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13.4.2. Specific TP Issues

Intra-Group Services

As per the regulations, a service charge between a taxpayer and a connected person should be consistent with the arm’s length principle. The following factors are to be considered while determining the arm’s length price for intragroup services:

  • Whether any real intra-group services have been provided;
  • Whether the provision of intra-group services has conferred an economic or commercial value to a group member and whether an independent enterprise in comparable circumstances would be willing to pay or perform in-house for its services;
  • Whether the charge for intra-group services involves shareholder or custodial activities, duplicative services, services for incidental benefits, or passive association benefit, in which cases such charge will be disregarded by the tax authorities;
  • Whether the charge for intragroup financing is at arm’s length interest rate; and
  • Whether the arm’s length price is determined using the prescribed methods, normally, the CUP or Cost-Plus Method is used.

For low-value-adding routine intra-group services, a 5% cost mark-up is accepted.

Low value-adding routine services mean services that are performed by one or more members of an MNE group on behalf of one or more other members of the group and:

  • The service is of a supportive nature;
  • The service does not form part of the core business activity of the MNE group with respect to external dealings with third parties;
  • The service does not require or involve the use or creation of unique or valuable intangible assets for its performance; or
  • The service does not involve the assumption or management of substantial risk by the service\ provider and does not give rise to the creation of substantial risk.

Routine services do not include services relating to research and development, manufacturing and production, and sales, marketing, and distribution.

Royalty Payments

Germany has introduced a restriction on the deductibility of royalty payments made to related parties from 2018 onwards. Pursuant to the new rules, royalty payments to related parties, which are subject to preferential tax regimes, made after 31 December 2017 are restricted in the following cases:

  • The income is taxed at a rate of less than 25% in the hands of the (direct or indirect) recipient, as a result of the benefits of a preferential regime; and
  • The preferential tax regime is not in compliance with the modified nexus approach developed as part of BEPS Action 5.

The non-deductible portion of the royalty payment is calculated as below:

(25% - actual tax rate on royalty income) / 25%

For example, if the actual tax rate was 12.5%, 50% of the payment would be non-deductible. If the actual tax rate was 0%, 100% of the payment would be non-deductible.

The royalty payments include payments for the assignment/ licensing of use or the right to use copyrights and industrial property rights, as also rights in trade, technical, scientific, and similar know-how, knowledge, and skills (e.g., plans, designs, and processes).

On 6 January 2022, Germany issued a guidance letter providing a list of jurisdictions with regimes that are considered as not compliant with the OECD Modified Nexus Approach for 2018, 2019, and 2020 assessment years and hence, are subject to the deduction restriction.

The list (as on 30 June 2021) includes the following jurisdictions:

Andorra Aruba  Barbados
Belgium Belize Botswana
Curacao France Greece
Great Britain Israel Italy
Jordan Kazakhstan Liechtenstein
Luxembourg China (only Macau) Malta
Malaysia Mauritius Mongolia
Netherlands  Panama Portugal
Saint Kitts and Nevis Saint Lucia Saint Vincent and the Grenadines
San Marino Switzerland Seychelles
Singapore Spain (national, Navarra and Basque Country)  Turkey
Hungary Uruguay Cyprus
Brunei Darussalam Cook Islands Dominica
Qatar  

The guidelines also include a list of jurisdictions that may potentially be subject to the restriction, but are still being examined and include jurisdictions that have replaced their regimes with new regimes that are compliant with the modified nexus approach (or have just removed the non-compliant regimes).

Cost Contribution Agreements

Cost Contribution Arrangements (CAAs) are contractual agreements between affiliated companies to share the contributions and risks in connection with the joint development, production, or procurement of intangible assets, tangible assets, or services, whereby it is expected that the relevant intangible assets, tangible economic goods or services will result in advantages for all CCA participants.

Where several enterprises within an MNE group collaborate in their joint interests, share common risks and make development or service cost contributions, such contribution can only be taxed to the extent that it does not permanently exceed the third-party price for the services obtained from the CCA.

Intangible Assets

Effective 9 June 2021, the concept of functional ownership of an intangible asset replaces legal and economic ownership. Therefore, group companies performing or contributing to the development, enhancement, maintenance, protection, and exploitation (DEMPE) functions, are deemed to participate in the (residual) profit generated from the intangibles. Intangible assets are defined as assets:

  • That are neither tangible assets nor shares;
  • That can be the subject of a business transaction without being individually transferable; and
  • That can give a person a factual or legal right.

The price adjustment clause applies in the case of transactions involving intangibles to ensure arm’s-length pricing because the valuation of intangibles is considered highly uncertain at the time of the transaction. Taxpayers need to examine after 7 years (earlier 10 years until 8 June 2021) whether the actual profit generated from the intangibles deviates significantly (by more than 20%) from the profit expectations on which the original valuation was based. If a deviation is more than 20% and no price adjustment clause has been agreed, the tax authorities can adjust the taxpayer’s income.

Permanent Establishment (‘AOA Approach’)

Effective 18 October 2014, Germany adopted the application of the Arm’s Length Principle to Permanent Establishments (Authorized OECD Approach, or AOA), commonly referred to as the Branch Profit Attribution Regulation. Under the regulation, permanent establishments (PEs) are effectively treated as functionally separate entities for tax purposes. This implies that the arm’s length principle is applicable in determining the profits attributable to the PE – i.e., all internal dealings between the PE and its head office and other group companies will be subject to a function-risk analysis for determining the attributable profits (see Sec. 4.1.).

Currently, the AOA is applied in all cases with respect to tax treaties with OECD countries, including in the case of older tax treaties where the new version of Art. 7 OECD-MA (as amended in 2010 or later) is not covered. However, with respect to transactions of intellectual property, the AOA approach applies only in cases where the tax treaty contains Art. 7 OECD-MA (as amended in 2010 or later).