If a parent holds more than 50% of the voting rights in a subsidiary having its place of management in Germany, the two may conclude a formal court-registered profit and loss pooling agreement (PLPA), which must be concluded for a period of at least five years. If certain conditions are fulfilled, the ensuing relationship is referred to as an Organschaft. Effectively, the annual results of an Organschaft are pooled at the level of the parent. The tax group subsidiary itself is only subject to tax with respect to 20/17 of the compensation payments made to outside minority shareholders, if applicable. Profits and losses within a group can therefore be offset, but there is no provision for the elimination of intra-group profits from the total tax base. It should also be noted that negative income of the parent or of the subsidiary incurred within an Organschaft is excluded from offset in the same or another year if a foreign country takes it into account in the taxation of an Organschaft member, or of any other entity.
The main conditions for a tax group for corporate tax/trade tax purposes are:
- The subsidiary is financially integrated; in effect, the parent must have held the shares in the subsidiary without interruption from the beginning of its business year sufficient to give it a majority of the voting rights in the subsidiary.
- The parent of an Organschaft must be an individual, a trading partnership, or a non-tax exempt corporation, association, or estate.
- The investment in the subsidiary must, from a functional point of view, be attributable to a German branch of the parent, and the income of the branch must be subject to German tax and not be exempt under a DTT.
- The subsidiary must be a corporation having its place of management in Germany and its registered seat in an EU/EEA member state.
- The parent and the subsidiary must have concluded a qualifying profit and loss pooling agreement (PLPA) to run for at least five years and be consistently applied throughout the term of the agreement. Under the PLPA, the subsidiary surrenders its entire income to the parent. Conversely, the parent is obligated to compensate the losses incurred by the subsidiary throughout the term of the agreement.
Extensive rules on transfer pricing in respect of all transactions with foreign-related parties are in force. The basic principle is that all cross-border inter-company business transactions should be priced at arm's length. Failure to meet the extensive documentation requirements applicable exposes the company to serious risk of penalties as well as unfavourable estimates by the tax authorities, who have the right to exercise every possible leeway or margin to the taxpayer's disadvantage.
Germany has adjusted its transfer pricing documentation rules to meet the recommendations of the OECD BEPS Project. The taxpayer has to prepare documentation specific to the country and each business (local file) as well as a master file with information regarding the global business operations of the group. Furthermore, a so-called country-by-country reporting (CbCR) must be prepared if the group's revenues exceed EUR 750 million and has to be submitted within one year after the end of the respective business year.
Documentation (local file and master file) need not be set up at the time of transaction nor in the course of a tax return, but only needs to be provided upon request during a tax audit. However, in case of extraordinary business transactions (e.g. restructurings, cost sharing, other material long-term agreements), documentation needs to be prepared within six months after the end of the business year in which the business transaction occurred (but again, it only needs to be provided upon request during a tax audit).
In preparation of a tax audit, starting prior to 1 January 2025, the tax authorities may request the relevant records/documentation. Upon specific request of the tax auditor, the documents must be furnished within 60 days of the request or, in case of extraordinary business transactions, within 30 days.
However, the bill implementing Council Directive (EU) 2021/514 of 22 March 2021 amending Directive 2011/16/EU on Administrative Cooperation in the Field of Taxation and Modernising the Law on Tax Procedure of 16 December 2022 foresees a tightening of the taxpayer’s obligations in the field of transfer pricing. In this regard, amendments will enter into force as early as 1 January 2023 but are to apply for the first time to tax audits for the 2025 assessment period or to tax audits in which the tax audit order was issued after 31 December 2024.
According to these changes in law, the tax authorities may request the submission of transfer pricing documentation at any time in the future. Additionally, German-compliant transfer pricing documentation must now be submitted not only upon explicit request by the tax auditor, but always within a period of 30 days from the start of a tax audit, i.e. upon notification of the tax audit. In practice, this will mean that taxpayers will have to prepare the transfer pricing documentation for all cross-border intercompany transactions upfront since the 30-day period will hardly be sufficient to prepare the obligatory documentation or at least to prepare it in the required quality.
On 9 June 2021, the Act on the Modernisation of the Relief from and the Certification of Withholding Taxes (Gesetz zur Modernisierung der Entlastung von Abzugsteuern und der Bescheinigung von Kapitalertragsteuer - AbzStEntlModG) came into force. The Act contains amendments or supplements to the Foreign Tax Act (FTA - Außensteuergesetz) and the General Tax Code (AO) that are relevant from a transfer pricing perspective.
The Act addresses key contents of BEPS Action Points 8-10 (Aligning Transfer Pricing Outcomes with Value Creation). For example, the Act contains a comprehensive revision and new version of Section 1 of the German Foreign Tax Act (FTA - Außensteuergesetz) and emphasises, among other things, the substance-over-form approach envisaged by the OECD and the application of the OECD 'DEMPE' concept in the context of intangibles. It should be mentioned that the German tax authorities assume that the DEMPE concept also applied according to German transfer regulations prior to the implementation of the Act and that the now revised version of Section 1 FTA simply clarifies the position.
There are no thin capitalisation rules as such; their substitute is the 'interest limitation' of, basically, 30% of EBITDA discussed in the Deductions section.
Controlled foreign companies (CFCs)
Pursuant to the German CFC taxation rules regulated in the Foreign Tax Act (FTA - Außensteuergesetz), certain low-taxed (less than 25%) income, referred to as passive income generated by a CFC, shall be subject to German tax at the level of the German shareholder, provided the CFC is deemed to be a so-called intermediate company (Zwischengesellschaft) and the German ownership criterion is fulfilled.
Due to transposition of the EU-ATAD into German law, changes to the German CFC rules were enacted in June 2021. The changes contain a revision of the German ownership criterion (replacement of the so-called 'concept of control' by tax nationals with a shareholder related group view) as well as changes to the tax treatment of the CFC’s dividend income. The changes are applicable for business years starting after 31 December 2021.
Passive income generated by a CFC that qualifies as an intermediate company will be attributed to the German shareholder regardless of whether the income is actually distributed or not (CFC income). The CFC income is subject to German corporation tax and trade tax.
EU/EEA subsidiaries will not be qualified as an intermediate company if a so-called motive test is fulfilled (i.e. the German shareholders prove that the specific income is derived from a substantial economic activity performed in the state of residence of the CFC). Following two judgements of the German Federal Fiscal Court on 22 May 2019 and 18 December 2019, prior to the changes to the German CFC regulations, the tax authorities also applied the motive test mutatis mutandis in certain third-country cases, provided there was a sufficient exchange of information (cf. Ministry of Finance circular dated 17 March 2021). According to the amendment through the ATAD Implementation Act and following the amendment of the control concept, the so-called 'motive test' may again only be applied vis-à-vis member states of the European Union or member states of the European Economic Area. An exception applies in relation to the extended CFC taxation in cases of income from invested capital.
According to the so-called Tax Haven Defence Act (‘Steueroasenabwehrgesetz‘, see Tax Haven Defence Act in the Other issues section), CFC taxation may also apply to the entire income (including active income and income for which the motive test is fulfilled) of an intermediate company if the intermediate company is resident in a non-cooperative tax jurisdiction.