The German Foreign Relations Tax Act (Außensteuergesetz or AStG) contains the general rules for applying Germany’s transfer pricing regime and for determining income from cross-border transactions between related parties. In 2008, the AStG was amended by adding new Sec. 1(3), which contains rules on the transfer of business functions abroad, which are subject to transfer pricing principles under German tax law. For clarification purposes, the amended act was accompanied by Function Transfer Regulations (Funktionsverlagerungsverordnung or FVerlV) issued by the German Federal Ministry of Finance (Bundesministerium der Finanzen or BMF).
On 17 July 2009, the BMF also issued a draft decree (Grundsätze der Verwaltung für die Prüfung der Einkunftsabgrenzung zwischen nahe stehenden Personen in Fällen von grenzüberschreitenden Funktionsverlagerungen (Verwaltungsgrundsätze – Funktionsverlagerung)) containing additional clarifications for the application of the transfer pricing rules to transfers of business functions abroad. The draft decree sets forth the tax administration’s understanding of the law on the basis of case examples and addresses further issues not contained in the AStG and the FVerlV thereby giving taxpayers the opportunity to avoid price adjustments which would lead to increased taxation. The decree was published in draft form and corporations, business organisations and the general public were given the opportunity to comment on its provisions until 28 August 2009.
The leading German economic association (Spitzenverband der deutschen Wirtschaft – BDI, DIHK, BDA, ZDH etc.) as well as other business organisations harshly criticised the draft, focusing on the following main aspects:

• Definition of function: Throughout the legislative process it was decided that Sec. 1(3) AStG should only cover functions as a whole, not partial functions. Through its definition of “function” in the draft decree, however, the BMF would also apply the new rules to partial transfers, which would be an overstepping of its legal boundaries.

• Transfer package: Under German tax law, a business function must be priced as a transfer package, which means that a reasonable price not only contains the sum of the prices for the transferred assets but also must take into account the profit expectations on the transfer. Since this price estimation is not in line with OECD standards — the OECD Discussion Draft on the Transfer Pricing Aspects of Business Restructurings focuses on the price determination of individual assets – the German rule could lead to double taxation.

• Burden of proof: Under general German tax law, the tax authorities must prove that a transfer price determined by the taxpayer does not meet transfer pricing principles. A tax office can estimate transfer prices only upon reasonable doubt regarding the prices determined by the taxpayer. As drafted, however, the draft decree would seem to shift this burden of proof to taxpayers while, at the same time, making this burden difficult to achieve.

• EU law: Two of the main tenets of EU law are freedom of establishment and freedom to provide services. Any taxation measures taken by an individual EU member state which are seen as limiting or blocking these freedoms are considered contrary to EU law. Given the draft decree’s increased obligations on function transfers as well as the potential higher taxation created by its profit-potential considerations, it is likely that the decree is contrary to EU law.

• Length and complexity of the draft: The draft consists of 72 pages, discussing several issues repeatedly without summarizing them.
We will keep you posted on the Ministry of Finance’s reaction to the various points of criticism.