Germany Publishes Newly Updated Administrative Guidance on Transfer Pricing

On December 12, 2024, the German Federal Ministry of Finance (BMF) has issued newly updated Administrative Guidance governing Transfer Pricing (Administrative Principles TP 2024). After 1.5 years, the previous Administrative Principles TP 2023 (see blog post of June 14, 2023) will be replaced. The Administrative Principles TP 2024 will be applied for the first time for the 2024 assessment period, while the Administrative Principles TP 2023 will still apply to all open cases and, for the last time, to the 2023 assessment period. The focus of the new version is primarily on changes in the areas of remuneration for intra-group distribution companies and intercompany financing relationships.

Simplified and streamlined approach for certain distribution companies (Amount B)

OECD approach

On February 19, 2024, the OECD has published its final report on Amount B as an appendix to Chapter IV of the OECD Transfer Pricing Guidelines. Amount B contains simplification measures for determining an arm's length routine profit for certain low-risk (“baseline”) marketing and distribution activities, known as the simplified and streamlined approach (see blog post of February 29, 2024).

The simplified and streamlined approach applies to business relationships where goods are purchased from a group company and subsequently resold to an unrelated party. Apart from further limitations to the scope of Amount B, the ratio of operating expenses to the sales of the distribution company must fall within a range of 3% to an upper bound of 20% till 30%, depending on the respective national implementation. The simplified and streamlined approach provides a specific framework for determining an arm's length routine profit for a distribution company based on the transactional net margin method. This is done using a global pricing matrix that contains fixed operating margins. The operating margin to be applied to the distribution company is selected based on the industry grouping and an intensity factor.

Domestic implementation in Germany from 2025 onwards

According to the Administrative Principles TP 2024, it is “not objectionable” (for the German tax authorities) if the transfer price for in-scope transactions is determined according to the simplified and streamlined approach. However, this optional safe-harbour rule of the simplified and streamlined approach presupposes firstly, that the in-scope transaction is conducted with one of about 50+ tax jurisdictions listed by the OECD (“covered jurisdictions”), including Argentina, Mexico, Serbia, and South Africa. Secondly, a Double Taxation Agreement (DTA) with Germany is required and thirdly, the other contracting state must apply the simplified and streamlined approach. This will apply for the first time for fiscal year 2025.

Employee secondments

According to the Administrative Principles TP 2024, the arm's length principle must also be applied to the provision of temporary workers. For this, reference is made to the BMF letter of December 12, 2023 (BStBl I 2023 p. 2179), while the Administrative Principles on Employee Secondments have been repealed.

Financial transactions

According to Section 1 para. 3d of the German Foreign Tax Act (AStG), financing relationships are not considered to comply with the arm's length principle if:

• the borrower cannot credibly demonstrate that (a) he could have provided the debt service for the entire term from the outset (debt capacity analysis) and (b) the financing is economically necessary and used for the business purpose;
• the interest rate to be paid exceeds the rate at which the company could finance itself based on the group’s credit rating, with the possibility of rebutting this through an individual rating derived from the group rating.

Furthermore, according to Section 1 para. 3e AStG, it should generally be assumed in financing relationships that a service is low in function and risk if the company merely intermediates the financing relationship or if it involves pass-through loans. Taxpayers still have the possibility of providing a rebuttal through the submission of a function and risk analysis (see blog post of March 26, 2024).

In addition, the Administrative Principles TP 2024 include numerous clarifications of the aforementioned requirements, such as:

• The arm's length nature of particularly risky financing relationships is explicitly not excluded;
• Holding arm's length liquidity reserves or capital buffers does not prevent that the borrowed capital is used in line with the business purpose;
• Debt sustainability can be demonstrated using forecast calculations, including consideration of follow-up financing;
• The rating used for determining the interest rate at the time the financing relationship is concluded can be used to substantiate debt sustainability, provided the rating classification is investment grade;
• In the case of short-term capital transfers, particularly from cash-pooling, debt sustainability can generally be assumed;
• For already granted loans that extend beyond December 31, 2024, it is not objectionable for i.a. debt capacity if these requirements are fulfilled (only) by December 31, 2024;
• Only if, based on an overall assessment of the loan conditions (e.g. loan amount, term, collaterals) and creditworthiness, the resulting interest rate is inconsistent with the arm’s length principle and falls outside the range of arm's length interest rates, an adjustment of income may be made;
• A credit rating can also be generated using standard market rating software, in which case the taxpayer must document how qualitative factors were appropriately considered in the rating;
• A rating derived from the group's credit rating can comply with the arm's length principle if the effects of corporate group affiliation (implicit support) are taken into account.

Practical implications

It is to be welcomed that the German tax authorities have "softened" the highly interpretative legal requirements regarding the arm's length nature of transfer prices for financing relationships. The Administrative Principles TP 2024 include further relaxations compared to its draft version. Still, German companies are well advised to review the arm's length nature of transfer prices for intercompany financing relationships to be compliant with the newly substantiated requirements.

It is also to be welcomed that the tax authorities allow the optional application of the simplified and streamlined approach (Amount B) starting in 2025. German companies are well advised to review the fixed determination of binding net profit margins for 2025 in a timely manner. Otherwise, there will be a risk of international double taxation.