Transfer Pricing Documentation in Germany

Transfer pricing documentation in Germany: what is required

Transfer pricing documentation is mandatory in Germany for taxpayers with cross-border transactions with related parties. Under § 90(3) of the Fiscal Code (Abgabenordnung, AO), the documentation comprises an overview of the transactions (the transaction matrix), a description of the transactions (factual documentation) and an explanation of why the conditions, in particular the transfer prices, are at arm's length (appropriateness documentation).

Companies that belong to a multinational group and had revenue of at least EUR 100 million in the previous financial year must also prepare a master file describing the group's global business and transfer pricing system. Under the current rules, the tax office can request the documentation at any time with a 30-day deadline, and in a tax audit the transaction matrix, master file and records of extraordinary transactions must be submitted within 30 days of the audit order without a separate request (§ 90(4) AO).

Missing or unusable documentation has serious consequences: a rebuttable presumption that German income is understated, the right of the tax office to estimate at the taxpayer's expense, and surcharges under § 162(4) AO. With tighter deadlines, documentation can no longer be prepared after an audit has been announced; it must be available in advance and kept up to date every year.

The components: local file, master file and transaction matrix

The transaction matrix was introduced as a separate element to give tax auditors a quick overview of the intra-group transactions at the start of an audit. It should list each category of transactions, for example the supply of goods, services, licences, financing and cost-sharing, with the counterparties, volumes, methods and the underlying contracts. The Profit Allocation Documentation Ordinance (Gewinnabgrenzungsaufzeichnungsverordnung, GAufzV) specifies the content of the local file and master file in more detail, broadly following the OECD Transfer Pricing Guidelines.

Documentation duties also apply to permanent establishments: the allocation of profits between a German permanent establishment and its foreign head office, or between a German company and its foreign permanent establishment, must be documented on the basis of the authorised OECD approach as implemented in German law.

Simplifications for smaller companies

Smaller companies are partly relieved. Under § 6 GAufzV, companies whose related-party supplies of goods do not exceed EUR 6 million and whose related-party remuneration for other services does not exceed EUR 600,000 in the current financial year are deemed to meet the documentation duties if they provide the required information on request and support it with existing documents. The simplification does not exempt them from arm's length pricing, and if the thresholds are exceeded, full documentation is required from the following year.

Many Mittelstand companies with foreign subsidiaries exceed these thresholds quickly. A German company that supplies goods worth EUR 8 million a year to its distribution subsidiary in France, for example, must prepare full transfer pricing documentation even if the group is otherwise small.

German subsidiaries of foreign groups face the same duties. Group-wide documentation prepared at headquarters is a useful starting point, but German auditors expect a local file that addresses the German entity's specific functions, risks and transactions, in German or, with the tax office's consent, in English. Translations demanded at short notice can eat into the 30-day period, so foreign groups should agree the language question with the tax office early.

Contemporaneous documentation and the 30-day deadline

As a rule, documentation for ordinary transactions does not need to be prepared at the time of the transaction, but it must be available within 30 days of a request. For extraordinary transactions, such as restructurings involving the transfer of functions, the conclusion of significant long-term contracts or changes to business strategy relevant for transfer pricing, documentation must be prepared contemporaneously (§ 90(3) AO). Under § 3 GAufzV, such records are still contemporaneous if they are prepared within six months after the end of the financial year in which the transaction took place.

In a tax audit, the transaction matrix, the master file and the records on extraordinary transactions must be submitted within 30 days of the audit order without a separate request; the auditors may request the remaining documentation at any time with a 30-day deadline. Extensions are possible only in justified individual cases. A 30-day period is too short to prepare a full local file from scratch, so groups should update their documentation annually, ideally together with the preparation of the tax return.

Consequences of missing or late transfer pricing documentation

The consequences are set out in § 162(3) and (4) AO. If the taxpayer does not submit documentation for a transaction, if the documentation is essentially unusable, or if extraordinary transactions were not documented contemporaneously, there is a rebuttable presumption that the German income is higher than declared. If the tax office must estimate and the income can only be determined within a range, it may use the upper end of the range to the taxpayer's disadvantage.

In addition, surcharges are imposed. If documentation is not submitted or is essentially unusable, or if the transaction matrix is not submitted, the surcharge is EUR 5,000, or between 5% and 10% of the additional income resulting from the adjustment if that amount is higher. Where usable documentation is submitted late, the surcharge is up to EUR 1 million, and at least EUR 100 for each full day of delay. These surcharges are imposed after the audit and are not tax-deductible.

Beyond these surcharges, adjustments lead to additional corporate income tax and trade tax, interest and, where the adjustment creates double taxation, the need for mutual agreement procedures under tax treaties or the EU Arbitration Convention. Our article on handling a German tax audit explains the audit process.

Getting the substance right

Good transfer pricing documentation is not only a formal requirement; it is the taxpayer's main evidence in disputes about the arm's length principle under § 1 of the Foreign Tax Act. Key points that German auditors examine include:

• Functional analysis: whether the characterisation of entities, for example as limited-risk distributors or contract manufacturers, matches the functions actually performed and the people who control risks.
• Benchmarking: the quality and recency of comparable data and the use of the interquartile range. Under § 1(3a) of the Foreign Tax Act, the range of arm's length values is narrowed where comparability differences remain, and in the absence of better indications the lowest and highest quarters are disregarded.
• Function relocations: transfers of functions, risks and opportunities abroad, which may trigger an exit charge on the transfer package.
• Financing transactions: interest rates, guarantees and cash pooling, where German rules on intra-group financing have been tightened.
• Intangibles: licence fees, development, enhancement, maintenance, protection and exploitation functions, and the attribution of returns to the entity that controls them.

Illustration: a German machinery manufacturer sells its products through subsidiaries in Asia that are characterised as limited-risk distributors with a fixed margin. In a tax audit, it emerges that the Asian subsidiaries employ engineers who adapt products to local markets and decide on pricing. The auditors argue that the subsidiaries perform more functions than documented, but also that the German parent's documentation lacks a benchmark for the engineering services. Up-to-date functional analyses and benchmarks would have allowed the company to defend its model or adjust it in time.

Intercompany agreements, year-end adjustments and dispute resolution

German tax auditors place considerable weight on written intercompany agreements concluded in advance. For transactions with controlling shareholders, the case law on hidden profit distributions traditionally requires clear and seriously implemented agreements made in advance, and auditors often apply similar expectations to cross-border transfer pricing. Agreements should define the services or goods, the pricing method, adjustment mechanisms and the allocation of risks in a way that matches the functional analysis in the local file. Agreements that exist only as group templates, without signatures or with content that contradicts actual conduct, weaken the taxpayer's position.

Year-end adjustments, used to bring the operating margin of a limited-risk entity into the target range, are common in practice. They should be based on a contractual clause agreed in advance, calculated consistently and reflected in both entities' accounts and, where relevant, in customs and VAT filings. Adjustments made only after an audit has begun are viewed with suspicion.

When an adjustment in Germany leads to double taxation, taxpayers can request a mutual agreement procedure under the applicable tax treaty, under the EU Arbitration Convention or under the EU Tax Dispute Resolution Directive as implemented in Germany. For significant recurring transactions, an advance pricing agreement with the Federal Central Tax Office and the foreign tax authority can provide certainty for several years in advance. These procedures take time and require the same high-quality documentation as an audit defence, so investing in documentation pays off twice. Our page on tax disputes covers the procedural options.

Transfer pricing interacts with permanent establishment rules, discussed in our article on permanent establishment risk, and with the global minimum tax under the Minimum Tax Act, which uses financial accounting data including intra-group transactions. Our international tax page provides an overview of our cross-border tax work.

How TRW & Co helps with transfer pricing documentation

We advise groups and Mittelstand companies on transfer pricing documentation and on the legal framework behind it: designing transaction matrices and local files, reviewing intercompany agreements, structuring function relocations and financing arrangements, and preparing for the 30-day deadlines in tax audits. In audits and disputes, we defend transfer pricing positions, negotiate with tax auditors, and pursue appeals before the finance courts and mutual agreement procedures. To discuss your documentation, contact us. This article provides general information and is not tax or legal advice.