assets. Now, however, the GAAP in Germany stipulate that self-developed long-term intangibles created after December 31, 2009, may be capitalized if the owner elects to do so. The only exceptions are self-made brands, publishing rights, customer lists, and similar assets.9 With respect to R&D expenses, only expenses arising from the development or advancement of products or procedures within the scope of applied research may be capitalized. Expenses for evident research—the independent and methodical search for new scientific or technical expertise for general purposes, regardless of technical applicability or economic success—cannot be capitalized. Nor can the costs of projects in which development cannot be distinguished from pure research.10 Business expenses that cannot be capitalized are immediately deductible. The capitalized expenses have to be depreciated over the useful economic life of the asset.

IV. The Development of Intangibles

In order to increase economic efficiency, multinational groups often assign their research and development projects to separate specialized companies within the international group. A company may fund and conduct R&D activity in three different ways: own development, contract research, and the R&D pool.11 In terms of location, forms of global development have been relevant for the past couple of years.

1. Own Development

In the case of "own development," the company conducts all research and development activities on its own. The development, ownership, and associated risks are concentrated within that company, which bears all the research and development expenses and reaps all the benefits that result.12 This form of R&D is rarely used by multinational groups, since ownership of the intangibles would then be located in various companies in several jurisdictions, making the protection and administration of these assets difficult and inefficient. In multinational groups, the development of intangibles is usually centralized, with local development restricted to minor adjustments required by local markets.

2. Contract R&D

A company engaging in "contract research" retains another company to conduct defined R&D activities on behalf of the principal. Contract research is used for basic and applied research, new inventions, and product development.13 The principal, rather than the research company, bears all the risks and reaps all the benefits of the activity.14 Because contract research is a service, the performing company receives remuneration, but it does not receive a license.15 Contract research may be ordered by any company, a group of companies, or an R&D pool.

Engaging in contract research is the most efficient way to exploit both local expertise and centralized ownership. It enables companies to make use of the specific knowledge of employees or research facilities existing in certain jurisdictions. At the same time, it makes it possible to place ownership of the intangible within the jurisdiction that best fits the business strategy, provides the best legal protection, and/or optimizes the multinational group's tax position.

3. R&D Pools

"R&D pools" are commitments in which the participants jointly undertake research and development activities. Each participant may have a different obligation: some may make personnel available while others provide funding, with the rest supporting the project by other means. In return, each participant benefits from the results of the research in its own or some other territory at no additional cost. The participants share the costs and risks according to a defined percentage of payment, e.g., cost allocation, and obtain co-ownership of the research results.16 R&D pools may also be implemented by unrelated parties.

4. Global Development

The term "global development" refers to any R&D activity that is conducted at multiple locations around the world by multiple R&D teams. The R&D teams work on the same project and share their results frequently, if not daily. Global development projects are often seen in the software industry. Since global development projects can be spread over multiple locations, they can be conducted in all three R&D forms: as own development, in the rare instances when a company has multiple R&D offices around the world; as contract research, in which a company engages multiple contractors that share results; or as R&D pools, when the participants are in multiple locations.

V. The Use of Intangibles

There are different ways to make use of an intangible asset: a company may either temporarily license the right to use it, sell it outright, or transfer it by other means.

1. Licensing or Transfer

The intellectual property rights owner (licensor) may enter into a licensing agreement with another party (licensee) authorizing the licensee to use such rights in return for an agreed payment (fee or royalty). Normally, the right to use the intangible is granted for a limited time and/or for a defined territory only, so the licensor remains the owner of the intangible. Restricting the license to a certain period, territory, application, etc., provides the licensor with a great deal of flexibility with respect to the exploitation of the intangible.

The intangible may also be sold and transferred. In such cases, no restrictions as to time, territory, or application apply. The legal character of the transaction is determined by the interpretation of the respective agreement and the consistent intention of the parties. In case of doubt, only the right of use is transferred. In contrast, a "transfer of title" includes the entire proprietary holdings of the intangible asset. Under German civil law, this is regarded as a sale and purchase agreement.

Where the intangibles are part of tangible assets—i.e., "embedded intangibles"—the allocation of the assets might differ. If, for example, the sale of goods includes the right to use an embedded intangible asset, no license fee will be due, as the fee will be included in the price for the goods.17 In such case, the use of the intangible is not restricted with regard to time or territory, but the intangible's application is limited to that of the purchased tangible asset.

The distinction between licensing and transfer is crucial, since only transfers effect immediate realization of profits to tax. A recurrent charge generally indicates licensing. Nevertheless, one must take care that the period of usage as provided in the respective agreement does not exceed the useful economic life of the asset. If it does, it is necessary to determine whether the owner by civil law is excluded from any influence during the useful economic life of the earning potentials. The owner is excluded if the claim for return is no longer of economic value or if there is no claim at all.18

2. Transfers of Functions

The restructuring of businesses, particularly the transfer of a function, was one of the critical issues addressed by Germany's 2008 Business Tax Reform Act. "Transfers of functions" are defined fairly broadly by law as the transfers of "entrepreneurial functions including all opportunities and risks as well as assets and other advantages connected herewith" (see the Foreign Tax Act ("FTA"), sec. 1, para. 3, sent. 9). The transfer of a function within the meaning of the FTA may be but is not necessarily based on an agreement between two group companies. It can be the simple transfer of a business unit or operational activity from one company to another, e.g., the centralization of the accounting function of two or more companies in a single company. It should be noted that the transfer of a function is relevant for tax purposes only if the function is transferred cross-border. If the transfer occurs within Germany, the rules of the FTA do not apply. In such case, the old principles still hold.

The transfer of earning potentials has always been subject to taxation. But the earning potentials had to be substantiated in a manner that made them concrete enough to be regarded as intangible assets.19 Under the new amended FTA, these earning potentials do not have to be concretized to be regarded as part of a function, the "transfer package."20 The distinction between a theoretical earning potential and a concrete intangible has blurred recently. As a result, this provision will raise numerous practical issues and discussions with the tax authorities (see below).21

The German Finance Ministry has published the draft of a circular with respect to the new provisions.22 The draft defines "function" as "a business activity that consists of similar business tasks which are performed by personnel of certain groups or departments of a company. The particular functions result from the task sharing within the enterprise and form an organic part of it."23 The draft further states that a transfer package comprises a function and the opportunities and risks it poses as well as the assets and other advantages connected therewith, which are transferred or let for use to the company taking over, in addition to the supply of services connected therewith.24 The doubling of a function is not within the scope of the transfer-package rulings. If, for example, a foreign parent company forms a new distribution company in China and the latter applies a marketing concept developed by an existing distribution company located in Germany that controls the German market only, no function and no part of a function are transferred; instead, the function is merely doubled. The transfer of the marketing concept is determined by the general rules and not characterized as a transfer package.25

VI. The Determination of the Arm's-Length Price

1. General Rules and Difficulties

Under German transfer-pricing procedures, it is important to distinguish between the legal owner and the economic owner of intangible assets, since only the latter disposes of the rights against the licensee or the buyer of the licensed or transferred assets economically. In general, the "economic owner" is the entity that develops an intangible and decides on the nature of the development. The development is made in its name, and it bears all the risks and expenses during the period of development. In contrast, the "legal owner" of intangibles—possible only in the case of legally protected assets—is the one who owns the actual legal power of disposal. The legal owner is not generally obliged to bear the expenses of the development. The legal owner might be the corporate affiliate that is responsible for the management and administration of all the intangibles of a group but bears no risk or expenses during their development.26

The determination of the transfer price is extremely difficult. First, intangibles are highly diverse; second, third-party data are difficult to obtain. The German tax authorities maintain a database with respect to royalties, but this database is not publicly accessible. In practice, a taxpayer being audited is often confronted with the tax auditor's contention that the royalties charged or paid by the taxpayer are not at arm's length because the database provides for other figures—a contention the taxpayer may or may not believe. Nevertheless, the taxpayer may use publicly assessable databases to support its own position.

The Enterprise Tax Reform Act 2008 codifies for the first time which transfer-pricing methods have to be applied and the manner in which this must be done. Section 1, Paragraph 3, of the FTA stipulates that the transfer price should be based on the comparable uncontrolled price method, the resale price method, or the cost-plus method. Consequently, other transfer-pricing methods, such as the profit split method and the transactional net margin method, should be used only in exceptional cases. These methods apply to both tangible and intangible assets. Irrespective of the transfer-pricing method applied, the enterprise has to make appropriate adjustments to the determined comparable price in order to reflect the facts and circumstances of the particular case.

In cases where unrelated prices or data are not available for determining the transfer price, the taxpayer may use third-party data that are only partly comparable and may make appropriate adjustments based on the specific facts and circumstances. Where no third-party data are available, the taxpayer is permitted to use hypothetical arm's-length tests. Again, appropriate adjustments are mandatory where necessary.

If the taxpayer does apply a hypothetical arm's-length test, the law assumes—although it can be rebutted by the taxpayer—that the parties to the transaction typically do not have complete knowledge of the future business development associated with the transferred intangibles, and a prudent manager would therefore insist on a price-adjustment clause. It is noteworthy that this legal assumption applies only if the factual business development deviates from the expected development. The law further provides that, if no price-adjustment clause is included in the transfer or license agreement and a material deviation occurs within the first 10 years of the term of the agreement, the transfer price adjustment has to be made retroactively for the completed fiscal years.

2. R&D

a. Contract Research

The ordering party is charged with the R&D expenses of the executing affiliate contractor. Establishing the service, obligation, and remuneration in a written R&D agreement is usually recommended, since determining these matters in a "framework" agreement simplifies the administration of an R&D project. The details of individual R&D projects in such cases are outlined in inserts attached to the framework agreement.

It is also necessary to establish that the project is undertaken on behalf of and at the risk of the principal, who defines the type and content of the project and supervises its completion.

Business expenses can be deducted only in compliance with the arm's-length principle; i.e., the costs should be evaluated according to whether the corporations involved have acted as unrelated third parties. Section 1, Paragraph 3, of the FTA stipulates that the transfer price should be based on the comparable uncontrolled price method, the resale price method, or the cost-plus method, but in fact only the latter method can be used, since there is only a small market for individual research, and consequently almost no comparable prices exist.27

b. R&D Pools

"Cost allocation" is a form of financing that is becoming more and more widespread, since it allows the costs of large projects to be shared among a number of companies. However, this form of R&D activity is more common in the case of unrelated parties, i.e., joint ventures, particularly for very expensive R&D projects. The advantage of cost allocation pools is that cost allocation does not require a single company to pre-finance all the development expenses and bear all the risks.28 Under certain conditions, liquidity might not be diminished to the extent that individual services would be invoiced. In such a case, the performing affiliates could generate a profit that has not been realized from the group's point of view, because the developed product might not yet have been commercialized29.

The German Finance Ministry has published a circular that sets forth the conditions under which a pool that consists of related parties is recognized for tax purposes.30 In general, a pool of related parties is recognized only if the pool members have a joint interest in the economic result of the pool's performance. In an R&D pool, for example, the interests of a holding company or an IP company would differ from those of a production company, so these companies could not be members of the same recognized R&D pool.31 According to the circular, all direct and indirect expenses that are connected to the services may be subject to the cost allocation.32

The importance of IT systems to R&D pools has led some to argue with respect to expenses that it is necessary to distinguish between expenses related to the transfer of know-how and those related to the infrastructure of IT systems as such. These arguments hinge on whether or not the expenses of each member are connected to the R&D pool.33 IT expenses are not apportionable if a "benefit test" (discussed below) determines that use of the IT system provides advantages to the group's parent but not to the pool and the participating affiliates. The expenses may be classified as stewardship expenses, which are not apportionable, or as costs of the pool, which are apportionable.34

According to the circular, a profit markup is not permitted.35 Allocation of the expenses among the pool members has to be appropriate and is determined by an allocation formula. Among the major criteria for this formula are the actual usage of the services offered and the expected benefits. The allocation has to be reviewed periodically in order to verify that each member's intended benefits are in accordance with the expenditures made by that member.36

According to the arm's-length principle, new members must make an entry payment before joining the pool37 and departing members have to be reimbursed for the benefits they would have derived from participating in the pool. The entry date determines the expenses and, as a consequence, the tax rate of the respective companies. Coordinating the exit of pool members with the entry of new members and payment of their corresponding entry fees permits expenses to be generated in a tax-efficient matter.38

The downside of the "pool cost-based allocation system" is that it entails extensive documentation and sizable administrative and coordinative tasks. To meet those demands, a written contract for the pool cost-based allocation system with a wide range of minimum standards is required by the German fiscal authorities. These contracts must include a service description, the calculation and allocation of charges, the expected benefits, efficiency controls, and adjustments. The supplier has to keep records of the work performed and the corresponding expenses of the respective burden centers and cost categories. The beneficiary has to document the benefits expected and the benefits received. This documentation is based, on the one hand, on problem analyses and objectives for the future and, on the other, on previously published monthly, quarterly, and annual reports. If under the arm's-length principle a prudent business manager would not enter into such written pool agreement, the fiscal authorities will not accept it. The same applies if the documentation requirements are not completely fulfilled.39 As a consequence, the pool partners' share in these expenses will not be tax-deductible, either in whole or in part.40

c. Global Development

The transfer-pricing issues in the case of global development are the same as in the case of contract research or R&D pools.

3. Licensing

If a group company lets patents, unprotected inventions, or other intangibles to an affiliate, payment must be made according to the arm's-length principle (see above). The payments are typically based upon the quantity produced or sold or upon the revenues of the licensee. In other cases, declining rates or additional lump-sum payments are made. Pursuant to Article 1, Section 6.2.2, of the 1983 Administrative Guidelines, and by analogy to the OECD Transfer Pricing Guidelines 1995, the payments can be made on the merits only if the licensor has developed the intangible at its own expense and risk and if the licensee benefits from the grant of the right to use ("benefit test").41 In the case of know-how and unprotected inventions, the intangible assets must be more than generally accessible, specialized knowledge that a third person would pay for.42

In the special case of business names, the German fiscal administration denies payment. Permission to use the name of the parent company is considered a support based on the relation to the shareholder (Rückhalt im Konzern)43 but not on civil law. This reasoning is generally comprehensible, since the granting of a business name is part of the founder's and, respectively, the shareholder's responsibility for its subsidiary, which is determined by company law. Therefore, no charges are deductible for tax purposes. The situation is different if the business name and the product trademark are identical. Then the royalty payment is deductible for tax purposes, particularly if the right to use the trademark extends to specific logos.44

In terms of amount, the described arm's-length principle has to be applied (see above). In general, the German fiscal authorities hold that a separate fee has to be assigned to any individual right of use. A unique royalty for multiple performances is allowed only if the used intangibles form a unity for technical and economical purposes.45

4. Transfers of Functions

Several tax experts propose the following method for applying the hypothetical arm's-length principle in the case of a transfer of a function in the sense of Section 1, Paragraph 3, of the FTA. Both a hypothetical seller's or assignor's price and a hypothetical buyer's or assignee's price must be ascertained, presumably resulting in the arithmetic average as the transfer price basis in the absence of another opposition being taken by the taxpayer. Anytime business functions are transferred, a compensation payment has to be made, determined by valuing the transfer package, which should equal the discounted value of the transferred earning potentials (see FTA, sec. 1, para. 3, sent. 9). The discount rate comprises a long-term interest rate and a risk factor. The risk factor should be calculated on the basis of the functions fulfilled and the risks borne by the parties referring to the situation before and after the transfer of the function. Not only each individual asset but also the underlying benefits resulting from the transfer itself form part of the transfer package and are considered when determining the tax basis. This also includes any benefits resulting from the location or jurisdiction and synergy effects, even if they are gained by the foreign assignee.46

The range of the agreement on the price is fixed by the minimum price of the supplier, including the reduction of earning potentials and the closure costs, on the one hand, and the maximum price of the assignee in the shape of earning potentials, on the other.47 The parties are required by law to agree upon a price-adjustment clause for the transfer package as a whole. Pursuant to the FTA (sec. 1, para. 3, sent. 10), transfer prices may be determined for individual assets rather than for the transfer package as a whole, if the transferred function does not include the transfer of essential intangible assets and benefits or if the overall result of the individual assets transferred complies with the arm's-length principle (a condition known as the "Escape Clause.")48 Intangibles are essential if they are needed for the transferred function and if their market price adds up to more than 25 percent of the total of the single prices of all the assets and benefits of the transfer package (see Funktionsverlagerungsverordnung, sec. 1, para. 5). The regulation focuses on any cross-border transfer, including the transfer from foreign jurisdictions to Germany. In the latter case, intangible assets in Germany may be capitalized and depreciated, but not transfer packages in total. This unequal treatment in comparison to outbound cases has been rightly criticized by commentators.49 Because of numerous undefined terms in the law and in the regulation, the tax experts demanded that these terms be defined—if not by the legislature, then at least by the financial administration.50

The German Finance Ministry published the draft of a circular regarding the new provisions.51 The draft defines "earning potentials" as the "expected profits" of both business partners, which in turn are defined as the cash value of the expected after-tax profits of the respective function (Reingewinn nach Steuern) for which a prudent business manager of the transferring company would give away the earning potential and a prudent business manager of the acquiring company would pay a price.52 The after-tax profits of a transferred function are determined by the Finance Ministry using the "direct method": the after-tax profits are calculated as the financial surpluses of the transfer package after interest and taxes (net receipts) that are expected during its useful life. The financial surpluses have to be derived from the business plan for the future. Pursuant to the Finance Ministry's draft, the plan or forecast may be based on the provisions of the German GAAP or the tax law or on other provisions, e.g., the International Financial Reporting Standards or U.S. GAAP, depending on the company's policy, and must be adjusted for noncash items appropriately. The business plan has to comprise plan balance sheets, plan profit-and-loss statements, plan financial budgets and—if necessary—additional bills for the calculation of the tax base.53 The ability to distribute the profits under company law is not relevant. In lieu of the "direct method," the taxpayer might apply the "indirect method," which implies an evaluation for the transferring as well as the acquiring company on the basis of corresponding principles.

The above illustrates how complicated the legislation and its interpretations are. Despite the Finance Ministry's circular, many questions remain unanswered. Since the taxation of transfer packages is not considered in the OECD Transfer Pricing Guidelines 1995 and therefore is not common in an international context, foreign fiscal authorities might not accept the transfer-package pricing model and might deny the depreciations of the adopting company.54 This situation is inconsistent with the commitment made by Germany in December 2008 to follow the principle that there is no double taxation in the case of cross-border transfers of assets in the EU.55

VII. Documentation Requirements

The documentation obligations are presented in Section 90 of the General Tax Act. The legislation, enacted in 2003,56 stipulates the obligation of the taxpayer to clarify transactions that occurred outside Germany and to deliver the required supporting evidence. The taxpayer is obliged to use all existing legal and functional options to perform this obligation, since the burden of proof is on him. He cannot argue that he is unable to clarify the facts or provide evidence if he was actually in the position to do so beforehand.

It is further stipulated that the taxpayer in a cross-border transaction is obliged to record the type and content of the business transaction for related parties. The documentation includes the economic and legal basis of the arm's-length principle with respect to pricing and other business terms. Documentation must be delivered to the tax authorities within 60 days of being requested. For extraordinary business transactions57 like restructurings or conclusions of long-term agreements, the documentation has to be set up "promptly," which is defined to be within the six-month period commencing after the completion of the fiscal year in which the transaction occurred. In cases of extraordinary business transactions, the period of document production is reduced to 30 days. The period can be extended upon application by the taxpayer.

Based on Section 90 of the General Tax Act, the Finance Ministry enacted a decree that provides details on how the evidence has to be provided and what documentation is required.58 Further details are included in the 2005 Administrative Guidelines.59 In general, the documentation must be based on the respective transaction, but it is permissible to group comparable transactions if such grouping is determined before the transaction occurs.

To the extent possible, the taxpayer is obliged to collect comparable publicly obtainable data supporting the transfer-pricing method applied by him. In particular, the taxpayer has to document comparable data resulting from his own third-party transactions, e.g., pricing, general terms and conditions, cost quotas, profit margins, cross margins, net margins, and profit splits.

The records have to comprise: (i) general information about the group and the ownership's structure, business, and organization; (ii) business relationships with related parties; (iii) analysis of functions and risks; and (iv) transfer-pricing analysis. Some of the information must relate to a general overview, consisting of group structure charts and the type of business (e.g., distribution, manufacturing services). Other records must show the type and extent of the business conducted with related parties (e.g., purchases, sales services, financing, and other use of assets). In particular, records must include the material intangible assets owned by the taxpayer and licensed by him to related parties. The functional and risk analysis must record the function and associated risk of the taxpayer and the related parties within the particular business transaction. It must further record material assets, the business strategy, and relevant market and competition relations and situations. Finally, the chosen transfer-pricing method, the explanation of the appropriateness of the chosen transfer-pricing method, calculation records, and data about comparable third parties should be documented. The 2005 Administrative Guidelines provide a more detailed list of the information the taxpayer has to record.

Companies that are continually active in research and development must keep detailed contemporaneous records on present and scheduled R&D activity as well as any activities of the foregoing three years connected with transfers or changes of function, since the fiscal authorities will be looking for any potential restructuring of intellectual property and other results of R&D activities.60

If the taxpayer does not produce the records, if the records are unusable, or if it is recognized that the records have not been filed in due time, it will be assumed that the taxpayer's income is higher than reported (although the taxpayer is permitted to rebut this legal assumption). If there is a range of possible "correct" incomes, the tax authorities are permitted to estimate the income at the upper level.

In addition, the taxpayer has to pay a penalty of at least €5,000 if he does not produce the documentation or if the documentation is unusable. The penalty will be 5 to 10 percent of the additional income that is assessed for the failure to produce the records if this amount exceeds €5,000. If the documentation is produced after the 60-day/30-day period, a minimum penalty of €100 per day will be due, up to €1 million.

VIII. Conclusion

On the one hand, the new transfer-pricing rules in Germany substantiated the arm's-length principle, which simplifies the choice of the relevant transfer-pricing method in many cases. On the other hand, documentation requirements have increased, and the German fiscal administration still does not provide access to its internal database of comparable prices of third parties. In the special case of global development, essential documentation is needed to satisfy the information demands of the fiscal authorities. German particularities like the taxation of transfers of functions complicate transfer-pricing issues. This topic is particularly likely to cause serious conflicts between the German fiscal authorities and those of foreign states. Meanwhile, companies are at risk of double taxation, leaving taxpayers with another challenge in the crucial area of transfer pricing.


1. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 694; Reiner/Haußer, Münchener Kommentar zum HGB, 2nd edition 2008, art. 266, sec. 21.

2. See German Finance Ministry, February 23, 1983, C5 – S 1341 – 4/83, art. 1, sec. 5.1.1, Federal Tax Gazette I 1983, p. 218.

3. See German Finance Ministry, April 12, 2005, IV B4 – S 1341 – 1/05, art. 1, sec., Federal Tax Gazette I 2005, p. 570.

4. See Federal Tax Court, May 22, 1979, file no. III R 129/74, Federal Tax Gazette II 1979, p. 634; July 3, 1987, file no. III R 7/86, Federal Tax Gazette II 1987, p. 728.

5. See Federal Tax Court, August 10, 1989, file no. X R 176-177/87, Federal Tax Gazette II 1990, p. 15.

6. See Federal Tax Court, July 3, 1987, file no. III R 7/86, Federal Tax Gazette II 1987, p. 728; July 28, 1994, file no. III R 47/92, Federal Tax Gazette II 1994, p. 873.

7. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 694.2.

8. See Ballwieser, Münchener Kommentar zum HGB, 2nd edition 2008, art. 247, sec. 18.

9. See sec. 248, para. 2, German Commercial Code and the German Accounting Law Modernization Act, May 26, 2009; art. 1, sec. 248, para. 2, and art. 2, sec. 4, Federal Tax Gazette I 2009, p. 1102.

10. See sec. 255, para. 2a, German Commercial Code and the German Accounting Law Modernization Act, May 26, 2009; art. 1, sec. 255, para. 2a, Federal Tax Gazette I 2009, p. 1102.

11. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 720; Jacobs, Internationale Unternehmensbesteuerung, 6th edition 2007, Chapter 5.IV.1.

12. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 720.1.

13. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 718.

14. See Kaminski, IStR 2001, p. 541.

15. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 718.1.

16. See Baumhoff, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, secs. 698, 720.3, 723; Kaminski, IStR 2001, p. 541; Portner, Schaumburg, Internationale Verrechnungspreise zwischen Kapitalgesellschaften, p. 80.

17. See Wehnert, IStR 2007, p. 559.

18. See Kessler/Kröner/Köhler, Konzernsteuerrecht, 2nd edition 2008, para. 8, secs. 355, 356.

19. See Kessler/Kröner/Köhler, Konzernsteuerrecht, 2nd edition 2008, para. 8, sec. 352.

20. See Kessler/Kröner/Köhler, Konzernsteuerrecht, 2nd edition 2008, para. 8, sec. 291, p. 353.

21. See Oestreicher/Hundeshagen, IStR 2009, p. 145; Rasch/Schmidtke, IStR 2009, p. 92.



22. See Draft Circular of the German Finance Ministry, Grundsätze der Verwaltung für die Prüfung der Einkunftsabgrenzung zwischen nahe stehenden Personen in Fällen von grenzüberschreitenden Funktionsverlagerungen ("Verwaltungsgrundsätze – Funktionsverlagerung"), July 17, 2009, IV.B.5.

23. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5, sec. 2.1.1.

24. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5, sec. 2.1.3.

25. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5, sec.

26. See Wehnert, IStR 2007, p. 559.

27. See German Finance Ministry, February 23, 1983, C5 – S 1341 – 4/83, art. 1, sec. 5.3, Federal Tax Gazette I 1983, p. 218.

28. See Jacobs, Internationale Unternehmensbesteuerung, 6th edition 2007, Chapter 5 BIV5a.

29. See Kaminski, IStR 2001, p. 543.

30. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122.

31. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 1.2.

32. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 1.

33. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 1.2.

34. See Fischer, IStR 2008, pp. 255, 256.

35. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 2.2.

36. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 3.

37. See German Finance Ministry, December 30, 1999, IV B4 – S 1341 – 14/99, Federal Tax Gazette I 1999, p. 1122, sec. 3.

38. See Kaminski, IStR 2001, p. 544.

39. See German Finance Ministry, December 12, 1999, IV B4 – S 1341 – 14/99, art. 5, Federal Tax Gazette I 1999, p. 1122.

40. See German Finance Ministry, December 12, 1999, IV B4 – S 1341 – 14/99, art. 6, Federal Tax Gazette I 1999, p. 1122.

41. See German Finance Ministry, February 23, 1983, C5 – S 1341 – 4/83, art. 1, sec. 6.2.2, Federal Tax Gazette I 1983, p. 218; Engler, Vögele/Borstell/Engler, Handbuch der Verrechnungspreise, 2nd edition 2004, sec. O 57; Jacobs, Internationale Unternehmensbesteuerung, 6th edition 2007, Chapter 5.IV.4.c; Wassermeyer/Baumhoff/Greinert, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 703.

42. See Jacobs, Internationale Unternehmensbesteuerung, 6th edition 2007, Chapter 5.IV.4.c; Wassermeyer/Baumhoff/Greinert, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 703.

43. See German Finance Ministry, February 23, 1983, C5 – S 1341 – 4/83, art. 1, sec. 6.3.2, Federal Tax Gazette I 1983, p. 218.

44. See Federal Tax Court, August 9, 2000, IStR 2001, p. 54; Wassermeyer/Baumhoff/Greinert, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. 703.2.

45. See German Finance Ministry, February 23, 1983, C5 – S 1341 – 4/83, art. 1, sec. 5.2.1, Federal Tax Gazette I 1983, p. 218.

46. See German Finance Ministry, Ordinance ("Funktionsverlagerungsverordnung"), August 12, 2008, sec. 3, para. 2, Federal Tax Gazette I 2008, p. 1680; Baumhoff/Ditz/Greinert, DStR 2008, p. 1950, Hervé, BC 2007, p. 197; Kessler/Kröner/Köhler, Konzernsteuerrecht, 2nd edition 2008, para. 8, sec. 434.

47. See Oestreicher/Hundeshagen, IStR 2009, p. 146.

48. See Hervé, BC 2007, p. 197.

49. See Wassermeyer/Baumhoff/Greinert, Flick/Wassermeyer/Baumhoff, Außensteuerrecht (March 2009), art. 1, sec. V93.

50. See Oestreicher/Hundeshagen, IStR 2009, p. 151.

51. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5.

52. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5, sec. 2.1.4.

53. See Draft Circular of the German Finance Ministry, July 17, 2009, IV.B.5, sec.

54. See Baumhoff/Ditz/Greinert, DStR 2008, p. 1952; Oestreicher/Hundeshagen, IStR 2009, p. 146; more general: Kessler/Kröner/Köhler, Konzernsteuerrecht, 2nd edition 2008, para. 8, sec. 358.

55. See Council of the European Union, Council Resolution on coordinating exit taxation, Brussels, February 12, 2008, 2911th ECONOMIC and FINANCIAL AFFAIRS, Principle C, and Oestreicher/Hundeshagen, IStR 2009, p. 145.

56. See also the Decree of the Ministry of Finance (Gewinnabgrenzungsaufzeichnungsverordnung) as of November 13, 2003; Federal Tax Gazette I 2003, p. 2296.

57. The definition of "extraordinary business transaction" was revised and expanded by the Enterprise Tax Reform Act 2008, August 14, 2007, Federal Tax Gazette I 2007, p. 1912.

58. See Footnote 29.

59. See the 2005 Administrative Guidelines (Grundsätze für die Prüfung der Einkunftsabgrenzung zwischen nahe stehenden Personen mit grenzüberschreitenden Geschäftsbeziehungen in Bezug auf Ermittlungs- und Mitwirkungspflichten, Berichtigungen sowie auf Verständigungs- und EU-Schiedsverfahren) as of April 12, 2005, Federal Tax Gazette I 2005, p. 570.

60. See Damji/Wolff, Der Schweizer Treuhänder 2007, p. 686.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.