International Tax and Transfer Pricing

International tax in Germany: an overview

International tax in Germany is shaped by three layers: German domestic law, which taxes residents on their worldwide income and non-residents on German-source income; Germany's network of double tax treaties, which allocates taxing rights and limits withholding taxes; and EU and OECD initiatives, from the Parent-Subsidiary and Interest and Royalties Directives to the anti-avoidance directives and the global minimum tax. For inbound investors, the key questions are how profits from Germany are taxed and repatriated, how intra-group transactions are priced, and when activities in Germany create a taxable presence. For German groups investing abroad, the controlled foreign company rules and the minimum tax add further layers.

This page explains withholding taxes on dividends, interest and royalties and how to obtain treaty or directive relief, the anti-treaty-shopping rule, permanent establishment risk, transfer pricing and documentation, controlled foreign company rules, the Minimum Tax Act implementing Pillar Two, and reporting obligations for cross-border arrangements. It is written for heads of tax, CFOs and in-house counsel of international groups and investors. Domestic corporate taxation is covered on our page on corporate and transaction tax.

Withholding taxes and treaty relief

Germany levies withholding tax (Kapitalertragsteuer) on dividends paid by German corporations at a rate of 25% (§ 43a(1) EStG) plus the solidarity surcharge of 5.5% on the tax amount. The paying company withholds the tax regardless of the recipient's residence. Foreign corporate shareholders can obtain relief under a double tax treaty, typically reducing the rate to 15%, 10%, 5% or zero depending on the treaty and the holding, or under the EU Parent-Subsidiary Directive, which allows exemption for qualifying holdings of at least 10% held by EU parent companies.

Relief is granted by the Federal Central Tax Office (Bundeszentralamt für Steuern), either by refund after payment or by an exemption certificate in advance. Foreign corporations can also claim a partial refund of withholding tax under domestic law to align their burden with the corporate income tax rate.

Interest paid to non-residents is generally not subject to German withholding tax unless it is secured by German real estate or paid on certain profit-participating instruments, although interest on loans may be taxable as German-source income in specific cases. Royalties for the use of rights in Germany, and certain payments for services and artistic performances, are subject to a withholding tax under § 50a EStG, which can also be reduced under treaties or the Interest and Royalties Directive. In recent years, the tax authorities have applied § 50a EStG to licences of rights registered in a German register, which has led to extensive filing obligations for licensors with no other German connection.

Anti-treaty shopping

A foreign corporation is not entitled to treaty or directive relief from withholding tax to the extent that its shareholders would not be entitled to the relief if they received the income directly, and the income does not relate to the corporation's own business activity (§ 50d(3) EStG). Holding companies that merely hold shares are therefore at risk unless they can show that the shareholders would themselves qualify or that the income is connected to genuine business activity. Exceptions apply for listed companies, and the burden of proof regarding substance and the shareholders' entitlement lies with the applicant. Structures using intermediate holding companies in treaty jurisdictions should be reviewed in light of this rule and of the principal purpose test in the multilateral instrument.

Relief for German residents investing abroad

German residents with foreign income avoid double taxation either through the exemption method or the credit method, depending on the treaty and the type of income. Business profits of foreign permanent establishments are usually exempt under German treaties, subject to activity clauses and switch-over rules that apply the credit method to passive income. Dividends from foreign subsidiaries benefit from the domestic participation exemption, while foreign withholding taxes on such dividends are generally not creditable. Interest and royalties are usually taxed in Germany with a credit for foreign withholding tax. Groups should model the interaction of foreign taxes, German taxes and the minimum tax when choosing where to locate functions.

Permanent establishment risk for inbound investors

A foreign company becomes subject to German tax on business profits if it has a permanent establishment in Germany. Under domestic law, a permanent establishment is any fixed place of business or installation serving the company's activity, including the place of management, branches, offices, workshops, warehouses and construction sites lasting more than six months (§ 12 AO). Treaties usually contain a narrower definition, with exceptions for preparatory and auxiliary activities and specific rules for dependent agents who habitually conclude contracts on behalf of the company.

Permanent establishment risk arises frequently in international tax practice in Germany: sales staff working from home offices in Germany who negotiate contracts, managing directors of foreign companies who live and work in Germany and thereby move the place of effective management, project sites and installation work, and servers or warehouses used for core activities. Once a permanent establishment exists, profits must be attributed to it under the authorised OECD approach, trade tax may apply, and the company must register, file tax returns and keep records. Remote working policies for international employees should be aligned with these risks. See also our page on immigration and global mobility.

Transfer pricing in international tax practice

Transactions between related parties must be priced as independent parties would have priced them under comparable circumstances; otherwise the tax authorities adjust the income (§ 1 AStG). The German rules follow the OECD Transfer Pricing Guidelines but contain specific provisions, for example on function relocations, which can trigger taxation of the transfer package of functions, risks and opportunities, and on financing transactions, where the borrower's ability to service the debt and the commercial rationale of the loan are examined.

Taxpayers must document the nature and content of their business relationships with related parties abroad, including a transaction matrix, a description of the business transactions, the comparability and functional analysis, and the transfer pricing method (§ 90(3) AO). Larger groups must prepare a master file describing the group's business, intangibles, financing and overall transfer pricing policy, and extraordinary transactions such as restructurings must be documented promptly. Documentation must be submitted within 30 days of a request, which tax auditors now issue routinely with the audit order. Failure to provide usable documentation leads to estimates at the taxpayer's expense and surcharges. Advance pricing agreements and mutual agreement procedures under treaties and the EU Arbitration Convention help to resolve double taxation; see tax audits and disputes.

Function relocations and exit taxation

Moving functions, risks and assets from Germany to a foreign group company can trigger taxation of a "transfer package" valued on the basis of the expected profits transferred, even if no single asset is sold. Similarly, transferring assets to a foreign permanent establishment or moving a company's place of management abroad can lead to exit taxation of hidden reserves. Restructurings of supply chains, the centralisation of intellectual property and the relocation of management functions should therefore be analysed for German international tax consequences before implementation, and documented carefully.

Resolving double taxation

When the German tax authorities and a foreign tax administration take inconsistent positions, for example after a transfer pricing adjustment, taxpayers can initiate a mutual agreement procedure under the applicable treaty. Within the EU, the EU Arbitration Convention and the directive on tax dispute resolution mechanisms provide procedures that lead to a binding decision within set periods. Advance pricing agreements, negotiated bilaterally or multilaterally, give certainty for future years. These procedures run alongside domestic remedies, so deadlines for objections and court actions must be observed to keep all options open.

CFC rules and the minimum tax

Germany's controlled foreign company rules in the Foreign Tax Act attribute passive income of a foreign company controlled by German residents to the German shareholders if the income is subject to low taxation (§ 7 AStG). Low taxation means an effective burden of less than 15% (§ 8(5) AStG). Active income, such as income from manufacturing, trading under certain conditions, services and qualifying holding activities, is excluded.

For companies in the EU or EEA, the shareholder can avoid attribution by showing that the company carries on a substantive economic activity there. The CFC rules interact with the participation exemption and the minimum tax and should be reviewed for each foreign subsidiary in a low-tax jurisdiction.

The Minimum Tax Act (Mindeststeuergesetz, MinStG) implements the EU directive on Pillar Two. It applies to German constituent entities of groups whose consolidated financial statements show annual revenue of EUR 750 million or more in at least two of the four preceding financial years (§ 1(1) MinStG).

Where the effective tax rate in a jurisdiction is below 15%, a top-up tax is levied, in Germany through an income inclusion rule, an undertaxed profits rule and a qualified domestic minimum top-up tax. Transitional safe harbours based on country-by-country reporting data reduce the compliance burden for the first years. Groups in scope must file information returns and top-up tax returns; preparing the data is a major project for tax and finance functions. Groups below the threshold should monitor their revenue, because acquisitions can bring them into scope, and buyers should assess the target's minimum tax position in due diligence.

Hybrid mismatches and deductions

German law implements the EU anti-tax avoidance directives. Anti-hybrid rules deny deductions where a payment is deductible in Germany but not taxed at the level of the recipient because of differences in the classification of entities or instruments, or where the same expense is deducted twice. Licence payments to related parties benefiting from preferential regimes that are not in line with the OECD nexus approach are partly non-deductible. Combined with the interest barrier and the arm's length requirements for financing, these rules mean that intra-group financing and licensing structures must be reviewed as a whole and adjusted where necessary. International tax planning based on mismatches between legal systems has become largely ineffective, and the documentation of commercial substance is now central.

Reporting and tax transparency

International tax transparency rules require various reports. Intermediaries, and in some cases taxpayers, must report cross-border tax arrangements that meet certain hallmarks to the Federal Central Tax Office (§ 138d AO), implementing the EU directive known as DAC6, with short deadlines after the arrangement is made available or implemented. Groups with consolidated revenue above the OECD threshold must file country-by-country reports, and public country-by-country reporting applies to large groups under EU law. Taxpayers must also notify the tax office of foreign holdings and permanent establishments.

Automatic exchange of information between tax authorities on financial accounts, rulings and country-by-country reports means that the German authorities increasingly know about cross-border structures before an audit begins. Consistency between filings in different countries has therefore become a practical necessity, and groups should ensure that the facts presented to different tax authorities are aligned.

• Map withholding tax flows and obtain relief certificates in advance.
• Review holding company substance against § 50d(3) EStG.
• Monitor permanent establishment risks from employees and directors in Germany.
• Keep transfer pricing documentation ready for submission within 30 days.
• Assess CFC and minimum tax exposure for low-taxed subsidiaries.

International tax questions frequently arise in transactions, where the target's international structure, withholding tax compliance and transfer pricing history are examined in due diligence and addressed through tax indemnities. They also arise when international clients set up their first German entity; see our GmbH formation checklist and our pages for US and Chinese investors.

How TRW & Co helps

We work with international groups, investors and their tax advisers on international tax in Germany. We structure inbound investments and holding companies with withholding tax, substance and treaty access in mind, assess permanent establishment risks from employees, directors and projects, draft intra-group agreements that support transfer pricing positions, and advise on CFC rules and the minimum tax in group structures. We assist with relief applications, DAC6 analysis and reporting, and represent clients in tax audits and disputes about international issues. To discuss an international tax question, please contact us.