Germany: 214. Final Regulations On The Taxation Of Permanent Establishments

Last Updated: 14 May 2001
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Dr. Frank Wiesmann

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Article Outline

1. Introductory

2. Outline of the directive

3. Permanent establishments as nexus for taxation

3.1 Permanent establishment concept in domestic law
3.2 Relation of domestic to treaty law
3.3 Domestic and tax treaty law compared

3.3.1 Fixed places of business as permanent establishments
3.3.2 Domestic law broader than treaty law

3.4 Permanent establishments: aspects not mentioned
3.5 Agent-based jurisdiction to tax

3.5.1 Agent-based tax nexus: German domestic law
3.5.2 Agent-based tax nexus: tax treaty law

Dependency
Authority to contract
Parent-subsidiary relationship
Independent agents
Income allocation to agent-based permanent establishments

3.6 Foreign tax attributes and nexus to tax ("isolated analysis")
3.7 Required duration of a permanent establishment
3.8 Construction and assembly projects

3.8.1 Required minimum duration
3.8.2 Consolidation of multiple projects (directive sec. 4.3.5)
3.8.3 Construction planning and supervision (directive sec. 4.3.2)
3.8.4 Consortiums and joint ventures (directive sec. 4.3.4)

3.9 Auxiliary and support functions
3.10 Bookkeeping requirements for German permanent establishments
3.11 Bookkeeping requirements for foreign permanent establishments

4. Consequences of a permanent establishment under a tax treaty

4.1 General rule: exclusion of profits of a foreign PE
4.2 Exceptions to the exemption method
4.3 Loss treatment

5. Profit and asset allocation: basic matters

5.1 Qualified separate enterprise approach
5.2 Internal transactions - basic rule and general exception
5.3 Internal transactions - specific exceptions
5.4 Methods of profit apportionment
5.5 Attribution of assets and liabilities to permanent establishments

5.5.1 Exclusive, predominant, and joint function assets
5.5.2 Joint function assets: capital gains
5.5.3 Asset attribution: special cases
5.5.4 Banks and insurance companies

5.6 Capitalisation of permanent establishments
5.7 Equity allocated to PEs of banks and insurance companies

6. Apportionment of revenue and expense

6.1 General (section 2.7, pp. 34 - 36)
6.2 Expense of creation and dissolution of a permanent establishment
6.3 Specific expenses, esp. market penetration expense

7. Currency conversion issues

8. Transfer of assets between domestic and foreign permanent establishments

8.1 Basic issues
8.2 Other preliminary observations
8.3 Transfer categories
8.4 Outbound transfers

8.4.1 Outbound Category 1: no tax consequences
8.4.2 Outbound Category 2: deferred taxation

Fixed assets
Current assets
Intangible assets / Base shifting
Option for immediate taxation

8.4.3 Outbound Category 3 (crossbound transfers): deferred taxation
8.4.4 Outbound Category 4: immediate taxation
8.4.5 Outbound Category 5: immediate taxation

8.5 Outbound transfers: problems
8.6 Inbound transfers

8.6.1 Inbound Category 1
8.6.2 Inbound Category 2
8.6.3 Inbound Category 3
8.6.4 Inbound Category 4: retransfer to home office

9. Partnerships

9.1 Attribution of permanent establishments to partners
9.2 Domestic and foreign partnerships
9.3 Bookkeeping for foreign and domestic partnerships
9.4 Partner's obligations to provide documentation and information
9.5 Contractual relationships between partner and partnership

9.5.1 Background
9.5.2 New position taken by directive

9.6 Loans by partners as partnership equity
9.7 Partnership equity

10. Other issues

10.1 Documentation and information
10.2 Independent services
10.3 Transition provisions
10.4 Superseded administrative pronouncements

11. Concluding remarks


1. Introductory

In late December 1999, the German Federal Ministry of Finance released the final version its long-awaited administrative regulations on the taxation of permanent establishments. The final regulations, known as the Betriebsstättenerlaß or Permanent Establishment Directive (hereinafter "the directive" or "the final directive") came almost two years after the circulation of proposed regulations in June of 1997 ("the draft directive"; see article no. 77). The directive was cleared in advance with the tax administrations of the various German states.

The directive (the official version of which numbers some 100 pages, including attachments) is comparable in length to the guidelines issued by the Federal Ministry of Finance in February 1983 dealing with transfer pricing between associated independent enterprises (the so-called Administrative Principles, Germany's basic transfer pricing guidelines). Numerous articles have been published on the directive in German professional journals since its release some fifteen months ago.

The final directive resembles the 1997 draft version. Many passages are unchanged or only slightly reworded. There are changes in the document's organisation, however. These include improvement in the directive's numbering system at the subsection level. Also, the treatment of certain subjects has been expanded, making the final version roughly 20 % longer than the draft version. Finally, there are a number of material changes of position on certain issues.

The directive often espouses broad principles (such as the "separate enterprise" approach for attributing profits to a permanent establishment), the application of which to particular cases depends on what is "reasonable" or "appropriate" under the specific circumstances. Under the German transfer pricing philosophy, minute regulation is regarded as counter-productive and there is instead a preference for relying on the sound judgement of taxpayers and tax auditors alike to reach results which are reasonably precise and in accordance with the arm's length standard. This being said, the directive has been criticised for being overly general, repeating the obvious, and providing little effective guidance on certain issues.

Prior to release of the directive, Germany had no comprehensive guidelines relating specifically to permanent establishments. The tax authorities instead dealt with permanent establishment issues by analogy to the 1983 intercompany transfer pricing guidelines. The new draft combines scattered existing administrative pronouncements and the holdings of leading court cases into a single document and states in writing many positions which the tax authorities have long taken in practice. The Official Commentary of the OECD Model Tax Convention on income taxation, which Germany's bilateral tax treaties generally follow, is often cited in support of the positions taken. Germany has tax treaties in force with some 75 countries, including all major trading nations.

The new rules seldom stray from the beaten path, but nevertheless contain certain inconsistencies and questionable positions on significant issues. The directive deals with both outbound and inbound transactions, that is to say, with permanent establishments set up by German entities in foreign countries as well as with those maintained by foreign entities inside Germany.

Like all German administrative regulations, the directive binds only the tax authorities with respect to their administration of taxes. Taxpayers are free to challenge provisions of the directive in the tax courts. The directive enjoys no presumption of validity, nor is it the product of rulemaking authority granted by the legislature to the tax authorities. Rather, it represents the position the tax authorities will take in applying the tax laws.

Despite the criticism levied by many authors against particular aspects of the new directive, most acknowledge that it promotes legal clarity by establishing a fairly comprehensive framework within which both taxpayers and tax auditors can work.

The following is a selective summary of matters of likely interest. Page numbers given when citing the directive refer to the version released by the Federal Ministry of Finance dated 24 December 1999.

2. Outline of the directive

Like the draft directive, the directive is divided into six parts of varying length. The following outline - not followed for purposes of this article - shows the basic structure together with the sections into which each part is divided. The various sections are broken down into subsections (not shown). The only change in the basic structure of the directive is the deletion of former section 4.6 (relating to permanent establishments of ocean-going vessels). Furthermore, two tables have been added to the directive's appendix.

1. Legal basis for the taxation of commercial permanent establishments
1.1 Domestic tax law
1.2 Tax treaties

2. Apportionment business property and income
2.1 General
2.2 Basic apportionment principles
2.3 Profit apportionment methods
2.4 Attribution of assets
2.5 Permanent establishment share of the equity of the overall enterprise (dotation capital)
2.6 Transfer of assets
2.7 Apportionment of expense and revenue
2.8 Currency conversion of permanent establishment profit/loss
2.9 Creation and discontinuation of a permanent establishment
2.10 Contribution of a permanent establishment to a corporation

3. Specific issues regarding the apportionment of business property and income
3.1 Services
3.2 Advertising and market penetration
3.3 Interest and similar payments
3.4 Management expense, general administrative expense, and related costs

4. Permanent establishments in special cases
4.1 Banks
4.2 Insurance companies
4.3 Construction projects and assembly work
4.4 Supervisory and coordination offices
4.5 Operation of ships at sea and on inland waterways
4.6 Prospecting for and extracting natural resources in international waters
4.7 Exploration [for natural resources]
4.8 Transportation facilities

5. Procedural matters
5.1 Documentation and cooperation requirements
5.2 Scope of cooperation requirements
5.3 Legal consequences of inadequate cooperation

6. Other matters
6.1 Independent services
6.2 Entry into force
6.3 Revocation of other administrative pronouncements

Appendix
Tax treaty tables (Appendices I - IV)
I. Permanent establishment requirements
II. Construction and assembly projects
III. Permanent representatives
IV. Presence deemed not to constitute a permanent establishment

Table 1:International business associations (except Eastern Europe)
Table 2:Eastern European business associations

3. Permanent establishments as nexus for taxation

3.1 Permanent establishment concept in domestic law

The term "permanent establishment" (Betriebsstätte) exists in German domestic tax law as well in Germany's tax treaties, which generally follow the OECD Model Tax Convention on Income and Capital (hereinafter the "OECD model tax treaty". The permanent establishment concept is defined for purposes of German domestic tax law in § 12 AO (Tax Procedure Act).

Germany's trade tax and income tax laws use the permanent establishment concept in a manner similar to tax treaty law to limit the scope of German taxation of commercial business income. Under § 2 (1) GewStG, commercial businesses are subject to trade tax only on their German source earnings, defined as earnings attributable to a permanent establishment on German territory (or on a commercial ocean-going vessel entered in a German shipping register) or to a German permanent representative.

Under § 49 (1) EStG (in conjunction with § 1 (4) EStG and § 2 KStG), natural and juridical persons not liable to tax in Germany on their worldwide income (non-resident persons) are subject to personal or corporate income tax only on their German source income as defined by § 49 EStG.

Commercial business income is generally considered to be from German sources only to the extent derived through a domestic permanent establishment or through a domestic permanent representative. (Exceptions exist with regard to the sale of German real property and material interests in German corporations, the operation of ships and aeroplanes, and respecting artistic, athletic, or similar performances.)

Commercial business income is one of the seven types of income subject to German income taxation. The nexus (permanent establishment / permanent representative) required to tax commercial business income earned by non-resident persons is, generally speaking, stronger than that required to tax the other six types of income. Income earned by foreign corporations and other foreign entities does not automatically constitute commercial business income. Instead, the categorisation of income earned by foreign entities generally depends on their German activities viewed in isolation (§ 49 (2) EStG).

3.2 Relation of domestic to treaty law

The principle is well established in German tax law that tax treaties limit, but never create, a German right of taxation. Hence, the methodologically proper approach to analysing any tax question is first to determine whether a right of German taxation exists under German domestic law and, if the result is affirmative, then to determine whether this right of taxation is limited by tax treaty law. Where no right of taxation exists under German domestic law, the terms of a tax treaty are irrelevant, because they cannot create such a right, even if the scope of taxation they accord to Germany is greater than that defined by Germany's domestic tax law.

3.3 Domestic and tax treaty law compared

The directive divides its treatment of permanent establishments into two sections, dealing first with domestic law (directive sec. 1.1), then with tax treaty law (sec. 1.2). In general, the directive states that the definition of "permanent establishment" in domestic law agrees with that in tax treaty law (directive sec. 1.2.1.1). While this may sound clear, it is in practice not always easy to tell from the directive where the similarities lie, much less the differences.

3.3.1 Fixed places of business as permanent establishments

German domestic tax law and the OECD model tax treaty agree on the following basic requirements for fixed places of business as permanent establishments:

  • The entity in question must have a certain degree of control, not merely temporary in nature, over a place of business in order for it to constitute a permanent establishment (cf. Official Commentary no. 4 to Art. 5 of the OECD model tax treaty; directive sec. 1.1.1.1). Kumpf/Roth (DB 2000, 741, 742/2) point out that the directive fails to make clear that the necessary control need not be contractual, but may instead be purely factual in nature.
  • There must be a link between the place of business and a specific geographical point in order for it to constitute a permanent establishment (Official Comments 5 and 20 to Art. 5 of the OECD model tax treaty; directive sec. 1.1.1.1 sent. 2).
  • A place of business must have a certain degree of permanence in order to constitute a permanent establishment (Official Commentary no. 6 to Art. 5 of the OECD model tax treaty; directive sec. 1.1.1.1 and 1.2.1.1). Whereas the required degree of permanence is not specified by the OECD model tax treaty or the Official Commentary, the directive states that, for both domestic and tax treaty purposes, a place of business will always be deemed to have the necessary degree of permanence ab initio where it exists for more than six months. This minimum time period is unrelated to the time period required for construction and installation projects in specific tax treaties. While the relevant passages in the directive are not entirely clear, they presumably mean that the required degree of permanence is present both where a place of business is intended to exist for more than six months when it is first established, even if it is abandoned sooner, and where a place of business in fact exists for more than six months, regardless of the original intention. The rigid "six month rule" is criticised in the literature (e.g. Göttsche/Stangl DStR 2000, 498, 499/1; neutral Baranowski IDW 26 Jan. 2000, Fach 3 Gruppe 2 p. 813; see also Institute of German Auditors [IDW] WPG 1997, 641 criticising the same rule in the draft version).
  • The business must be wholly or partly carried on through the place of business in order for it to constitute a permanent establishment (Official Commentary no. 7 to Art. 5 of the OECD model tax treaty; directive sec. 1.1.1.1 and 1.2.1.1).

3.3.2 Domestic law broader than treaty law

The definition of "permanent establishment" under German domestic law (§ 12 AO) is broader than that under typical German tax treaties at least in the following respects:

  • German domestic tax law contains no negative list for activities of a preparatory or auxiliary character analogous to Art. 5 (4) of the OECD model tax treaty. Such activities thus constitute a permanent establishment under German domestic law, whereas they do not under tax treaty law.
  • Construction and installation projects constitute permanent establishments under German domestic law if they last for a period of more than six months, as opposed to twelve months under Art. 5 (3) of the OECD model income tax treaty. Approx. 30 German tax treaties specify a period of more than six months, while a slightly greater number adopt the twelve month OECD recommendation, and a few stipulate periods of more than nine months, 183 days, or three months. A table showing the relevant periods is attached to the directive as its Appendix II.
  • A place of management can constitute a permanent establishment under German domestic law without the presence of a fixed place of business, whereas the directive, citing Official Commentary no. 12 to Art. 5 of the OECD model tax treaty, states in its sec. 1.2.1.1 that a fixed place of business is required under the OECD model tax treaty. Official Commentary no. 12 relates to all of the examples given in Art. 5 (2) of the OECD model tax treaty. The directive thus presumably endorses Official Commentary no. 12 with respect to branches, offices, factories, workshops, and places of extraction of natural resources as well, though it does not say so.
  • The directive states in its sec. 1.1.1.1 (next to last sentence) that none of the examples of permanent establishments given in § 12 sent. 2 AO (the list includes a place of management and is similar to, but more inclusive than, the list in Art. 5 (2) of the OECD model tax treaty) necessarily requires the existence of a fixed place of business. The directive cites a decision by the Federal Tax Court that referred specifically only to places of management and construction sites. Kumpf/Roth consider the directive's position to be questionable (Kumpf/Roth DB 2000, 741, 742 at fn. 18 and 19).

3.4 Permanent establishments: aspects not mentioned

The directive does not comment on the following permanent establishment issues (list in part adapted from Kumpf/Roth FR 2000, 500, 505 ff.):

  • The directive does not state whether personnel must generally be assigned to a place of business in order for it to constitute a permanent establishment. The prevailing view in the German literature is that no personnel need be present, but the issue is unsettled (see Kumpf/Roth DB 2000, 741 at fn. 15 and Portner IStR 1999, 641, 647). However, in connection with transportation facilities (directive sec. 4.8), language added to the final version of the directive states that "activities by personnel in or at the place of business ... are not necessary in every case. Rather, the activities of the enterprise by virtue of the place of business ... are sufficient, in particular in the case of fully automated facilities" (citing the Federal Tax Court's pipeline decision of 30 October 1996 (BStBl II 1997, 12).
  • The directive is silent on the issue of when permanent establishments exist in connection with e-commerce. Germany's tax authorities are pursuing a consensus at the OECD level before committing themselves on this issue (cf. Röhner RIW 2000, 182, 186/2; Baranowski IWB 26 January 2000 Fach 3 Gruppe 2 p. 813). A directive issued by the Karlsruhe Regional Tax Office dated 11 November 1998 (IStR 1999, 439), which does not represent the official view of the German tax authorities as a whole, takes the position that computer servers are fixed places of business, but do not create permanent establishments because their installation represents an activity of a preparatory or auxiliary character. Kumpf/Roth (FR 2000, 500, 506) note that, even if a server constitutes a permanent establishment, the profits attributable to it would generally be low because of its generally minimal relative contribution to value added.
  • The directive is silent on issues posed by telecommunications services (lines, modems, radio facilities, satellite technology). Kumpf/Roth loc. cit. cite the satellite transponder decision of the Rhineland-Palatinate Tax Court, which is currently on appeal to the Federal Tax Court (case number I R 130/97; see article no. 205).
  • The directive makes little mention of the new business structures emerging in connection with the globalisation and virtualisation of commercial operations. There is not a word on global trading or call centres. There is little discussion of the attribution of profits to entities or divisions which perform functions (such as research and development, management services, manufacturing, sales and marketing) for other group members or units at little or no economic risk to themselves. This topic is touched on only in connection with contract manufacturing in sec. 3.1.3 of the directive. Kumpf/Roth agree, however, with the basic approach taken to contract manufacturing, i.e. to adjust downwards the profits attributable to the activity because of the low associated economic risk (FR 2000, 500, 506/1).
  • The directive does not comment on the consequences of the introduction of the Euro for the determination of profit for EU permanent establishments. The advent of the Euro eliminates exchange risks amongst the currencies of participating EU countries.
  • The directive does not comment on the allocation of income between a controlled subsidiary and an agent-based permanent establishment constituted by such a subsidiary (see "Income allocation to agent-based permanent establishments" at end of sec. 3.5.2 below).

3.5 Agent-based jurisdiction to tax

3.5.1 Agent-based tax nexus: German domestic law

Strictly speaking, German domestic law is narrower than OECD treaty law in that agents do not constitute permanent establishments under German domestic law. Nevertheless, the concept and consequences of a domestic permanent representative (ständiger Vertreter) under German domestic tax law (§ 13 AO) resemble those of an agent-based permanent establishment under Article 5 (5) and (6) of the OECD model tax treaty. While German domestic law regards any permanent representative, whether of an independent or a dependent status, as creating a sufficient nexus to tax, administrative regulations (R. 222 (1) EStR) have long provided that agents of an independent status (commission agents (Kommissionäre), brokers (Makler), and, under certain conditions, commercial representatives (Handelsvertreter) acting in the normal course of their business do not cause the profits of their foreign principal to become subject to German tax. The directive incorporates and reaffirms these regulations.

A permanent representative is defined by § 13 AO (reiterated almost verbatim in sec. 1.1.2 of the directive) as a person who

  • conducts business on behalf of a [commercial] enterprise,
  • does so on an ongoing [as opposed to a temporary] basis, and
  • is subject to its instructions.

The directive (sec. 1.2.2) states that the concept of a permanent representative, as limited by the administrative regulations referred to above, is broader than that of a dependent agent under Art. 5 (5) of the OECD model tax treaty in the following ways:

  • a permanent representative need not habitually exercise his authority on behalf of the enterprise
  • a permanent representative need not conclude contracts on behalf of the enterprise, and may instead handle activities of a preparatory or auxiliary character (such as maintaining a stock of goods or merchandise for delivery)

To this one may add that

  • a permanent representative need only act as an intermediary in securing contracts for his principal without being authorised to contract for the enterprise or "to negotiate all elements and details of a contract in a way binding on the enterprise" (Official Commentary no. 33 on Art. 5 of the OECD model tax treaty).

Hence, the threshold of activity is lower for a permanent representative than for a dependent agent.

3.5.2 Agent-based tax nexus: tax treaty law

The directive adopts the familiar distinction between dependent and independent agents but provides disappointingly little guidance on the many issues in this area (directive sec. 1.2.2). Somewhat obliquely, the directive makes reference to the three factors needed in order for an agent to constitute a permanent establishment under Article 5 (5) of the OECD model convention:

  • Dependency of the agent on the foreign principal
  • Authority to contract for the foreign principal and regular (habitual) use of this authority
  • Engaging in activities beyond those of a preparatory or auxiliary nature.

Dependency

Concerning the first requirement, it is stated that an agent need not be an employee of his principal to be a dependent agent. The failure of an agent to bear the economic risk of his activities is cited as an indication of dependency. The passage in question is unchanged from the 1997 draft version of the directive.

At the time, the Institute of German Auditors (IDW) recommended that language be added providing that the determination of the agent's compensation under any of the standard transfer pricing methods, including the cost-plus method, shall not be interpreted as meaning that the agent does not bear the economic risk of his activities (WPG 1997, 641). This recommendation was not acted on. Kumpf/Roth likewise state that failure to bear the economic risk of one's activities cannot be inferred from the fact that the agent is remunerated on a cost-plus basis (DB 2000, 741, 742/2). However, the tax authorities' rejection of the IDW's recommendation indicates that they are not willing to rule out the inference in all cases.

The guidance offered on the subject of dependency is woefully inadequate. Official Commentary no. 32 on Art. 5 of the OECD model tax treaty states that dependent agents are agents who are not independent agents within the meaning of Art. 5 (6) of the OECD model tax treaty, which refers to brokers, general commission agents, and other agents of an independent status. By citing failure to bear economic risk as an indication of dependency, the German tax authorities imply that they do not propose to distinguish between dependent and independent agents on legalistic grounds. German law contains precise statutory models for brokers, general commission agents, and commercial representatives (who are generally regarded in the German literature as the prime example of 'other agents of an independent status'). Can a general commission agent fit the statutory model in all formal respects but still fail to bear the economic risk of his activities? This is an obvious question which the directive unfortunately fails to address. The directive does not even say whether commercial representatives may be agents of an independent status.

The directive is silent as to whether an agent is dependent on his principal merely because all of the agent's revenue is earned by acting for a single principal (or persons controlled by or under common control with this principal). This should not be the case.

Authority to contract

With regard to the existence of authority to contract, the 1997 draft directive stated that such authority exists if the agent can bind his principal "either legally or economically" (sec. 1.2.1, p. 14). The IDW (loc. cit.) criticised the vague concept of 'economically binding authority' and suggested deleting this expression and instead quoting from Official Commentary no. 33 on the OECD treaty provision in question to the effect that authority to contract exists when the agent is authorised to negotiate all elements and details of a contract in a way binding on the enterprise even if the contract is signed by another person in the country in which the enterprise is situated. While the tax authorities deleted nothing from the directive, they did add a slight paraphrase of the suggested language from Official Commentary no. 33, which gives some content to the concept of economically binding authority without, however, limiting it to the situation referred to in Official Commentary no. 33.

Parent-subsidiary relationship

Citing Art. 5 (7) of the OECD model tax treaty, the directive states that the parent-subsidiary relationship (and presumably any other affiliation) is as such irrelevant to whether a subsidiary constitutes an agent-based permanent establishment for its parent (or presumably for any other related entity). The passage in question has been reworded compared with the 1997 draft version and now states that a subsidiary can only constitute a dependent agent for its parent if the agency relationship results from circumstances other than the fact of corporate control and is outside the ordinary course of the subsidiary's business.

Independent agents

Under Article 5 (6) of the OECD model convention, an independent agent can constitute a permanent establishment for his principal if he acts outside of the normal course of his business. Citing the Federal Tax Court decision reported on in article no. 12 (BFH BStBl II 1995, 238 - 14 Sept. 1994), the directive shifts the emphasis from the normal course of the agent's specific business to the normal course of the general type of business in the particular industry. While this is arguably not in line with the OECD model treaty, it correctly states the holding of Germany's highest tax court on this subject (cf. Kumpf/Roth DB 2000, 741, 742/2).

Income allocation to agent-based permanent establishments

The directive does not comment on the income allocable to a permanent establishment created by an agent, including a subsidiary constituting a dependent agent or an independent agent acting outside of the normal course of its business. The better view is that the permanent establishment's income includes the fee payable to the agent on the transaction, which simultaneously constitutes an expense allocable to the permanent establishment, hence reducing the latter's net taxable income. Under this view, the critical question is, what, if anything, remains after deduction of the agent's fee and why? In other words, by how much, if anything, does the permanent establishment's income exceed the agent's fee? No consensus exists in the literature as to the proper approach to this problem. Cf. Endres (IStR 1996, 1 [4]) and Mössner, Steuerrecht Internationaler Unternehmen, 1992, p. 87.

3.6 Foreign tax attributes and nexus to tax ("isolated analysis")

The final sentence of sec. 1.1 on p. 5 of the draft directive provided that account was to be taken of the foreign activities of a foreign entity whenever this would cause the foreign entity to derive German source income from trade or commerce. The relevance of foreign activities is the subject of dispute in the German literature. The IDW (WPG 1997, 641) took the position that foreign activities (or foreign tax attributes) were irrelevant as a basic matter and that it would therefore be improper to consider them in order to cause a foreign entity to earn German source income from trade or commerce.

The passage in question was deleted from the final version of the directive (directive sec. 1.1).

3.7 Required duration of a permanent establishment

As explained in sec. 3.3.1 above, the final directive contains a rigid six month rule as to when a permanent establishment possesses the required degree of permanence (directive sec. 1.1.1.1 and 1.2.1.1).

A six month limit is found in the second sentence of § 12 AO, which provides that construction and assembly work creates a permanent establishment if it goes on for more than six months. The Federal Tax Court has held that, while exceeding the six month limit is evidence that a facility possesses the required degree of permanence, it is only conclusive on the issue with regard to construction and assembly work.

3.8 Construction and assembly projects

Comments on construction and building projects are found in sec. 1.1.1.2, 1.2.1.2, and 4.3 of the final directive, with the most detail being provided in sec. 4.3, the length of which increased from four pages in the 1997 draft to over seven pages in the final directive. Only selected aspects are discussed in this article.

3.8.1 Required minimum duration

The six month period during which construction and assembly work does not constitute a permanent establishment under German domestic tax law is extended to one year under roughly half of Germany's tax treaties. Brief temporary interruptions by reason of e.g. inclement weather, strikes, material shortages, etc. are counted for purposes of determining the duration of a construction or assembly project.

3.8.2 Consolidation of multiple projects (directive sec. 4.3.5)

Under German domestic law, a permanent establishment exists with respect to all construction and assembly sites in a group of projects simultaneously under way if any project in the group exceeds the six month limit. Furthermore, a series of projects following immediately one upon the other constitutes a permanent establishment if the series of projects taken as a whole lasts more than six months. No economic or commercial relationship between the various sites is required (cf. Federal Tax Court 21 April 1999 - IStR 1999, 604). By contrast, the directive explains that Article 5 (3) of the OECD model convention permits several simultaneous and/or successive discrete building sites to be consolidated and treated as a single site for purposes of determining a site's scope and duration only if they "form a coherent whole commercially and geographically" (Official Commentary no. 18 on Art. 5 of the OECD model tax treaty).

Section 4.3.5 of the directive (p. 61) states that, for German tax treaty purposes, discrete sites must be "commercially and geographically related" in order to be treated as a single overall project. The directive decrees an absolute limit of 50 km straight line distance for purposes of determining geographic proximity. The apparent intention is to treat all sites which are within 50 km of each other as geographically related and all sites which are further apart as geographically unrelated. The 50 km rule was retained in the final directive despite objections by the Institute of German Auditors (WPG 1997, 641) that the question of geographic proximity should be answered based on the individual facts and circumstances without reference to a rigid limit not found in the OECD model income tax treaty. Cf. also Kumpf/Roth DB 2000, 500, 503/2.

Examples and language added to the final version of the directive state that no construction site is to be counted twice in applying the 50 km rule. Hence, if site A is 50 km from site B, and site C is 50 km from site B, but further from site A, only sites A and B or sites B and C may be consolidated, depending on the order in which they were commenced.

Citing Official Commentary no. 20 on Art. 5 of the OECD model tax treaty, the last paragraph of sec. 4.3.5 (p. 63) states that floating construction projects and construction projects which by their nature advance from place to place (such as construction of a road or railway line) are as a rule geographically and commercially related without regard to the 50 km limit.

Sec. 4.3.5 of the directive provides considerable additional guidance as to when several projects may be consolidated and when the rules of Art. 5 (3) of the OECD model tax treaty are to be applied to each project separately. It is also noted that the fact that a construction or assembly project does not possess the required minimum duration under Art. 5 (3) of the OECD model tax treaty does not preclude the existence of an agent-based permanent establishment under Article 5 (5).

3.8.3 Construction planning and supervision (directive sec. 4.3.2)

The directive's comments on construction planning and supervision adopt the position of Official Commentary no. 17 on Art. 5 of the OECD model tax treaty that planning and supervision of the erection of a building are covered by Art. 5 (3) of the OECD model tax treaty "if carried out by the building contractor," but not if performed by someone else as an isolated activity.

The directive's specific provisions on point have caused considerable confusion, however. As explained by Münch (DB 2000, 2140, 2142), a member of the working group which drafted the directive for the Federal Ministry of Finance, the core statement of sec. 4.3.2 (p. 59) of the directive is that planning and supervision work constitutes part of a construction or assembly project and is hence subject to the rules of Art. 5 (3) of the OECD model tax treaty only when carried out by a person who bears the predominant economic responsibility (liability) for completion of the work. Furthermore, the extent to which an entity carries out construction or assembly work is irrelevant.

The following conclusions flow from Münch's interpretation, the validity of which is, however, questionable:

  • Where the general contractor performs planning and supervision work on site, this activity creates a permanent establishment for the general contractor under Art. 5 (3) of the OECD model tax treaty, provided the general contractor bears at least 51 % of the liability to third parties for completion of the project.
  • Where the general contractor has delegated (e.g. to other members of a construction consortium) more than 49 % of the third party liability, its planning and supervision work on site is not subject to Art. 5 (3) of the OECD model tax treaty. Whether such work creates a permanent establishment for the general contractor depends on the general rules of Art. 5 (1).
  • Planning and supervisory work carried out by any other party who does not bear at least 51 % of the liability for completion of the project is likewise governed by the general rules of Art. 5 (1), not by the rules of Art. 5 (3) of the OECD model tax treaty.
  • Where parties act as members of a joint venture (Arbeitsgemeinschaft), any on-site planning and supervision work performed by one of the joint venturers will be subject to the rules of Art. 5 (3) of the OECD model tax treaty because the activities of the joint venture are attributed to all of its members under sec. 4.3.4 of the directive.

As already noted, it is questionable whether Münch's comments are consistent with the present wording of the directive. There would appear to be no basis in the directive in particular for the bright line of 51 % liability drawn by Münch. Further clarification is needed in this area.

3.8.4 Consortiums and joint ventures (directive sec. 4.3.4)

Companies often cooperate in bidding for and carrying out construction projects. The directive differentiates between associations of partner firms depending on whether the association constitutes a consortium (Konsortium) or a joint venture (Arbeitsgemeinschaft) from a German perspective. Joint ventures are single-purpose civil law partnerships under German law. The directive proposes to look to the activities of the joint venture as a whole and apply a so-called "uniform treatment" (Einheitsbetrachtung) or entity approach. The activities of the joint venture as such are important. Hence, the only question is whether the joint venture as such has a permanent establishment. If so, each of its members will have one as well, pro rata. If not, none of the members has a permanent establishment with respect to its activities as joint venturer. The treatment of joint ventures thus appears to follow that recommended for partnerships in Official Commentary no. 19.1 on Art. 5 of the OECD model tax treaty.

On the other hand, the directive states that each member of a consortium must be examined separately to determine whether it has a permanent establishment.

The justification for the different approach for consortiums is a bit confused, but seems to hinge on the understanding that, in the case of a consortium, the principal contracts either with all of the consortium's members on the basis that each will perform specific parts of the overall project (so-called "external consortium") or with only one member of the consortium ("internal consortium"), whereas in the case of a joint venture the principal contracts with the joint venture as an entity.

In the case of both consortiums and joint ventures, the directive recognises separate contractual relationships between members of a consortium or joint venture and the quasi-entity represented by the consortium or joint venture (cf. sec. 9.5 below). Profit on such relationships is therefore realised upon completion of performance on the specific contract, not when the consortium or joint venture has completed the overall project (directive sec. 4.3.4 last paragraph).

3.9 Auxiliary and preparatory functions

Under Art. 5 (4) of the OECD model convention, fixed places of business used solely for carrying out auxiliary and preparatory functions do not create permanent establishments. The tax treaty permanent establishment concept is more restrictive than that under German domestic tax law (§ 12 AO) in this respect (see sec. 3.3.2 above).

The comments in sec. 1.2.1.1 of the directive on activities that are auxiliary or preparatory in character are considerably more detailed than those in the 1997 draft version, but remain cursory and abstract. Where the directive states that "auxiliary activities accompany primary activities and follow after them in time sequence," the word "and" should probably read "or" (see Kumpf/Roth DB 2000, 741, 742 fn. 22).

The directive distinguishes primary activities from auxiliary activities using language taken from Official Commentary no. 24 on Art. 5 of the OECD model tax treaty: a primary activity "forms an essential and significant part of the activities of the enterprise as a whole" (p. 18). The research activities of a pharmaceutical company are given as an example of a primary activity (cf. Official Commentary no. 23 on Art. 5 of the OECD model tax treaty).

Citing a 1996 decision involving an underground oil pipeline (BFH BStBl II 1997, 12 - 30 Oct. 1996), sec. 4.8 of the directive - dealing with transportation facilities - provides that railroads and utility lines constitute permanent establishments for the enterprise which maintains them. In the decision relied on, the transportation of crude oil and oil production was the principal business activity of the pipeline's operator. In its 1997 comments on the draft directive (WPG 1997, 641), the IDW argued out that transportation facilities would not constitute a tax treaty permanent establishment if they were not related to the operator's principal business activity and suggested an amendment to this effect. The final version of the directive instead contains new language stating that transportation operations, such as the transportation of fluids and gasses in pipelines, do not as a rule constitute activities of an auxiliary character, implying that they generally create permanent establishments.

With regard to transportation facilities, sec. 4.8 of the directive furthermore states that "activities by personnel in or at the place of business ... are not necessary in every case. Rather, the activities of the enterprise by virtue of the place of business ... are sufficient, in particular in the case of fully automated facilities."

3.10 Bookkeeping requirements for German permanent establishments

The German permanent establishment of a foreign entity is required to keep separate books and records in Germany if the permanent establishment constitutes a "branch establishment" (Zweigniederlassung) within the meaning of § 13 HGB (Commercial Code) or if the permanent establishment exceeds certain turnover or profit limits and is specifically requested to keep books by the tax office (§§ 13d - 13g HGB; § 238 HGB and §§ 140, 141, 146 AO). The tax authorities have discretion to permit the books to be kept abroad and to grant other relief from the normal bookkeeping obligations (§ 148 AO). Special recordkeeping requirements exist for VAT purposes under § 22 UStG. The directive repeats these principles in its section 1.1.3.2.

Numerous authors have pointed out that the European Court of Justice (ECJ) held in its Singer decision (15 May 1997 - DB 1997, 1211; see article no. 87) that a member state violates EU law by requiring the domestic branch establishment of an entity with its legal seat in another EU country to keep books in the member state in order to qualify for a net operating loss carryforward or carryback. It is inferred from this decision that § 146 (2) AO violates EU law by requiring the German permanent establishment of an EU enterprise to keep its books in Germany.

In addressing this issue, Münch (DB 2000, 2140 - with further references) concedes that the pertinent part of § 146 (2) AO is probably inconsistent with EU law and argues that, where the German permanent establishments of EU enterprises apply for permission under § 148 AO to keep books and records in another EU member state, such permission must be granted as long as the tax authorities' access to the foreign books is comparable to that which bookkeeping in Germany would permit. He states that tax authority access to the taxpayer's electronic systems will often be necessary to ensure this. "Electronic audit" provisions were included in Germany's 2000 tax reform bill and take effect in 2002 (see article no. 213).

3.11 Bookkeeping requirements for foreign permanent establishments

The accounting and recordkeeping requirements of German resident persons apply to their entire business operations and thus cover foreign permanent establishments as well. It makes no difference whether the profit or loss from the foreign permanent establishment is excluded from the German domestic tax base or not. For foreign permanent establishments which comply with requirements under foreign law to keep books and records, the directive provides, however, in its sec. 1.1.4.2, that it is sufficient to incorporate the results (account balances) of this accounting system into the accounting of the domestic enterprise. The adjustments necessary to comply with German tax accounting principles must be identified as such.

If no separate accounting system exists for the foreign permanent establishment, the directive provides that its transactions must be recorded in the accounting system of the domestic enterprise in such a way as to enable them to be identified.

The directive also cites various relevant provisions of German tax procedural law (§§ 138 (2), 90, 97, 146 (2) - (4), 200, 379 AO, § 16 AStG), which define the taxpayer's obligations to provide information and other forms of cooperation.

4. Consequences of a permanent establishment under a tax treaty

4.1 General rule: exclusion of profits of a foreign PE

The consequences of the existence of a permanent establishment are dealt with under subsections 1.2.4 - 1.2.6 of the directive (pp. 21 - 24). As between two treaty states, the right of taxation of an entity's business profits is reserved exclusively to the entity's country of residence unless the entity maintains a permanent establishment in the other treaty state, in which case that state (the source state) may tax the profits attributable to the permanent establishment and the state of residence must adjust its taxation of those profits so as to avoid double taxation thereof.

Where Germany is the state of residence, its tax treaties generally avoid double taxation by exempting the profits of a foreign permanent establishment operated by a German resident entity from German taxation. Until the discontinuation of net worth taxation in 1996 (see article no. 76), the property attributable to a permanent establishment was also excluded for purposes of net worth taxation. In the case of individuals, including partners in partnerships, the exemption is subject to a so-called "progression clause" (Progressionsvorbehalt) meaning that the average tax rate is that which would have applied without the exemption, resulting in application of a higher tax rate to a base from which the permanent establishment profits have been excluded.

The directive notes in section 1.2.4 on p. 22 that dividends, interest, and royalties are only part of the exempt business profits of a foreign permanent establishment if the respective shareholding, debt claim, or intangible asset is "effectively connected" to the permanent establishment. No guidance is provided in interpreting the term "effectively connected," but reference is made to a decision of the Federal Tax Court on point (BFH BStBl II 1996, 563 - 30 August 1995).

4.2 Exceptions to the exemption method

The directive calls attention to a variety of situations in which Germany avoids double taxation under the credit method instead of the exemption method:

  • Under certain tax treaties, the exemption is subject to an activity clause, meaning that it is only granted if the foreign permanent establishment is engaged in an "active" trade or business (as defined in the particular tax treaty - see directive sec. 1.2.4 p. 24 first sentence).
  • Certain German tax treaties contain subject-to-tax clauses denying the exemption when the other treaty state does not in fact exercise its right of taxation under the tax treaty (directive sec. 1.2.6 - see article no. 74). Such clauses are a departure from normal German treaty practice, under which potential or "virtual" taxation by the source state is sufficient to qualify for the exclusion. The final directive accepts the Federal Tax Court's decision of 27 August 1997 (BStBl II 1998, 58), which held that the extent to which the source state taxes a particular type of income is irrelevant for purposes of subject-to-tax clauses (a reversal of position compared with the 1997 draft directive). Language was also added to the final directive requiring the taxpayer to prove that his income was subject to actual taxation in the source state where a subject-to-tax clause applies.
  • The international transactions tax act overrides Germany's tax treaties with respect to certain passive income (e.g. interest) from low-tax jurisdictions (§ 20 (2) AStG). From 2001 onwards, a low-tax jurisdiction is one in which the effective rate of tax is under 25 % of the tax base determined under German tax principles. See directive sec. 1.2.4.
  • With respect to loans and other contractual dealings between German partners of a partnership operating in a tax treaty country, the German tax authorities take the position in sec. 1.2.3 (p. 21) of the directive that the credit method applies instead of the exemption method where sums (e.g. loan interest) paid by a partnership to the partners are not taxed fully in the other treaty state because it classifies the income differently from Germany for tax treaty purposes (e.g. as interest instead of business profits). Krabbe (IWB Fach 3 Gruppe 2 p. 863, 867) states that the switchover to the credit method will apply in all qualification conflict situations. The issues involved are explained in more detail in sec. 9.5.2 below.

4.3 Loss treatment

German domestic tax law disallows the deduction of most foreign losses on the domestic tax return (§ 2a (1) EStG). Non-deductible foreign losses are carried forward indefinitely and may be set off against later profits on a country-by-country basis.

Foreign permanent establishment losses may be deducted without time limit just like losses from domestic operations provided the foreign permanent establishment meets certain activity requirements (§ 2a (2) EStG).

Where a tax treaty exists, losses ("negative income") generated by foreign permanent establishments are, like profits, generally excluded from the German domestic tax base under tax treaty law. In the case of individuals, including partners in partnerships, the general prohibition on use of foreign losses contained in § 2a (1) EStG applies for "progression clause" purposes as well. This means that disallowed foreign losses may not be deducted from domestic income for progression clause purposes. For progression clause purposes, such losses may, however, be carried forward indefinitely and set off against later exempt foreign income on a country-by-country basis. If the losses are generated by a permanent establishment meeting the activity requirements of § 2a (2) EStG, the general prohibition on deduction of foreign losses does not apply, hence the foreign losses should be deductible from domestic income for progression clause purposes (negative progression) even in a tax treaty context.

Provided the foreign permanent establishment met certain activity requirements, taxpayers were permitted - through the end of the 1998 their assessment year - to elect to deduct the otherwise excluded losses on their German tax returns (§ 2a (3) EStG). For taxpayers who made such elections, subsequent profits through their 2008 assessment periods are subject to German tax to the extent of losses previously deducted.

The directive makes superficial reference to the provisions set forth above (sec. 1.2.4, p. 22).

5. Profit and asset allocation: basic matters

5.1 Qualified separate enterprise approach

The directive endorses the so-called "separate enterprise" approach to determining the profits of a permanent establishment (cf. OECD model convention Article 7 (2)). Under this approach, one attributes to the permanent establishment the profits which it would have earned had it performed the same or similar functions as a separate enterprise on an arm's length basis (directive sec. 2.2, p. 24).

There are two major differences between the "separate enterprise" or "arm's length" approach as applied to permanent establishments and the allocation of profit and loss among independent associated enterprises. The first is the general prohibition on profit markups for internal transactions between permanent establishments (see sec. 5.2 below), the second is the allocation of expense of all types, including general administrative expense, irrespective of where it is incurred (see sec. 6.1 below). Because of the prohibition on profit markups for internal transactions, the approach followed by the directive is known in the German literature as a "qualified separate enterprise approach."

5.2 Internal transactions - basic rule and general exception

The directive departs from a pure separate enterprise approach as regards internal transactions, stating that no profit may be earned on transactions between the permanent establishments of the same enterprise (section 2.2, p. 25). This position is repeated with specific regard to notional interest for use of equity capital in section 3.3 (p. 46).

The reason given for the general rule denying profit markups on internal transactions is that an enterprise is legally incapable of contracting with itself. Of course, it is equally impossible for a particular permanent establishment to contract independently in its dealings with third parties. The contract with the third party is always on behalf of the enterprise as a whole. Nevertheless, the separate enterprise approach is applied with respect to such contracts. The grounds for refusing to follow an unqualified separate enterprise approach with regard to internal transactions thus appear formalistic and illogical.

Section 2.2 of the directive has, however been modified compared with the 1997 draft version to provide that the apportionment of profits between the head office and its permanent establishments with regard to internal transactions shall take place on an arm's length basis if two conditions are met:

  • The company unit which is rendering performance must do so in the normal course of its business, and
  • An appropriate allocation of income must be possible based on the allocation of functions between the head office and the permanent establishment.

This general exception to the basic rule is potentially of greater importance than the specific exceptions discussed in section 5.3 below. Kumpf/Roth (DB 2000, 741, 744/2) note that the scope of this exception is unclear.

There is criticism in the German literature of the qualified separate entity approach (see IDW WPG 1997, 641, Kumpf/Roth loc. cit., and Göttsche/Stangl DStR 2000, 498, 503 with further references). The rejection of profit markups with respect to internal transactions introduces a major difference between the allocation of profits among the various subsidiaries of a controlled group and the allocation of profits of a single enterprise to its various permanent establishments, even though the economic functions of permanent establishments may well be identical to those of subsidiaries.

5.3 Internal transactions - specific exceptions

In addition to the general exception discussed above, the directive also makes the following specific exceptions to the rule prohibiting profit markups on internal transactions between permanent establishments:

  • Where services are rendered by one permanent establishment to another and the performance of such services constitutes the primary activity of the permanent establishment rendering the service, an arm's length profit markup is not only permitted, but required (directive sec. 3.1.2, p. 43). If the arm's length profit cannot be determined, the directive states that use of the cost plus method with a markup of 5 % to 10 % is acceptable. No profit markup is permitted to the extent the services in question constitute a secondary activity.
    The above is not to apply, however, in the case of management and general administration services as described in section 3.4 of the directive. Section 3.1.2 of the directive states that these services are governed by the general rule.
  • A markup is permitted, but apparently not required, for advertising services performed by a permanent establishment for other permanent establishments as the primary function of the service provider (directive sec. 3.2.1, p. 45).
  • A permanent establishment which manufactures products for the head office according to the latter's specifications (Lohnfertigung, verlängerte Werkbank) is entitled to the profit normally earned at its location for performing such a function (directive sec. 3.1.3, p. 44). Presumably, it would make no difference if the function was performed for another permanent establishment instead of for the head office.
  • For lending institutions (banks), internal interest payments between permanent establishments are to be recognised on the grounds that money is the goods in which banks trade (sec. 4.1.4, p. 52). Interest payments will only be recognised on that part of the capital provided by another unit of the same enterprise which exceeds the equity endowment ("dotation") which the arm's length standard requires (see sec. 5.6 below).

Kumpf/Roth (DB 2000, 741, 745/1) argue that the principles underlying the above should be extended to cars provided by a car rental enterprise, patents made available by a patent licensing enterprise, and funds provided by a group financing company to their respective permanent establishments. Kumpf/Roth would also extend the exception to funds provided by a permanent establishment created to finance other parts of the same enterprise.

The tensions in the positions taken by the directive on the important issue of profit markups on internal transactions reflect a similar contradiction running through the Official Commentary on Article 7 of the OECD model convention.

5.4 Methods of profit apportionment

The directive states that the profits of an enterprise attributable to a particular permanent establishment may be determined either by a "direct" method based on analysis of functions performed and transactions engaged in or by an "indirect" method, by which is meant some form of formulary apportionment. A preference is expressed for the direct method, especially where the head office and the permanent establishment perform different functions. Profits are then to be determined "on the basis of the accounts and the German profit determination provisions" (directive sec. 2.3.1, p. 26). The strong implication is that the separate accounts of the permanent establishment (see sec. 3.6 and 3.7 above) will form the starting point for review of the result reported.

Under the indirect method (sec. 2.3.2, p. 27), the profit or loss of the enterprise as a whole is apportioned between the permanent establishment and the head office "on the basis of an appropriate formula". A sentence in the 1997 draft requiring such formula to approximate as closely as possible "the economically appropriate result" is not contained in the final version of the directive.

Despite the theoretical preference for the direct method, the directive specifies acceptable apportionment formulae for certain cases in which the permanent establishments involved perform the same functions and have the same internal structure. The "approved" formulae are as follows:

  • Turnover (sales) for enterprises providing services and trading in goods
  • Revenue from premiums for the insurance business
  • Share of working capital for banks
  • Wage and salary expense for manufacturing enterprises.

Language was added to the final version making clear that the cited formulae are merely examples of acceptable apportionment factors, not an exhaustive list.

5.5 Attribution of assets and liabilities to permanent establishments

The attribution of positive assets and negative assets (liabilities) to a permanent establishment can have considerable impact on its profits as well as its net worth. The latter aspect diminished in significance after 1996 in view of the discontinuation of German net worth taxation.

5.5.1 Exclusive, predominant, and joint function assets

Section 2.4 of the directive (pp. 27, 28) begins with the statement that assets must be attributed either to the head office or to a permanent establishment (either-or approach). Attribution of an asset to both pro rata is thus not permitted. Assets intended for exclusive use and exploitation by the permanent establishment are to be attributed to it. The same applies for income-producing assets where the permanent establishment has made the predominant contribution to earning the income yielded. Kumpf/Roth (DB 2000, 741, 746/1) comment that this second attribution rule is difficult to comprehend and presumably relates to intangible assets developed by a permanent establishment but used by other units of the enterprise. For purposes of attribution, the structure, organisation, and general purpose of a permanent establishment are taken into consideration (functional analysis) - as is the central function of the head office (see below).

Assets which can fulfil their intended function as part of either the permanent establishment or the head office (joint function assets) may be attributed to either one at management's discretion, provided the exercise of such discretion is objectively clear. The fact that an asset is carried on the books of the head office or permanent establishment is evidence of management's intention, but is not determinative of the issue. The revenue and expense attaching to joint function assets is to be apportioned in light of the relative actual use. The either-or approach does not apply to revenue and expense related to such assets.

5.5.2 Joint function assets: capital gains

Capital gains on the disposition of joint function assets are likewise to be apportioned on the basis of relative use (directive sec. 2.4 p. 28). This provision was contained in the 1997 draft version and attracted strong criticism at the time (Strunk/Kaminski IStR 1997, 513, 515/2). The pro rata apportionment of capital gain on the sale of assets is arguably inconsistent with Germany's tax treaties. The pro rata apportionment of capital gains from joint function assets may thus apply only where no tax treaty is in effect, leading to an indefensible difference in the treatment of capital gains in treaty and non-treaty cases (Strunk/Kaminski IStR 2000, 33, 40). Kumpf/Roth (DB 2000, 741, 746-747) state that the capital gain on the disposition of an asset must be attributed to the permanent establishment to which the asset is allocated.

Göttsche/Stangl (DStR 2000, 498, 504) call attention to another problem. When assets are transferred from the German head office to a permanent establishment in a tax treaty state to which the exemption method applies, or from such a permanent establishment to the head office, the difference between the fair market value of the asset at the time of transfer and the asset's book value is charged to the transferring unit as deferred profit to be realised at a later time (see sec. 8 below). The rules for handling such transfers make no provision for pro rata deferred profit treatment on transfers of joint function assets.

Example

A fixed asset used half each by the head office and its foreign permanent establishment (subject to a tax treaty employing the exemption method for avoidance of double taxation) is transferred from the permanent establishment to the head office. The book value at the time of transfer is 50, the fair market value is 100. The asset is then sold by the head office for 100. Since the head office takes the transferred asset onto its books at fair market value, the gain on the sale is nil. While the permanent establishment realises gain of 50, this gain is exempt in Germany under the tax treaty. Had the sale been made by the permanent establishment before the transfer, the gain of 50 would have been attributable half each to the head office and permanent establishment (from a German perspective). Depending on whether the permanent establishment or the head office is subject to a lower rate of taxation, prior transfer to the head office results in tax savings or causes extra tax expense.

5.5.3 Asset attribution: special cases

Because of the weight given to the "central function" of the head office, funds serving the enterprise as a whole are to be attributed to the head office "as a rule" (directive sec. 2.4 p. 28). The 1997 draft version contained an exception for "excess funds" generated by the permanent establishment, but this was deleted from the final directive. Kumpf/Roth loc. cit. p. 746/2 consider this deletion inconsistent with the separate enterprise approach to determining permanent establishment profits because a subsidiary could have retained its own earnings.

Investments in other companies are also "as a rule" attributable to the head office, unless they support the operations of the permanent establishment.

Assets need not be attributed to a permanent establishment by reason of their temporary use if they would have been rented or leased between independent parties, or where assets are used by several permanent establishments simultaneously or successively, provided in both cases a procedure exists for apportioning the related expense and revenue among the various parts of the enterprise.

5.5.4 Banks and insurance companies

Sections 4.1.2 and 4.2.2 of the directive deal with the attribution of assets to the permanent establishments of banks and insurance companies respectively. See Kumpf/Roth FR 2000, 500.

5.6 Capitalisation of permanent establishments

In sec. 2.5.1 (p. 29), the directive takes the position that a permanent establishment must have an arm's length "equity dotation" or "equity endowment" (Dotationskapital). A sentence added to the final directive states that this applies even where losses generated by the permanent establishment have consumed a material part of the original equity capital. Another addition permits undercapitalisation of a permanent establishment where the other parts of the same enterprise likewise have insufficient equity.

At issue here is the extent to which interest expense paid to third parties is properly attributable to a particular permanent establishment. The high German tax rates may incline a German entity with foreign permanent establishments to seek to reduce their share of interest expense by providing them with a percentage of equity in excess of that of its German permanent establishments. Foreign entities may assign little or no equity to their German permanent establishments for the same reason.

The basic provisions respecting capitalisation are unchanged from the 1997 draft directive, in response to which the Institute of German Auditors (IDW - WPG 1997, 641) emphasised the discretion enjoyed by a businessman in determining how to fund his business. Relying on a case cited in the directive (BFH BStBl II 1987, 550 - 1 April 1987), the IDW noted that the court held that the decision of a businessman (as reflected for example in the company's books) is to be respected for tax purposes unless it conflicts with what is "commercially and economically necessary." This standard is a generous one allowing considerable leeway to the business in question. The IDW furthermore noted that "the amount of equity which is customary in a particular industry cannot be determined and is in particular not reflected by the statistical average equity in an industry".

The directive instructs tax authorities to apply the arm's length standard to the capitalisation issue, emphasising the limitations on managerial discretion, not its wide scope. If no appropriate external comparables can be discovered, the directive provides in sweeping terms that "there is no objection to apportioning the equity of the enterprise as a whole by means of an estimate in light of the relative functions of the home office and the permanent establishment" (internal comparison). If the head office and the permanent establishment perform the same functions, the debt-to-equity ratio of the head office is cited as potentially appropriate for the permanent establishment as well (so-called mirror image method).

As Göttsche/Stangl note (DStR 2000, 498, 505), the directive provides no guidance as to when the functions of the home office and its permanent establishment are sufficiently similar to use the mirror image method. There is likewise little guidance as to how to go about the prescribed external and internal comparisons.

When interests in a German partnership are purchased, the directive provides in its sec. 2.5.2 that the capitalisation of the partnership by the selling partners is a standard for assessing the necessary capitalisation of the partnership under its new ownership.

In the event a permanent establishment's debt is found to be excessive, the 1997 draft directive provided that reclassification of debt as equity was to begin with the loans bearing the highest rate of interest. In response to criticism, this rule has been changed to one under which the "time sequence" in which the debts are incurred is determinative. The final directive does not state, however, whether a LIFO or a FIFO approach is to be followed, leading Strunk/Kaminski to conclude that the taxpayer has discretion in this matter (IStR 2000, 33, 36). Göttsche/Stangl question this conclusion and see a need for further clarification by the tax authorities (DStR 2000, 498, 504/2).

5.7 Equity allocated to PEs of banks and insurance companies

In its sec. 4.1.3, the directive fixes minimum equity capital amounts for the domestic permanent establishments of banks and insurance companies. For European Union banks, these depend on the bank's balance sheet amount:

Balance sheet total "x"

Minimum equity

x ≤ DM 100 million

DM 2 million

DM 100 million < x ≤ DM 500 million

2.0 % of the balance sheet total

DM 500 million < x ≤ DM 1 billion

DM 10 million

DM 1 billion < x ≤ DM 2 billion

1 % of the balance sheet total

DM 2 billion < x ≤ DM 5 billion

1 % of DM 2 billion plus 0.5 % of the excess

DM 5 billion < x

1 % of DM 2 billion plus 0.5 % of DM 3 billion plus 0.25 % of the amount over DM 5 billion

For the permanent establishments of U.S. and Japanese banks, the same rules apply except that the minimum capital begins at EURO 5 million. For other non-EU banks, the capital required under German bank regulatory law applies (directive p. 51).

For the domestic permanent establishments of insurance companies, the directive likewise requires the minimum capital prescribed by German bank regulatory law (section 4.2.2, p. 56).

See Kumpf/Roth FR 2000, 500 for more detail on the equity requirements of banks and insurance companies.

6. Apportionment of revenue and expense

6.1 General (section 2.7, pp. 34 - 36)

The allocation of expenses to permanent establishments differs from that to subsidiaries in that all types of general expense (including stewardship expenses and general interest expense) are in principle allocable irrespective of where incurred and without any contractual basis provided the permanent establishment is at least indirectly benefited thereby. Expense and revenue items exclusively related to a specific permanent establishment are of course allocated to it alone.

The directive states that costs incurred by the head office in connection with its permanent establishment (such as the cost of financing, management and general administration, supervision and coordination) that are not directly allocable to the permanent establishment will be attributed to it, on a pro rata basis where appropriate. While the relevant provisions are somewhat more vaguely worded than in the 1997 draft version, the directive implies that the taxpayer's cost accounting and allocation will be considered as a starting point if the following conditions are met:

  • Comparability of the cost accounting systems used by the head office and the permanent establishment
  • Existence of differentiated and easily verified cost accounting records
  • Complete coverage of the permanent establishment
  • Periodic review of the cost accounting system and adjustment in response to changed circumstances

The directive permits allocation of expense and revenue on a lump-sum basis or after consolidating costs into certain blocks provided either of two conditions is met:

  • The allocation system meets the above requirements, takes account of the specific functions performed, and leads to results which are sufficiently close to those which allocation of the individual revenue and expense items would yield;

or

  • Allocation of the individual revenue and expense items is impossible or unreasonably difficult.

The following are cited as potentially necessitating adjustments to the results reported by the taxpayer:

  1. Transfer of fixed and current assets between permanent establishments
  2. Expenses booked to a domestic permanent establishment but in fact attributable to a foreign permanent establishment
  3. Attribution to foreign permanent establishments of an inappropriately small share of the following expenses incurred by the domestic head office:
    • general management and administration expense including supervision and coordination expenses
    • advertising expense
    • research and development expense
    • interest expense.

6.2 Expense of creation and dissolution of a permanent establishment

The directive's provisions on expense relating to the creation and dissolution of a permanent establishment (sec. 2.9, pp. 41 ff.) have provoked a good deal of controversy.

Where the creation of a permanent establishment is contingent on the success of attempts to acquire a contract, sec. 2.9.1 of the directive provides that expenses incurred in connection with such attempts (acquisition expenses) are allocable to the head office. All other expense is said to be allocable to the permanent establishment even if it never comes into being. This means that most expense incurred by a German head office in connection with a failed foreign permanent establishment will be subject to the loss utilisation restrictions described under sec. 4.3 above. The tax authorities base their position on a 1983 decision by the Federal Tax Court interpreting § 3c EStG (BStBl II 1983, 566; 4th Chamber). § 3c EStG disallows the deduction of expenses related to tax exempt income.

Critics cite more recent case law on § 3c EStG stemming from the 1st Chamber of the Federal Tax Court. These decisions of 29 May 1996 (reported on in article no. 54) held that expenses incurred by German corporations to finance the purchase of investments in foreign corporations which paid tax-free dividends under tax treaty law were deductible in Germany except to the extent of tax free dividends received in the same assessment period. Otherwise, the court said that the relationship between the tax-free income and the expenses was insufficiently direct to justify denying the deduction under the cited statute. It is thus argued with respect to expenses for permanent establishments that never come into existence (hence generating no tax-free income at all) that the relationship required under § 3c EStG cannot be present, hence that the expenses for failed permanent establishments must be allocable to the head office (cf. Göttsche/Stangl DStR 2000, 498, 507).

On the other hand, Münch (DB 2000, 2140, 2141) contends that the position taken by the directive does not rest on § 3c EStG (which would, incidentally, limit it to tax treaty contexts, as only under tax treaties are the profits of foreign permanent establishments tax exempt in Germany). Rather, the rule expounded is said to be based on general principles of expense attribution in accordance with causation.

Citing directive sec. 4.3.7 (second paragraph, sentence 2, relating to the allocation of profit from construction project permanent establishments between PE and head office), Münch notes that, where a permanent establishment generates income, the profits attributable to the head office should in principle include a share to cover acquisition expenses. However, under the directive the head office receives no such share. In light of this rule, which increases the profits attributable to the permanent establishment, Münch submits that it is fair to require the permanent establishment to bear most of the costs which arise when efforts to create a permanent establishment fail to bear fruit.

Where a permanent establishment is dissolved such that no permanent establishment (fixed place of business or construction project) any longer exists, the subsequent related revenue and expense remains attributable to the permanent establishment under directive sec. 2.9.2 until the end of the fiscal year following that of dissolution. A closing balance sheet is prepared at such date. Thereafter, expense and revenue is to be allocated to the head office.

6.3 Specific expenses, esp. market penetration expense

Sections 3.2 - 3.4 (pp. 44 - 47) of the directive deal with the following types of specific expenses:

  • advertising and market penetration expense (sec. 3.2)
  • interest expense (sec. 3.3)
  • management and general administrative expense (sec. 3.4).

The directive permits the costs of advertising expense to be divided between different parts of an enterprise in accordance with middle or long range planning. As mentioned in sec. 5.3 above, the directive permits a profit markup with regard to advertising expense only where rendering advertising services constitutes the primary function of the unit providing such services.

With regard to market penetration expenses, the directive repeats positions taken in the 1983 transfer pricing guidelines for associated enterprises, the general thrust of which is to minimise the costs of market penetration borne by a domestic marketing subsidiary. The directive follows the Federal Tax Court's leading case on point (BFH BStBl II 1993, 457 - 17 Feb.1993; see article no. 51 sec. 4.4) by stating that market penetration expense is generally only borne by a marketing permanent establishment to the extent it can still earn a reasonable profit. No specific guidance is provided as to what profit is "reasonable".

The directive appears to contemplate three basic market penetration expense scenarios:

  1. a division such that the marketing PE earns a "reasonable" profit from the start
  2. a division such that the marketing permanent PE bears a disproportionate share of the expense and in return purchases merchandise at low prices on a long term basis, permitting it to enter the profit zone after at most three years and to equalise all losses within a clearly defined period to follow
  3. a division such that the manufacturing unit (e.g. head office) bears a disproportionate share of the expense and in return sells merchandise at higher prices on a long term basis, permitting it to enter the profit zone after at most three years and to equalise all losses within a clearly defined period to follow

The directive stresses the need for advance documentation, including profitability analyses, at least where scenarios (ii) or (iii) are followed, both of which involve a set-off.

The directive also repeats the position of the 1983 guidelines that price reductions or similar actions intended to defend or increase the existing market share are as a basic matter to be borne by the manufacturing unit, not the marketing unit. This appears inconsistent with the position on market penetration, the basic requirement of which is that the marketing permanent establishment must earn an adequate profit.

7. Currency conversion issues

The directive contains detailed provisions on this subject (sec. 2.8, pp. 36 - 41) not dealt with in this article.

8. Transfer of assets between domestic and foreign permanent establishments

The directive deals at length with transfers of assets between domestic (German) and foreign permanent establishments (directive sec. 2.6, pp. 30 - 36).

8.1 Basic issues

There are two schools of thought in Germany regarding transfers of assets between two permanent establishments of the same enterprise. The prevailing view in the literature is that such transfers are events internal to the business in question not triggering any realisation of tax, even when assets leave the German tax sphere (outbound transfers). The directive is based on the opposing view that outbound transfers trigger German taxes. The directive's theoretical underpinnings are weak, however. German tax law contains no provision addressing the tax consequences of outbound transfers, which certainly do not constitute dispositions and, in the prevailing view, likewise cannot be characterised as withdrawals in the sense of § 4 (1) EStG. While a high court decision (BFH 30 May 1997 - BStBl II 1997, 760) holds that outbound transfers do constitute withdrawals, the decision has attracted much criticism and it is not cited in the directive.

The directive in fact refrains from all discussion of the legal basis of the asset transfer rules it propounds. These rules in fact make considerable concessions to the prevailing view, albeit on "equitable grounds". Hence, outbound transfers of fixed and current assets by German resident taxpayers trigger no immediate taxation under the directive. Where such transfers are made to permanent establishments in countries subject to tax treaties under which Germany avoids double taxation by the exemption method, the directive states that the transfer in principle triggers immediate taxation, but that the tax authorities will permit taxation to be deferred "on equitable grounds". Only outbound transfers by non-resident persons and (apparently) partnerships trigger immediate taxation under the directive.

Under the prevailing view, outbound transfers never trigger any tax, hence there is no taxation to defer. Since, however, the results reached under the directive are largely consistent with those reached under the prevailing view, one might regard the theoretical discussion as academic. However, the results reached by the directive are, in certain cases, inconsistent with the prevailing view. This applies notably to outbound transfers by non-residents (transfers from the domestic permanent establishment of a non-resident entity to its foreign permanent establishment). Hence, there is a distinct chance that some of the results reached under the directive could be successfully challenged in court.

One should note that the prevailing view does not necessarily lead to the conclusion that transfers of appreciated assets from domestic permanent establishments to foreign permanent establishments cause Germany to lose the right to tax the appreciation that occurred prior to the transfer. One must distinguish clearly between two issues:

  • When is income is realised?
  • How is income, once realised, to be allocated between domestic and foreign permanent establishments?

The distinction between the time of realisation of income and the manner of its allocation is clearly articulated by Kramer (IStR 2000, 449, 450), who notes that the two issues are frequently confounded. Kramer's central point is that income cannot be allocated until it is realised.

8.2 Other preliminary observations

Kramer points out (loc. cit. p. 450/1) that the transfer of assets between permanent establishments is only relevant to enterprises that allocate income using the direct method (see sec. 5.4 above). For enterprises using an indirect method involving formulary apportionment, asset transfers are relevant only to the extent they affect the result yielded by the formula used to apportion income. Kramer regards the indirect method as theoretically superior to the direct method of income allocation between permanent establishments because of the contradiction inherent in the direct method, namely that it treats different parts of the same enterprise as separate enterprises (loc. cit. p. 457/2 see also sec. 5.1 ff. above). However, in Kramer's opinion, successful use of the indirect method would require an international consensus, for instance within the European Union, on income apportionment formulae and methods for determining the income to be apportioned.

Kramer likewise notes that the different treatment accorded transfers between domestic (German) permanent establishments of the same enterprise and the treatment prescribed for cross-border transfers raises the possibility that the relevant provisions of the directive may violate European Union law (Art. 43 = ex Art. 52) of the EU Treaty (loc. cit. p. 450-451).

Lastly, there is a latent conflict between the rules expounded by the directive with regard to capital gains on the sale of joint function assets and the rules described below relating to asset transfers between permanent establishments. See sec. 5.5.2 above.

8.3 Transfer categories

The directive describes numerous different types of transfers and prescribes rules for each. For purposes of this article, the types of transfers have been grouped into "outbound" and "inbound" transfers and numbered. This organisation is not found in the directive itself. The list of outbound transfers includes transfers between two foreign permanent establishments of the same domestic enterprise, although such transfers are really "crossbound".

8.4 Outbound transfers

8.4.1 Outbound Category 1: no tax consequences

  • Transfer of fixed or current assets from the domestic head office to a foreign permanent establishment in a country with which Germany either has no tax treaty or a tax treaty under which it avoids double taxation by the credit method

Such transfers have no tax consequences provided eventual taxation of the profits from the asset is still ensured (directive sec. 2.6.1, pp. 30-31). The condition will generally be met as long as the business is owned by individuals or entities subject to tax in Germany on their worldwide income.

8.4.2 Outbound Category 2: deferred taxation

  • Transfers from the domestic head office to a foreign permanent establishment in a country with which Germany has a tax treaty under which it avoids double taxation by the exemption method

Fixed assets

The directive states that the excess of the arm's length price over book value at the time of the transfer shall be recorded as a special item (Merkposten) on the liabilities side of "collateral accounts" (Nebenrechnung) to be kept by the domestic home office. If the asset is subject to scheduled depreciation, the special item is reversed on a straight line basis (debit special item, credit revenue) over the remaining useful life of the asset in the foreign permanent establishment, thus attributing gain to the transferring head office in the amount of the unrealised appreciation at the time of transfer. The foreign permanent establishment takes the asset onto its books at the arm's length price and depreciates it from this value.

The directive considers the above rules to be based on equitable grounds, thus implying that, by the letter of the law, the full amount of unrealised appreciation (hidden reserves) should be taxed at the time of the transfer. Kramer (IStR 2000, 449) objects strongly to the view that tax is deferred for reasons of equity. He argues that the transfer of an asset inside a business does not trigger tax under German law (see sec. 8.1 above), hence that immediate realisation of gain is impermissible. Despite his dissent with regard to the legal theory, Kramer agrees by and large with the results reached under the so-called "special item method."

However, if the outbound transfer does not constitute a taxable event, the question arises as to why the home office should realise any gain at all as a result of the transfer. Kramer fails to address this question directly. His answer seems to be that the special item method allocates the income flowing from the transferred asset in the period following the transfer. The appreciation inherent in the asset at the time of transfer is used as a measure of the transferring unit's appropriate share of such income. Since fixed assets generate income over time, it is logical for this income to be allocated to the transferring home office pro rata temporis.

If the asset is sold or otherwise leaves the foreign permanent establishment, the directive states that the amount of any special item remaining on the collateral accounts of the head office shall be immediately charged to revenue.

While this rule is appropriate where an asset is sold or otherwise disposed of, it would cause the head office to realise gain when an asset that it had transferred to a foreign permanent establishment was destroyed in a fire or otherwise lost (casualty loss). Kramer is critical of this aspect of the rules because it requires income to be recognised for tax purposes where in fact none is realised. Where no income has been realised, none can be allocated.

After passage of 10 years, the amount of any special item remaining on the collateral accounts of the head office is charged to revenue regardless of whether the asset has been disposed of by the foreign permanent establishment. Kramer is critical of this rule as well, because the mere fact that 10 years have passed does not cause income to be realised. Again, where no income has been realised, none can be allocated. The rule requiring automatic recognition of gain after 10 years will probably have its greatest impact on transfers of non-depreciable assets, such as interests in other companies.

Presumably, the tax authorities would defend the result reached by the directive in the case of casualty losses by arguing that, from the time of transfer, the risk of such losses is borne by the foreign permanent establishment. Furthermore, the sum of the income realised by the transferring home office and the loss sustained by the foreign permanent establishment is the same as if no transfer had ever taken place. Hence, for the enterprise as a whole, the event has no effect on income.

Example

An asset worth 200 with a book value of 100 is transferred from the German home office to a foreign permanent establishment. A special item of 100 is set up on the collateral accounts of the home office. The asset's remaining useful life is 5 years. At the start of the third year after transfer, the asset is destroyed by fire. The loss is uninsured. In Years 1 and 2, the home office realises gain of 20 per year or 40. The foreign permanent establishment depreciates the asset from 200 to 120 over the same period. When the asset is destroyed in Year 3, the foreign PE records a loss of 120. The home office records a gain of 60. The net loss is 60, which is what it would have been had the asset never been transferred and destroyed while still present at the home office.

In the sense that the rules laid down by the directive generally reach the same result for the overall enterprise as if no transfer had ever occurred, they arguably have nothing to do with income realisation and are only concerned with income allocation. Cf. Kramer loc. cit. p. 455/1).

The above rules apply mutatis mutandis where the arm's length price at the time of transfer is less than the book value. The excess of book value over the arm's length price is recorded as a special item on the assets side of the collateral accounts of the transferring home office and charged to expense over the asset's remaining useful life (debit expense, credit special item).

Current assets

An outbound transfer of a current asset is treated similarly except that the special item entered on the liabilities side of the collateral accounts is not reversed until the asset in question is sold of or otherwise leaves the foreign permanent establishment.

Where current assets are sold, the rules yield appropriate results. Where they are accidentally destroyed or become worthless, the problems are the same as for fixed assets.

Intangible assets / Base shifting

For outbound transfers of intangible assets, the directive applies the rules for fixed and current assets mutatis mutandis.

The 1997 draft stated that immaterial assets were transferred to a foreign permanent establishment when used or exploited by it on an exclusive basis. The final directive instead provides that immaterial assets are transferred to the extent used or exploited by the permanent establishment, raising the prospect of pro rata transfers (despite the fact that directive sec. 2.4 requires an either/or approach to asset attribution - see sec. 5.5.1 above).

A sentence added to the final directive states that manufacturing and production know-how used by a foreign permanent establishment in connection with products or product lines transferred to it (base shifting) is subject to the outbound transfer rules.

The directive thus focuses on transfers of self-developed intangibles not shown on the commercial or tax balance sheet of the enterprise (§ 248 (2) HGB; § 5 (1) EStG). Application of the rules outlined above results in allocation of income to the domestic head office despite the fact that no income is realised for commercial or tax accounting purposes. Kramer (loc. cit. p. 455/2) argues that the rules for intangible assets can be justified as rules for allocating the income earned by exploitation of the respective intangibles. In other words, income would be deemed earned by the transferring home office in an amount equal to the arm's length value of the asset at the time of transfer. This income would be spread over the asset's useful life, unless it is disposed of sooner.

Kramer constructs an example under which transferred production know-how becomes worthless after its transfer but before expiration of its useful life (due to invention of a superior alternative production technique). Under the rules laid out in the directive, this would lead to realisation of gain in the amount of the special item remaining on the collateral accounts of the home office. This treatment is inconsistent with the theory that the directive's transfer rules relate to income deemed earned from the transferred intangible, since the premature worthlessness of the asset would require downward adjustment of the deemed income.

The superannuation of intangibles thus poses issues similar to casualty losses for fixed assets (see above).

Option for immediate taxation

Taxpayers may elect for immediate taxation of gain and immediate deductibility of loss on Category 2 asset transfers to foreign permanent establishments. The election may be exercised separately for fixed assets and for current assets on an annual basis for each foreign permanent establishment.

Kramer (loc. cit. p. 452/2)) is critical of the election because it permits income to be recognised for tax purposes before it is realised.

8.4.3 Outbound Category 3 (crossbound transfers): deferred taxation

  • Transfers from a foreign permanent establishment the profit of which remains subject to German taxation because no tax treaty applies to a foreign permanent establishment the profit of which is excluded from the German tax base by virtue of a tax treaty (subsection (2.6.1 (e), p. 34).

The directive is referring to transfers from the foreign permanent establishment of a German resident (person subject to tax in Germany on his worldwide income).

It is unclear from the relevant subsection whether the transferring foreign permanent establishment must be located in a country with which Germany has no tax treaty, as the subsection's heading implies, or can be located in a treaty country as long as Germany avoids double taxation by the credit method, as the logic of Category 1 would seem to dictate.

The directive provides that the rules for Outbound Category 2 (deferred taxation) will apply here as well.

8.4.4 Outbound Category 4: immediate taxation

  • Transfers by non-residents from a domestic permanent establishment to a foreign permanent establishment (including the head office - section 2.6.3, p. 34).

The directive denies deferred taxation treatment to this category of outbound transfers on the grounds that the assets in question have completely left the German tax sphere. However, as noted above (sec. 8.1), German tax law contains no provision making this a taxable event.

In Outbound Category 2 and 3 transfers, profits from the asset in question remain subject to German taxation in principle because they are attributable to persons subject to tax in Germany on their worldwide income (German resident person), even though they are excluded from the tax base under a tax treaty.

Various authors contend that deferred tax treatment must be extended to Category 4 outbound transfers to permanent establishments located within the European Union to avoid discrimination against EU resident persons by allowing them the same deferral as German residents. See IWB WPG 1997, 641 and Kramer IStR 2000, 449, 456. Kramer also notes that the treatment mandated by the directive can violate the non-discrimination clauses of tax treaties.

8.4.5 Outbound Category 5: immediate taxation

  • Transfers of an asset held as "domestic business property" (inländisches Betriebsvermögen) to a "foreign partnership" (directive sec. 2.6.4). The provision applies as well to transfers of "special business property" (Sonderbetriebsvermögen) to a "foreign partnership."

The directive denies deferred taxation on transfers of domestic business property to "foreign partnerships". The term "domestic business property" would include property held in the domestic permanent establishment of a partnership.

Section 1.1.4 (p. 10) of the 1997 draft directive defined "foreign" and "domestic" partnerships as ones which were formed or organised in a foreign country or in Germany respectively. This has been changed in the final directive (sec. 1.1.5.1 p. 14) to define foreign partnerships as partnerships "present" or "existing" in a foreign country ("eine im Ausland bestehende ... Personengesellschaft"). It is difficult to say when a partnership might "be present" or "exist" in a foreign country. Section 1.1.5.1 of the directive defines the term "domestic partnership" as one which is "resident" in Germany ("eine im Inland ansässige ... Personengesellschaft"). This only compounds the confusion as partnerships are transparent entities under German tax law, hence not resident anywhere.

By its terms, Outbound Category 5 does not apply to transfers of domestic business property to a "domestic partnership." If this meant a partnership formed in Germany, the category would not be sensibly defined because the place of formation of a partnership is freely manipulable. (see also sec. 9.2 below).

Category 5 may be intended to apply to transfers to the foreign permanent establishment of a partnership which is in some sense a "foreign" partnership. For instance, a German resident individual may contribute an asset he has for years used in his domestic commercial business to the foreign permanent establishment of a newly formed "foreign" partnership in which he is a partner. The transfer would be covered by Category 5. In a purely domestic context, German tax law has long permitted taxpayers to move assets tax free between their various domestic businesses including partnerships (so-called Co-Entrepreneur Directive, codified as § 6 (5) EStG) and restricted by the 1999 Tax Relief Act, reinstated by the 2000 Tax Reduction Act - see article no. 167 sec. XIV and 209 sec. 3.6). The purpose of Category 5 may be to deny deferred taxation on transfers to "foreign partnerships". If so, the provision is anomalous in that the directive is by and large not concerned with transactions between different businesses. An administrative regulation is also not able to override statutory law (§ 6 (5) EStG).

Transfers from a partnership's domestic permanent establishment to its foreign permanent establishment are transfers within the same business. Outbound Category 5 is perhaps intended to apply to such transfers, though they would not constitute transfers "to" a partnership because the same partnership would own the asset before and afterwards.

The principle underlying Outbound Categories 1 - 4 is that no immediate taxation results from the transfer of assets within the same business where the business is owned by persons subject to tax in Germany on their worldwide income (resident persons). On the other hand, outbound transfers of assets owned by non-residents trigger immediate tax. Application of this principle to partnerships would entail a complicated pro rata approach under which transfers between the domestic and foreign permanent establishments of a partnership would trigger immediate taxation to the extent attributable pro rata to non-resident partners, but not to the extent attributable to German resident partners. Assuming Outbound Category 5 to apply to such transfers, it appears to reject such a pro rata approach.

If, instead of contributing an asset to a partnership, its owner, being a partner in a partnership, merely gives the partnership the right to use the asset, e.g. under a long term lease, this would cause the asset to become special business property (Sonderbetriebsvermögen) of the respective partner under German domestic tax principles. Outbound transfers of special business property to a "foreign partnership" likewise fall under Category 5.

To summarise, the provisions relating to Outbound Category 5 are difficult to interpret because based on the confusing concept of "foreign partnerships". It is furthermore unclear whether the provisions are intended to apply only to transfers of property used in a separate business to a "foreign partnership," or also to transfers of assets between permanent establishments of a "foreign partnership," or to both.

8.5 Outbound transfers: problems

In its discussion of outbound transfers, the directive frequently speaks of transfers between a domestic (German) head office and a foreign permanent establishment. The directive apparently assumes that the entity in question will be subject to tax on its worldwide income if its head office is in Germany. "Head office" is defined by the directive to mean the permanent establishment where the principal place of management is located (sec. 2.1, p. 24). On first impression, the assumption appears to hold as a matter of German domestic tax law (though possibly not under some of its tax treaties) in the case of corporations. It seems unwarranted in the case of individuals (sole proprietors) and partnerships.

Above all, the directive's treatment of the following transactions triggers tax on gain in Germany which, under standard German tax rules, has not yet been realised:

  • Outbound transfers by non-residents
  • Outbound transfers to foreign partnerships (to the extent between the permanent establishment of the same partnership)
  • Casualty losses of assets transferred to foreign permanent establishments
  • Election of immediate taxation on transfer
  • Automatic realisation of profit 10 years after transfer of assets

In the absence of statutory provisions overriding the principle that income is not taxable until realised, the treatment of these situations is of dubious validity. The treatment of outbound transfers by non-residents (Outbound Category 4) in addition raises questions under EU law and the non-discrimination provisions of tax treaties.

Finally, Kramer (loc. cit. p. 450/1, 457/1) sharply criticises the distinction made between Outbound Category 1 and 2 transfers. Ignoring Outbound Category 1 transfers to permanent establishments in non-tax treaty states or states with which Germany's tax treaty uses the credit method results in an unjustifiable difference in the allocation of profits between domestic and foreign permanent establishments depending on the tax treaty status of the receiving permanent establishment. Kramer notes that an exact division of income is necessary in Outbound Category 1 cases as well because the foreign tax credit (§ 34c EStG, § 26 KStG) is subject to a limit determined by the ratio of foreign income to worldwide income.

8.6 Inbound transfers

Inbound transfers are covered by section 2.6.2 on p. 33 of the directive. The second paragraph of section 2.6.3 on p. 34 also deals with inbound transfers. Again, there are several categories of transfers to consider. Basically, assets received in inbound transfers which cause an asset to become subject to German taxation (Verstrickung) will be entered on the books of the receiving German permanent establishment (including the head office) at their arm's length value. If the asset was already subject to German taxation before the inbound transfer, it will be taken onto the books of the receiving German permanent establishment at its prior book value. In neither case is gain or loss realised in Germany.

8.6.1 Inbound Category 1

  • Transfers or re-transfers of assets to the domestic head office from a foreign permanent establishment located in a country with which Germany has no tax treaty or a tax treaty under which it avoids double taxation by the credit method.

The transaction involves movement of an asset inside a single legal entity inside the normal German tax sphere. The asset in question is booked off the balance sheet of the transferring foreign permanent establishment and entered at the previous book value on that of the receiving domestic head office without realisation of gain or loss either in Germany or abroad. (If a re-transfer is involved, the prior outbound transfer will have been an Outbound Category 1 transfer.)

8.6.2 Inbound Category 2

  • Transfers to the domestic head office of assets purchased or produced by a foreign permanent establishment located in a country with which Germany has a tax treaty under which it avoids double taxation by the exemption method.

The transaction causes a tax exempt asset to enter the normal German tax sphere. The asset is revalued at its arm's length price on the books of the foreign permanent establishment prior to the transfer, causing it to realise gain or loss, which is however exempt from tax in Germany under the tax treaty. The domestic head office takes the asset onto its books at the arm's length price without realising profit.

8.6.3 Inbound Category 3

  • Transfers of assets to the German permanent establishment of an entity with a foreign head office (regardless of whether the transfer comes from the foreign head office or another foreign permanent establishment - 2nd paragraph of section 2.6.3).

Here, the transaction causes an asset which was completely outside of the German tax sphere to enter the normal German tax sphere. The asset is entered on the books of the German permanent establishment at its arm's length value. The transfer has no German tax consequences for the transferring foreign permanent establishment.

8.6.4 Inbound Category 4: retransfer to home office

  • Re-transfer to the domestic head office of an asset previously transferred by the head office to a foreign permanent establishment in a country with which Germany has a tax treaty under which it avoids double taxation by the exemption method (prior Outbound Category 2 transfer)

The provisions governing this transaction, which causes a tax exempt asset to re-enter the normal German tax sphere, were changed considerably in the final directive. In the process, drafting errors occurred which make the new rule confusing.

Under the 1997 draft version of the directive, the head office took the asset back onto its books at the arm's length price at the time of re-transfer, less the amount of any special item still remaining in the collateral accounts of the home office with respect to the asset.

The pertinent passage of the final directive reads as follows:

Where an asset transferred to a foreign permanent establishment pursuant to sec. 2.6.1 [of the directive] is re-transferred to the domestic home office, any special item set up for this asset shall be released in full amount without impacting earnings and any elective immediate realisation of income shall be reversed. The re-transfer is considered as an event [with retroactive effect] within the meaning of § 175 (1) sent. 1 no. 2 AO. If the special item has already been fully credited to revenue by reason of the 10 year limit (sec. 2.6.1 (a)), the apportionment of income between the parts of the enterprise shall be based on the arm's length price at the time of retransfer.

As interpreted by Kramer (DStR 2000, 449, 453 ff.), the final directive is not materially different from the draft directive (despite widely disparate wording). Where the directive provides for release "in full amount" of any special item set up for the asset in the collateral accounts, it is referring, in Kramer's view, only to the special amount remaining in the collateral accounts at the time of the retransfer. Furthermore, the release itself is effected by offsetting remaining special item against the arm's length value of the asset at the time of retransfer, so that the asset is in effect taken back onto the books of the head office at arm's length value less residual special amount, exactly as under the draft directive. The amounts charged to earnings prior to retransfer are not reversed under this reading of the directive. Furthermore, where the taxpayer opted for immediate full taxation at the time of the original transfer, Kramer states that the original gain realised is not to be reversed in full amount, but only to the extent the gain realised as a result of the election exceeds the gain which would have been realised through pro rata chargebacks of the special amount to revenue.

Kramer also applies the "special item" method to the foreign permanent establishment to allocate income to it attributable to appreciation which occurred while the asset was in its hands.

As interpreted by Kumpf/Roth (DB 2000, 2192), the final directive differs radically from the draft directive. Under their interpretation, the draft directive provides for a return to the status quo ante in the event of retransfer. The head office takes the asset back onto its books at the value it would have had if the original transfer had never occurred. The remaining special item is simply wiped out, not set off against the asset's arm's length value at the time of retransfer. Furthermore, release of the special item "in full amount" means reversal not just of the residual special item at the time of re-transfer, but reversal as well of any partial chargeoffs of the special item against revenue. Where the taxpayer elected immediate full taxation, this is also naturally reversed in full under this reading of the directive, not just to the extent it exceeds the gain which would have been realised without the election.

The implications of the Kumpf/Roth interpretation can be positive or negative from the standpoint of the German taxpayer. In their Example 1, a truck is transferred to a foreign permanent establishment and retransferred after one year because the PE is disbanded. From a German perspective, the re-transfer causes the tax exempt earnings of the foreign PE to increase and the taxable earnings of the home office to fall. Their Example 2 involves transfer and re-transfer of a highly appreciated stockholding. Although the stock appreciated in value while held in the foreign permanent establishment, it returns to the home office at its original book value. When sold, the appreciation is realised and attributed to the home office, not to the foreign permanent establishment.

The views of Kramer and Kumpf/Roth are diametrically opposed. The tax authorities have yet to make their own views known on this subject.

9. Partnerships

9.1 Attribution of permanent establishments to partners

The directive affirms in its sec. 1.1.4 (p. 10) the long-standing German position that a permanent establishment maintained by a partnership is attributed pro rata to its partners (although an interest in a commercial partnership does not itself constitute a permanent establishment) This principle applies to both general and limited partners and to "German" as well as "foreign" partnerships.

9.2 Domestic and foreign partnerships

Section 1.1.4 (p. 10) of the 1997 draft directive defined "foreign" and "domestic" partnerships as ones which were formed (organised) in a foreign country or in Germany, respectively. This was changed in the final directive (sec. 1.1.5.1 p. 14) to define foreign partnerships as partnerships "present" or "existing" in a foreign country ("eine im Ausland bestehende ... Personengesellschaft"). It is difficult to say when a partnership should be considered as "existing" in a foreign country. Is this the case when it was organised under foreign law? when its principal place of management is in a foreign country? when it maintains any foreign permanent establishment? when its partners, or managing partners, are all or predominantly resident in foreign countries?

Section 1.1.5.1 of the directive defines the term "domestic partnership" as one which is "resident" in Germany ("eine im Inland ansässige ... Personengesellschaft"). This only compounds the confusion as partnerships are transparent entities under German tax law, hence not resident anywhere.

Perhaps one should conceive of partnerships as being foreign to the extent they maintain permanent establishments in foreign countries and domestic to the extent they maintain permanent establishments in Germany. Hence, a partnership with permanent establishments both in Germany and abroad would be both a domestic and a foreign partnership.

There are at any rate several passages in the directive which make more sense if the terms are thought of in the suggested manner. For instance, in its sec. 2.6.4 (p. 34), the directive refers to outbound transfers to a "foreign partnership," where it may mean transfers to the foreign permanent establishment of any partnership (see sec. 8.4.5 above). See also the discussion of interest payments by a partnership to a partner (directive sec. 1.2.3, p. 21; see sec. 9.5 below).

The best solution would be to eliminate the terms "foreign" and "domestic" partnerships from the directive altogether and redraft the passages affected in terms of the location of the permanent establishments maintained by partnerships.

9.3 Bookkeeping for foreign and domestic partnerships

The directive states in its sec. 1.1.5.4 that the distributive share of a domestic partner in a foreign partnership is to be determined on the basis of the accounts of the partnership as maintained in accordance with foreign law. Appropriate adjustments are to be made to the foreign accounts in order to bring them into line with German law, notably § 15 (1) sent. 1 no. 2 EStG. It is, however, not necessary for the foreign partnership to maintain separate accounts in accordance with German law. The determination of profits is to be made under § 4 (1) EStG; § 5 EStG does not apply. The inapplicability of § 5 EStG in general simplifies tax accounting, but is otherwise seldom of practical significance.

The distributive share of a foreign partner in a foreign partnership from the partnership's German permanent establishment is to be determined under §§ 4 (1), 5, and 15 (1) sent. 1 no. 2 EStG, the primary difference being the applicability of § 5 EStG. (It is unclear whether the above would apply as well for the distributive share of a German partner from the German permanent establishment of a foreign partnership.)

The directive correctly states that foreign partners are not liable to German tax on their share of the profits of a "German" partnership's foreign permanent establishment (sec. 1.1.5.5, p. 16). This is a necessary consequence of the pro rata attribution of permanent establishments to the partners.

9.4 Partner's obligations to provide documentation and information

The directive provides in its sec. 1.1.5.3 (p. 15) that partners are generally required to provide all necessary information and to produce the partnership's accounts, the year-end financial statements, and other business records as necessary, subject to the limits of what is reasonable to expect of the partner and appropriate in light of the amounts involved.

The tax authorities did not act on recommendations by the Institute of German Auditors to relax these requirements for limited partners, who typically have little access to information of the above sort.

9.5 Contractual relationships between partner and partnership

9.5.1 Background

German domestic law treats interest on loans granted by partners to their partnerships as part of the profits of the partnership, thus denying tax recognition to these relationships (§ 15 (1) sent. 1 no. 2 EStG). Similarly, rents and royalties paid by a partnership to a partner are also added back to the profits of the partnership. This rule exists essentially to prevent depletion of the trade tax base in the case of partnerships engaged in trade or commerce. Without the special rule, the partnership income subject to the trade tax on earnings could be reduced by payments from the partnership to the partners. With respect to the now abolished trade tax on capital, a similar rule was developed which treated assets belonging to the partners as partnership property if the asset was used to a sufficient extent in the partnership (so-called "special business property" - Sonderbetriebsvermögen).

In a tax treaty context, these rules have caused considerable controversy. It was argued that the assimilation to partnership earnings of interest paid by a partnership to a partner applied for tax treaty purposes as well when a domestic partner makes a loan to a partnership, the sole permanent establishment of which is located in another treaty state. Accordingly, the interest paid by the partnership to the domestic partner should, so the argument ran, be added back to the profits of the partnership, attributed to its foreign permanent establishment, and excluded from the German tax base. This would result often in a double exclusion for the sums involved, since the country where the permanent establishment is located will as a rule recognise the loan to the partnership and treat the interest paid to the German partner as a deductible expense in computing the profits of the partnership. The interest payment to the foreign partner by the partnership is often exempt from tax in the source state under the terms of the applicable tax treaty.

The Federal Tax Court has held in cases involving the tax treaty with the U.S. in force prior to 1990 that the interest paid in such situations does not constitute business profits within the meaning of the tax treaty (even though it would constitute commercial business income under German domestic law). The court instead applied the interest article of the treaty to the payments, permitting Germany to tax them as interest received by one of its residents (BFH 27 Feb. 1991 - BStBl II 1991, 1709 and 31 May 1995 - BStBl II 1995, 683).

9.5.2 New position taken by directive

The tax authorities have been grappling with the above issues for years. The relevant section in the 1997 draft directive (sec. 1.2.1, p. 15) was poorly worded and contradictory. In the final directive (sec. 1.2.3, p. 21), the tax authorities present a new approach to the problem.

The tax authorities abandon the holding of the above cited Federal Tax Court decisions, which they now consider as having reached the right result on the wrong grounds, and state that interest etc. paid by a commercial partnership to its partners is indeed included in commercial business income and subject to the Business Profits article of Germany's tax treaties (Art. 7 of the OECD model tax treaty). However, where the other treaty state fails to tax the income in question, or does not tax it fully, because it qualifies the income under a different article of the tax treaty (e.g. the interest article), Germany will not exclude such income from its tax base and will instead avoid double taxation under the credit method, instead of the exemption method.

From the standpoint of the tax authorities, the new approach has a major advantage over that followed by the Federal Tax Court because it enables Germany to tax the interest earned from foreign resident partners on loans to German permanent establishments. The approach adopted by the courts would have obliged Germany to classify such income under the interest etc. articles of the respective conventions and exclude the income from the tax base of the respective German permanent establishments.

The new rules are defended and explained at length by Krabbe (IWB 23 Feb. 2000, Fach 3, Gruppe 2 p. 863, 866). He states that, where a treaty state exempts income from taxation, its application of the exemption method is premised on the tacit assumption that the other treaty state regards itself as having the right to tax the relevant income. Where this is not the case, because the two treaty states subsume the income in question under different articles of the tax treaty, the first treaty state is entitled to avoid double taxation under the credit method, whether or not the tax treaty in question explicitly gives it the right to do so.

Other authors (such as Strunk/Kaminski IStR 2000, 33, 41) see no legal basis for a switch from the exemption method to the credit method in the case of qualification conflicts. Göttsche/Stangl surmise that the controversy will be settled by the Federal Tax Court.

The cited Federal Tax Court case law and the position taken by tax authorities in the directive lead to identical results as regards loans and licensing of intangibles by German residents to partnerships operating in foreign countries. At issue is the treatment of such transactions by foreign residents with partnerships operating in Germany. Such transactions can be of great practical significance, especially when one recalls that the thin capitalisation rules of § 8a KStG do not apply to partnerships. Affected is not only the income taxation of the persons involved, but also the trade tax on earnings. Despite the trade tax add-backs, the potential savings are great.

9.6 Loans by partners as partnership equity

Citing a decision of the Federal Tax Court of 22 January 1981 (BStBl II 1981, 427), the 1997 draft directive provided that "a loan by a partner to a partnership of unusually long duration results in reclassification of the [partner's] debt claim as dotation capital of the permanent establishment for tax purposes" (sec. 2.7.2, p. 29).

This provision was not included in the final directive.

9.7 Partnership equity

The directive provides that when interests in a German partnership are acquired by non-resident persons, an arbitrary reduction of the capital accounts (presumably by means of withdrawals) will not be permitted since the level of equity previously in the partnership will be regarded as a benchmark for what is necessary from a business perspective (sec. 2.5.2, p. 30).

The counter-arguments with regard to minimal equity in permanent establishments in general (see sec. 5.6 above) apply in the context of partnerships as well.

10. Other issues

10.1 Documentation and information

Like the 1983 transfer pricing guidelines for associated enterprises, the directive contains no specific documentation or information requirements. However, the German tax authorities issued draft regulations on transfer pricing documentation in August 2000, and a revised draft was circulated internally in April 2001. See article no. 216.

Section 5 of the directive (pp. 77, 78) reminds the taxpayer of his basic obligation to cooperate and provide information, and that this obligation is heightened under § 90 AO (tax procedure act) in situations involving foreign countries. In particular, the directive states that German resident taxpayers will as a rule be expected to provide the tax authorities with copies of the tax returns submitted and tax assessment notices received with respect to their foreign permanent establishments so as to permit verification that the tax positions taken in foreign jurisdictions are consistent with those taken in Germany.

The standard position of the tax authorities is repeated that a taxpayer is required to produce not only all documents and information within his actual control, but also all that to which he, by exercise of reasonable foresight, could have secured access or a right of access under the circumstances. The legal consequence of inadequate cooperation or inadequate documentation by the taxpayer is denial of relevant deductions and/or estimation of tax owing by the tax authorities (§§ 160, 162 AO). No fines or other special penalties exist.

10.2 Independent services

Section 6 of the directive (p. 78) provides for its application by analogy to independent services under Article 14 of the OECD model convention.

10.3 Transition provisions

The transition provisions contained in sec. 6.2 of the 1997 draft were not included in the final version. The directive is instead applicable from the 2000 assessment period onwards.

10.4 Superseded administrative pronouncements

Section 6.3 (p. 79) of the directive provides that the following administrative pronouncements are superseded by the directive:

  • Directive of 31 May 1979 on the corporation tax treatment of non-resident insurance companies
  • Directive of 12 Feb. 1990 (BStBl I, 72) on the transfer of assets to and from a foreign permanent establishment the profits of which are excluded from German taxation under a tax treaty
  • Directive of 3 June 1992 (DB 1992, 1655) on the transfer of assets from a domestic permanent establishment to a foreign head office
  • Directive of 24 Aug. 1984 (BStBl I, 458) on the treatment of supervisory and coordination offices maintained by foreign corporate groups in Germany
  • Directive of 29 Nov. 1996 (BStBl I, 136) on the dotation capital of the domestic permanent establishments of foreign banks.

11. Concluding remarks

The taxation of permanent establishments is of fundamental importance for the taxation of international operations. The detail of this report on the directive is commensurate with the significance of the subject matter. Numerous omissions were nevertheless necessary. The parts of the directive dealing with currency conversion issues, the permanent establishments of banks and insurance companies, construction and assembly work, supervisory and coordination offices, ships, and mining operations have in particular been dealt with highly selectively or not at all.

Disclaimer and notice of copyright

This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. KPMG Germany in particular insists that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While KPMG Germany's articles are carefully reviewed, it can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised against KPMG Germany on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Germany (KPMG Deutsche Treuhand-Gesellschaft AG). No use of or quotation from the article is permitted without full attribution to KPMG Germany. Distribution to third persons is prohibited without the express written consent of KPMG Germany in advance.

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