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The new administrative principles for transfer pricing – An initial appraisal of the practical impact

The German fiscal authority published new administrative principles for transfer pricing on 14.7.2021; these came into effect immediately and will apply to all assessment periods that are still open. The new administrative principles now refer directly to the OECD Transfer Pricing Guidelines, which are attached to the administrative principles as an appendix, and should ensure dynamic alignment with future developments in the international context.


The new administrative principles replace, amongst others, the 1983 administrative principles as well as parts of the 2005 administrative principles procedures that were not updated in December 2020. They also follow on from the transfer pricing updates in the External Tax Relations Act (Außensteuergesetz, AStG) in May 2021 and should ensure that, in Germany, the interpretation and application of the arm’s length principle will be harmonised with the post-BEPS Transfer Pricing Guidelines. Moreover, there have also been a number of systemic changes. 

The new administrative principles consist of six chapters in total. In the following section we discuss the most important regulations (unless otherwise indicated, the referenced/cited paragraph numbers relate to these).

Assessing the arm’s length nature of a transaction

Paragraph 1.5 could be regarded as a kind of leitmotif for the administrative principles. According to this paragraph, by applying the arm’s length principle the aim is not merely to adjust a transfer price but, instead, also includes the basic idea behind the transaction (i.e., the general conduct of the parties) as well as the terms and conditions of the respective business relationship. While the OECD also focuses on the need to perform an analysis of the general circumstances of the taxpayer and to adequately define the controlled transactions, the German administrative principles appear to overemphasize this aspect. This is also reflected in, among others, paragraph 1.22, according to which, apart from the price, the terms and conditions (e.g., contract period, payment terms, discounts and bonuses) and also adjustment clauses, collateral as well as clauses for amending and terminating contracts could per se be subject to the application of the arm’s length principle and trigger a transfer price adjustment. 

Please note: This leitmotif - particularly in conjunction with the administrative principles that were amended in December 2020 - could be a harbinger of (more) controversial discussions during future tax audits. Tax auditors could feel compelled to require extensive explanations on the arm’s length nature of individual terms and conditions; this would not only increase the compliance burden (and the burden of proof) for taxpayers but would also call into question the holistic approach for the application of the arm’s length principle (including outcome-oriented approaches). 

Economic substance, risk control and the hypothetical arm’s length test

Alignment with the OECD Guidelines implies that transfer pricing regulations reflect a view of the arm’s length principle that is characterised by economics where the functional and risk analysis is the most important feature.  

Value chain analysis

Paragraph 3.7 stipulates, among other things, that a value chain analysis has to be carried out to provide the basis for determining whether or not the apportionment of profit within a multinational enterprise adequately matches the functional and risk profiles of the individual entities. Here, however, the provision is unclear as to the cases where taxpayers would be expected to perform a value chain analysis that goes beyond a functional and risk analysis in the sense of quantifying the individual value-creating contributions.

Arm’s length test

With respect to transfer pricing methods, a strong emphasis is placed on the so-called hypothetical arm’s length test, i.e., the use of economic valuation methods (such as, e.g., discounted cash flow). According to paragraph 3.12, the hypothetical arm’s length test has to be applied instead of traditional transfer pricing methods if the latter do not provide sufficiently reliable results (e.g., due to a lack of an adequate level of comparability). It further states that the hypothetical arm’s length test has to be ‘generally’ applied to transactions that involve (all kinds of and not just the difficult-to-value) intangible assets, business restructurings and transactions for which the profit apportionment method is used but for which no comparables can be identified.

Risks for taxpayers

From a taxpayer’s perspective, the risk is that the fiscal authority, in conjunction with the wide-ranging obligations to disclose and provide internal information (planning data, etc.), could effectively use the hypothetical arm’s length test as an instrument for scrutinising any analysis prepared by the taxpayer on the basis of OECD transfer pricing methods.    

Please note: In this connection, an interesting side note is that, according to paragraph 3.14, taxpayers are expected to explain all discrepancies, which might be detected, between valuations performed for non-tax purposes and those for transfer pricing purposes.

Other transfer pricing issues

The German administrative principles include regulations on some practical issues that reflect certain unnecessary idiosyncrasies. First of all, in the case of price-adjustment clauses, they do not distinguish between intangible and difficult-to-value assets (paragraph 3.52) and, moreover, it would appear that the German fiscal authorities are generally unwilling to make this distinction (cf. comment above on paragraph 3.12). Consequently, in future, all intangible assets could be subjected to a more detailed examination during an audit.  

For intra-group services, the new German administrative principles make reference to Chapter VII of the OECD Guidelines. However, something that is missing in this context is a reference to or inclusion of the documentation related to a ‘simplified approach’ (or the concept of such a simplified approach). Instead of a cross-reference to paragraph 7.64 of the OECD Guidelines, paragraph 3.78 of the German administrative principles stresses the taxpayer’s wide-ranging documentation requirement. 

Please note: In other words, in the case of remuneration for services rendered, the allocation of costs is likely to remain an area of potential conflict and high administrative expenses for taxpayers.

One of the, possibly, most interesting developments is the fact that the construct of a so-called ‘hybrid entity’ has apparently been removed from the German transfer pricing rules (at any rate, this seems to be implied in paragraph 3.33). In the past, this classification of a company, which exhibits the features of an entity that performs routine functions as well as of an entrepreneurial entity, sometimes made it difficult to align German transfer pricing rules with international regulations, in particular, when it came to classifying the contracting parties and the use of the transactional net margin method.

Conclusion and recommendation: It is certainly a welcome development that the fiscal authority has aligned its new administrative principles more closely with the international OECD Guidelines and, in the international debate, national perspectives should increasingly fade into the background. Nevertheless, it cannot be denied that, due to the very wide scope of application (in terms of both content as well as time), new areas of discussion will open up. Consequently, all taxpayers with cross-border business relationships would be well advised to re-examine their existing documentation of transfer prices with a view to potential problem areas. However, the real challenges will only become apparent in the course of future tax audits.

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