Proposed modifications to the German Transfer Pricing Legislation

Dr. Björn Heidecke (Partner,  Deloitte Germany, Hamburg)

By Dr. Björn Heidecke (Director, Deloitte Germany, Hamburg) & Tatchamon Nanavaratorn (Senior Consultant, Deloitte Germany, Hamburg)

As part of the obligation to implement the European-wide mechanism to counter base erosion and profit shifting, the German Federal Ministry of Finance circulated a draft law on 10 December 2019 (hereafter referred to as “draft law”). Besides conforming to the requirement as directed by the EU Anti-Tax Avoidance Directive, the draft law brings about the modification to the current transfer pricing legislation of both the Foreign Tax Act (Außensteuergesetz) and the Fiscal Code (Abgabenordnung), and it introduces topics not previously codified into the legislation in accordance with the BEPS concepts introduced by the OECD. The draft law takes a strict stance on businesses’ actual conducts rather than their contractual arrangements.

This article aims to provide a brief overview of the most significant modifications proposed by the draft law to the current German transfer pricing legislations. The following article addresses these selected topics: transfer pricing method hierarchy and application, intangibles and DEMPE concept, matters relating to financial transactions and price adjustment clause as well as master file compliance.

Overview of changes in the draft law

The draft law proposes the elimination of the transfer pricing method hierarchy, emphasizing that all transfer pricing methods – both traditional transaction methods and transactional profit methods – have equal efficacy in testing for arm’s length prices. The method selection process places more importance to the suitability of the method for individual transaction and circumstances. On establishing the arm’s length range from a large set of data, the draft law assigns the interquartile range as the standard statistical tool for narrowing the range.

In the absence of a legal reference point for defining intangibles from a transfer pricing perspective in the German legislature, court cases are often used. Controversies often arise, as there are interpretation differences. The draft law addresses the lack of a legal reference point and proposes a more robust definition of intangibles. It introduces a uniform legal definition analogous to definitions used in the OECD Guidelines.

The draft law adopts the DEMPE concept as initially introduced by the OECD, in place of the functional analysis process currently used to determine the entitlement of the residual returns from the use or exploitation of the intangibles. Here, the draft law emphasizes the actual conduct and assigns more weight to the party performing the significant DEMPE functions (making decisions and assuming the related risks) than the party simply holding the contractual rights to the residual returns.

The draft law codifies the rules on financial transactions and authorizes a treaty override rule to deny interest expense reduction, unless the taxpayer can prove not only the justification for the financial transaction but also apply an arm’s length interest rate. Rationalizing for the intercompany financial transaction requires being able to fulfill the entire debt service from the beginning and demonstrating that there is an economic necessity behind the transaction.

The draft law designates that an arm’s length interest rate is the rate that does not exceed that of the group’s external refinancing interest rate. The draft law prefers the cost-plus method for treasury functions in finance transactions. The arm’s length mark-up continues to be determined based on the functions performed and risks assumed. It is likely that during the further legislative process the guidance published in the OECD’s report on the treatment of financial transactions from February 2020 will be considered.

In the current legislation, the taxpayer needs to stipulate a so-called price adjustment clause in the agreements in case of applying the so-called hypothetical arm´s length test to value intangibles and relocations of functions. The hypothetical arm´s length test is a two-sided approach considering profit expectations. If no price adjustment clause has been stipulated and if the actual price deviates substantially from the price based on planning data, German tax authorities are allowed to perform an income adjustment during a period of 10 years.

The draft law modifies this rule by reducing the default period to 7 years. Furthermore, it is explicitly applicable to intangibles transactions. Next to this, it stipulates that substantial deviation is deemed to occurred when the profit forecasts deviate from the actual profits by more than 20%. The adjustment is not to be applied if the taxpayer can reasonably demonstrate one of three conditions: the unpredictability of the actual profit performance at the time of the transfer price setting, that the unpredictability was taken into the price calculation or if it involves a licensing agreement that is tied to a sale or profit performance component.

As such, the taxpayer should in case of intangibles document carefully the planning process and should be able to explain deviations. Furthermore, an arm´s length price adjustment clause needs to be agreed upon in order not to end up in the 7 years default assumption.

The draft law lowers the materiality threshold on the preparation of the master file, requiring that group entities with a turnover exceeding EUR 50 million instead of EUR 100 million (on a single entity basis) be subjected to the master file compliance rule. Further, the draft law stipulates the obligation of electronic submission of the master file to German transfer pricing legislation. At the end of the fiscal year, companies will have one year to prepare and submit the master file.


Further clarifications concerning the interpretation of the points mentioned above are expected after the discussion of the Federal Cabinet, which has been postponed several times due to the outbreak of COVID-19. Currently, the discussion on the draft law by the Federal Cabinet has been put on hold with no new date for announced. It is likely that not all of its tenets will be adopted into the final legislation; it remains unclear which may be dropped. It is recommended that businesses review and maintain documentations to their existing transfer pricing systems.

Proposed modifications to the German Transfer Pricing Legislation

Dr. Björn Heidecke is Director at Deloitte Germany, Hamburg.



Tatchamon Nanavaratorn is Senior Consultant at Deloitte Germany, Hamburg.