Unofficial English Translation

 

Draft bill

of the Federal Ministry of Finance

 

 

Ordinance on the application of the arm's length principle pursuant to section 1 (1) of the Foreign Tax Act in cases of cross-border relocation of functions

(Function Relocation Ordinance - FVerlV)

 

A.   Problem and goal

With the Act to Modernise the Relief from Withholding Tax and the Certification of Capital Gains Tax (Withholding Tax Relief Modernisation Act - AbzStEntModG) of 2 June 2021 (Federal Law Gazette I p. 1259), the regulations on the arm's length principle were adapted to the current OECD Transfer Pricing Guidelines and restructured. In this context, the provisions on the transfer of functions were specified and transferred to a new paragraph 3b in section 1 of the Foreign Tax Act (AStG). Regulations on the transfer package from the previous Transfer of Functions Ordinance (FVerlV) are now defined in the Act. As a result, the regulations of the previous FVerlV no longer refer to the current version of the Act or have become obsolete through their inclusion in the Act.

 

B.   Solution

Pursuant to Section 1 (6) AStG, the Federal Ministry of Finance is authorised to issue a statutory order, with the consent of the Bundesrat, regulating the details of the uniform application of the arm's length principle within the meaning of Section 1 (3b) AStG. In addition to cases of the deferral of profits from permanent establishments, this power to issue a statutory order will continue to be used only for cases of the transfer of functions in order to ensure legal certainty and clarity in this area. The ordinance is intended to ensure, even more specifically than in the law, that taxpayers and the administration find competitively neutral solutions that are acceptable in an international context. Germany's taxation rights are to be exercised appropriately in the sense of equality of taxation. The revised ordinance does not go beyond the previous ordinance, but reorganises the regulations in distinction to the law.

 

C.   Alternatives

None.

 

D.   Budgetary expenditure without compliance costs

The ordinance serves to secure tax revenue.


E.   Compliance costs

 

E.1   Compliance burden for citizens

The ordinance does not lead to any change in the compliance burden for citizens.

 

E.2   Compliance costs for the economy

The regulation does not lead to any change in the compliance burden for business.

 

Of which bureaucratic costs from information obligations

The regulation does not lead to any change.

 

E.3   Fulfilment expenditure of the administration

The regulation does not lead to any change in the compliance burden for the administration.

 

F.   Further costs

No other direct costs are incurred by the economy, including small and medium-sized enterprises.

 

Effects on individual prices and the price level, especially on the consumer price level, are not to be expected.


 

Draft bill of the Federal Ministry of Finance

Ordinance on the application of the arm's length principle pursuant to section 1 (1) of the Foreign Tax Act in cases of cross-border relocation of functions

(Function Relocation Ordinance - FVerlV)

From ...

 

On the basis of section 1(6) of the Foreign Tax Act of 8 September 1972 (Federal Law Gazette I p. 1713), as amended by the Act of 2 June 2021 (Federal Law Gazette I p. 1259), the Federal Ministry of Finance decrees:

 

 

A s s e s s m e n t 1

 

A l l o m e v e r a t i o n s

 

 

§ 1

 

General provisions

 

(1)    A function is a business activity that consists of a grouping of similar operational tasks performed by specific units or departments of an enterprise. It is an organic part of an enterprise, without the need for a sub-operation in the tax sense.

 

(2)    A transfer of functions within the meaning of section 1(3b) of the Foreign Tax Act occurs if a function, including the associated opportunities and risks as well as any assets or other benefits that may have been transferred or left along with it, is transferred or left in whole or in part so that the acquiring company can perform this function or expand an existing function. The function transferred as a whole in accordance with sentence 1 constitutes the transfer package. Business transactions that are realised within five business years shall be combined as a single transfer of function at the time when the requirements of sentence 1 are economically fulfilled by their joint realisation.

 

(3)    In cases of transfer of functions, intangible assets are essential within the meaning of section 1(3b) sentence 2 of the Foreign Tax Act if they are necessary for the transferred function and their arm's length price amounts in total to more than 25 per cent of the sum of the individual prices of all assets and other benefits of the transfer package and this is credible, taking into account the effects of the transfer of function, which are evident from the records within the meaning of section 2 sentence 2.

 

(4)    If an acquiring enterprise independently provides the services previously provided exclusively to the transferring enterprise, in whole or in part, to other enterprises at prices which are higher than the remuneration according to the cost-plus method or which are to be set higher in accordance with the arm's length principle, a remuneration in accordance with § 2 shall be charged to the other enterprises at the time of the first provision for assets and other advantages previously provided free of charge by the transferring enterprise for the provision of services; the assets or other benefits in question shall be deemed to be a transfer package, provided that the other requirements for this are met.


(5)    A transfer of functions within the meaning of paragraph 2 shall not be deemed to have taken place if there is no restriction on the exercise of the function in question at the transferring company within five years of the assumption of the function by the acquiring company, although the other requirements of paragraph 2, sentence 1 are met (duplication of functions). If such a restriction occurs within this period, a transfer of functions shall be deemed to have taken place at the time when the restriction occurs, unless the taxpayer proves that this restriction is not directly related to the duplication of functions.

 

 

A s s e s s m e n t 2

 

W e r t h e T r a n s f e r p a c e t s

 

 

§ 2

 

Value of the transfer package

 

The area of agreement (§ 6) shall be determined taking into account all circumstances of the individual case on the basis of a function and risk analysis before and after the relocation of functions, whereby, in addition to actually existing alternatives for action, location advantages or disadvantages, synergy effects and tax effects shall be taken into account. The starting point for the calculations are the documents that were the basis for the company's decision to carry out a relocation of functions. For the calculation of the area of agreement, a capital value-oriented valuation method is to be used. For this purpose, the expectations of the financial surpluses of the participating companies corresponding to the standard of section 1, paragraph 1, sentence 3 of the Foreign Tax Act, appropriate capitalisation interest rates (section 4) and a capitalisation period dependent on the circumstances of the exercise of the function (section 5) shall be taken as a basis.

 

 

§ 3

 

Components of the transfer package

 

(1)    If different agreements are made for individual parts of the transfer package or if such agreements are to be assumed in accordance with the arm's length principle, arm's length prices are to be used for all parts of the transfer package which correspond in total to the value of the transfer package as a whole determined in accordance with § 2.

 

(2)    In the cases of section 1, paragraph 2, sentence 3, section 1, paragraph 4 or section 1, paragraph 5, sentence 2, the transfer prices for the business transactions that have led to a transfer of functions shall be set in accordance with the arm's length principle in such a way that, together with the originally determined transfer prices, they correspond to the value of the transfer package as a whole determined in accordance with section 2.

 

 

§ 4

 

Capitalisation rate

 

In order to determine the appropriate capitalisation interest rate, the interest rate for a risk-free investment must be used as a basis, taking into account the principles of equivalence, and a risk-adequate premium derived from the capital market must be applied.


The term of the comparable risk-free investment shall be based on how long the function taken over is expected to be performed. The surcharge shall be calculated in such a way that it takes into account the circumstances relevant for risk assessment in comparable cases between unrelated third parties for both the acquiring and the relocating company.

 

 

§ 5

 

Capitalisation period

 

If no reasons for a specific capitalisation period depending on the circumstances of the exercise of the function are proven, an unlimited capitalisation period is to be taken as a basis.

 

 

§ 6

 

Determination of the area of agreement

 

(1)    For a relocating enterprise that can expect financial surpluses from the function, the lower limit of the agreement range (minimum price) within the meaning of section 1(3a) sentence 5 of the Foreign Tax Act results from the compensation for the elimination or reduction of the financial surpluses plus any closure costs incurred. The cash value is decisive. Actually existing alternatives for action that the transferring company would have as a company independent of the acquiring company shall be taken into account without calling into question the entrepreneurial disposition authority of the transferring company.

 

(2)    In cases where the transferring company is no longer able to perform the function itself with its own resources for legal, factual or economic reasons, the minimum price corresponds to the liquidation value.

 

(3)    If a company relocates a function from which it cannot expect any financial surpluses in the long term, it may be in line with the conduct of a prudent and conscientious manager of the relocating company to accept, as a minimum price, a payment for the relocation of the function that only partially covers the closure costs incurred or to make a compensation payment to the acquiring company for taking over the source of the losses in order to limit losses.

 

(4)    The cash value of the expected financial surpluses of the acquiring company from the function taken over is regularly the upper limit of the income range (maximum price) within the meaning of section 1(3a) sentence 5 of the Foreign Tax Act. Actually existing alternative courses of action that the acquiring company would have as a company independent of the transferring company are to be taken into account without calling into question the entrepreneurial disposition authority of the acquiring company.

 

(5)    Also in the cases of paragraphs 2 and 3, where the minimum price of the relocating company is zero or below, the arm's length principle shall be applied to examine what price an independent third party would be willing to pay to take over the function.


§ 7

 

Claims for damages, compensation and indemnification

 

Statutory or contractual claims for damages, compensation and indemnification, as well as claims that would be available to unrelated third parties if their alternative courses of action were contractually or factually excluded, may be taken as a basis for the taxation of a transfer of functions if the taxpayer can demonstrate that such third parties would have acted in a comparable manner in similar circumstances. The taxpayer must also prove that no significant intangible assets or other benefits have been transferred or made available for use, unless the transfer or making available is a necessary consequence of claims within the meaning of sentence 1.

 

 

A s s e s s m e n t 3

 

S c r i p t i o s

 

 

§ 8

 

Application to permanent establishment cases

 

The provisions of this Ordinance shall apply mutatis mutandis to the extent that, pursuant to section 1(5) of the Foreign Tax Act, section 1(3b) of the Foreign Tax Act applies to a business relationship within the meaning of section 1(4) sentence 1 number 2 of the Foreign Tax Act.

 

 

§ 9

 

Application instructions

 

This Ordinance shall apply for the first time to assessment periods beginning after the

31 December 2021. The Regulation on the Relocation of Functions of 12 August 2008 (Federal Law Gazette I p. 1680), as amended by Article 24 of the Act of 26 June 2013 (Federal Law Gazette I p. 1809), shall apply for the last time to assessment periods ending before 1 January 2022.

 

 

§ 10

 

Entry into force, expiry

 

This Ordinance shall enter into force on the day following its promulgation. At the same time, the Radio Relocation Ordinance of 12 August 2008 (Federal Law Gazette I p. 1680), which was amended by Article 24 of the Act of 26 June 2013 (Federal Law Gazette I p. 1809), shall expire.

 

The Federal Council has agreed.


 

Justification

 

A.  General part

 

 

I.             Objective and necessity of the regulations

 

§ Section 1 (3b) AStG ensures, in accordance with the existing double taxation agreements and the OECD Transfer Pricing Guidelines, that hidden reserves from operational functions created in Germany and the related assets or other benefits are correctly allocated to German taxation when transferred to associated enterprises abroad.

§ Section 1 (3b) in conjunction with Section 1 (3) sentence 7 AStG. In conjunction with Section 1 (3) sentence 7 of the German Income Tax Act (AStG), however, only define the guidelines for the compilation and valuation of the so-called transfer package and leave the more detailed definition and questions of business valuation in the sense of a uniform design to the statutory instrument.

 

II.            Essential content of the draft

 

The ordinance is essentially based on the previous Relocation of Functions Ordinance of 12 August 2008 (Federal Law Gazette I p. 1809), which was repealed by Article 24 of the Act of

26 June 2013 (Federal Law Gazette I p. 1809). Insofar as provisions of the previous Ordinance were transferred to Section 1 of the Foreign Tax Act by the Act to Modernise the Relief from Withholding Tax and the Certification of Capital Gains Tax (Abzugsteuerentlastungsmodernisierungsgesetz - AbzStEntModG) of 2 June 2021 (BGBl. I p. 1259), they are no longer contained in the new Ordinance; blind references that arose were adjusted. Linguistic inaccuracies in the previous ordinance have been clarified.

 

III.           Alternatives

 

None.

 

IV.          Regulatory competence

 

The competence of the Federal Ministry of Finance to issue ordinances follows from section 1(6) AStG.

 

V.           Compatibility with European Union law and international treaties

 

The regulations on the transfer of functions are based on the internationally recognised arm's length principle, which is also reflected in Art. 9 OECD-MA and the OECD transfer pricing guidelines, and implement this in national law.

 

VI.          Regulatory consequences

 

None.


1.      Legal and administrative simplification

 

The regulations adapt the existing provisions of the previous FVerlV to the new version of the law. This closes gaps that have arisen due to the restructuring of the underlying law. Duplications resulting from the transfer of provisions of the previous ordinance into the law are eliminated.

 

2.      Sustainability aspects

 

The legal ordinance is in line with the German Sustainability Strategy in that it secures the tax revenue of the state as a whole. Thus the indicator area

8.2 (Public debt - consolidate public finances, create intergenerational justice). There is no sustainability relevance with regard to other indicators.

 

3.      Budgetary expenditure without compliance costs

 

None.

 

4.      Compliance costs

 

The ordinance does not lead to any change in the compliance burden for citizens, the economy and the administration.

 

5.      Further costs

 

No other direct costs are incurred by the economy, including small and medium-sized enterprises.

 

Effects on individual prices and the price level, especially on the consumer price level, are not to be expected.

 

6.      Further regulatory consequences

 

Taking into account the different life situations of women and men, there are no discernible effects that run counter to equality policy objectives pursuant to Section 2 of the Joint Rules of Procedure of the Federal Ministries.

 

VII.         Time limit; evaluation

 

The regulations are intended to have a permanent effect, so that a time limit cannot be considered.

 

Due to the unchanged effects on the annual compliance expenditure, an evaluation of the regulations is not necessary.

 

 

B.  Special part

 

Regarding Section 1 (General Provisions) Regarding § 1 (General Provisions)

Re paragraph 1

 

Paragraph 1 was taken over from the previous version of the legal ordinance with the same wording and content.


Re paragraph 2

 

Sentence 1 was adapted to the new version of section 1 (3b) AStG by the AbzStEntModG of

2 June 2021. Sentence 2, which has no direct counterpart in the previous version of the statutory instrument, supplements sentence 1 and clarifies that the function referred to in section 1(3b) sentence 1 AStG as a whole, which constitutes the transfer package, includes the function within the meaning of paragraph 1 that is transferred or relinquished in whole or in part in accordance with paragraph 2 sentence 1, including the associated opportunities and risks as well as any assets or other benefits that are also transferred or relinquished. The object of a transfer of functions is thus the part of an entire function that has been transferred or relinquished, even if only part of the function of the transferring enterprise has been transferred. Sentence 3 corresponds to the previous sentence 3.

 

Re paragraph 3

 

The previous paragraph 3 could be omitted because § 1 paragraph 3b sentence 1 AStG now defines the transfer package. Paragraph 3 now contains the provisions of the previous paragraph 5, which have been adopted with adjustments to the new statutory provisions.

 

Re paragraph 4

 

Paragraph 4 takes up the only relevant provision from § 2 of the old statutory instrument due to the omission of exemptions in § 1 AStG and transfers the rule example from the previous § 2 paragraph 2 sentence 2 to the new statutory instrument.

 

Re paragraph 5

 

Paragraph 5 essentially corresponds to the previous paragraph 6.

 

The previously contained paragraph 7 could be omitted, since in the cases mentioned there it is also ensured according to the remaining regulations that a realisation of relocations of functions does not occur.

 

Regarding Section 2 (Value of the Transfer Package) Regarding § 2 (Value of the Transfer Package)

§ Section 2 takes over the content of the regulations of the previous Section 1 (4) and Section 3 (2) and, instead of profit potentials, uses the term "financial surpluses", which is common in business valuations. The remaining provisions of the previous § 3 could be omitted, since § 1 paragraph 3a sentences 5 and 6 AStG already refer to the area of agreement.

 

Re § 3 (Components of the transfer package)

 

§ Section 3 corresponds to the previous section 4 with subsequent adjustments, with the exception of the deletion of the previous paragraph 2, which is no longer needed due to the lack of concrete regulatory content. The doubtful cases addressed there so far are reliably regulated by the correct application of the other applicable tax law.

 

Re § 4 (Capitalisation rate)

 

§ Section 4 corresponds for the most part, with editorial clarifications, to the previous Section 5. Sentence 3 has been reworded for clarification purposes in order to emphasise that the risk premium to be applied does not only refer to "customary" (previous version) comparison parameters, but must have a transaction reference that third parties would also include in their considerations, so that the risk premium is "customary".


Re § 5 (Capitalisation period)

 

§ 5 corresponds to the previous § 6.

 

Re § 6 (Determination of the area of agreement)

 

§ 6 corresponds to the previous § 7 with subsequent editorial adjustments and clarifications.

 

Re § 7 (Claims for damages, compensation and indemnification)

 

§ 7 corresponds to the previous § 8 with subsequent editorial changes.

 

Regarding Section 3 (Final Provisions)

 

Re § 8 (Application to permanent establishment cases)

 

§ Section 8 clarifies that the regulations on the relocation of functions are also applicable to transactions between an enterprise and its permanent establishment within the meaning of section 1(5) sentence 1 of the Foreign Tax Act.

 

Re § 9 (Application provision)

 

The new regulation applies to all completed transactions (relocations of functions) in assessment periods beginning after 31 December 2021. The previously applicable version of the Ordinance applies to relocations of functions completed prior to that date. The Ordinance is thus based on the new version of section 1 of the Foreign Tax Act by the Withholding Tax Relief Modernisation Act of 2 June 2021.

 

Re § 10 (Entry into Force, Expiry)

 

Article 10 provides that this Ordinance shall enter into force on the day following its promulgation. At the same time, the Ordinance on the Relocation of Functions of 12 August 2008 (Federal Law Gazette I p. 1680), which was amended by Article 24 of the Act of 26 June 2013 (Federal Law Gazette I p. 1809), shall expire.