Fundamental German Federal Fiscal Court (BFH) judgement

Central decision on the appropriateness test of transfer prices

Two of our member firms have been involved in a very practice-relevant case at the German Federal Fiscal Court (BFH). The subject of the court proceedings was the income adjustment in the event of relocation of production to a sister company abroad.

Ralf Haberle from Moore Rhein Ruhr GmbH (legal part of the case) and Dr. Sven Helm from Moore Treuhand Kurpfalz GmbH (tax part, in particular transfer pricing) pooled their expertise and successfully represented their joint client in the German Federal Fiscal Court.

The German Federal Fiscal Court ruling in this matter, which has since been published, was issued on 9 August 2023. The ruling is a key decision for the appropriateness test for transfer prices, a so-called leading case.

In its judgement, the German Federal Fiscal Court ruled partly in favour of and partly against the position represented by our two member firms in the proceedings. The main findings of the judgement are as follows:

1. Section 1 para. 1 of the German Foreign Tax Act (AStG) is generally not applicable in comparison to other income correction provisions (here: section 8 para. 3 sentence 2 of the German Corporate Tax Act –KStG–) and only applies if and to the extent that the other provision orders income corrections to a lesser extent (section 1 para. 1 sentence 3 or 4 AStG).
Unfortunately the German Federal Fiscal court did not provide a clear guideline for the classification of a routine. Therefore, this will still be a big point of dispute when dealing with German tax authorities (e.g. in tax field audits).

2. An overall view of individual business transactions (here: Deliveries of materials and reverse acquisitions of the processed material) is possible if a separation of the transactions would not do justice to the economic content of the transaction.
The German Federal Fiscal Court confirms the applicability of a hypothetical arm’s length test when supported by one of the standard methods, as in the case of the C+ Method and a retrospective verification by TNMM.

3. The consideration of material costs of a production company within the framework of the cost-plus method if the client sells the materials to be processed to the production company at cost price and buys them back after processing.
The ruling confirms, as argued by the member firms, that location benefits can be allocated between business units and thus higher margins abroad can be justified.

4. Section 1 para. 1 sentence 2 of the Function Relocation Ordinance (FVerlV) requires that the function is an organic part of a company without the need for a operating unit (tax technical term) in the tax sense. This requires that the production for a customer can be regarded as independent production within the company and therefore as an organic part of the company.
The German Federal Fiscal Court has specified, with great practical relevance, what can be the subject of a transfer of functions.

5. The inclusion of planned costs is the most suitable way to take into account the so-called ex-ante approach to be applied when determining transfer prices (see also Section 1 para. 3 sentence 4 AStG).
In its ruling, the German Federal Fiscal Court did not follow the distinction between toll and contract manufacturing as argued by the two member companies.

6. In order to take location advantages into account, the scope of the location advantages must first be determined and an allocation made on the basis of the respective functions, risks, assets used and realistically available alternative courses of action.
The German Federal Fiscal Court further clarified that the hidden profit distribution pursuant to Sec. 8 para. 3 s. 2 German Corporate Income Tax Act takes precedence over a profit adjustment pursuant to Sec. 1 para. 1 German Foreign Tax Act and that the latter is only applicable to the extent that the adjustment pursuant to this provision goes further than the adjustment pursuant to the hidden profit distribution.

You can find the judgement of the BFH here: BFH, ruling dtd. August 9, 2023, I R 54/19