Disputed topic: Transfer of functions
Since 2008, the German Foreign Tax Act (AStG), which has been amended several times in the meantime, has regulated the case of a transfer of functions as a special case of a transfer price adjustment between internationally affiliated companies. According to the statutory provision (currently Section 1 (3b) AStG), the appropriate transfer price for the function as a whole must be determined in the event of a transfer of functions. This so-called transfer package includes not only the sum of all individual assets that are the subject of the transfer, but also other benefits such as synergies or positive goodwill. Since its introduction, the provision has been controversial among experts and has repeatedly led to disputes in tax audit practice. There has been very little case law on this topic to date, but now - as far as can be seen - the first supreme court decision has been issued that deals with the elements of a transfer of functions.
Relocation of uneconomical production abroad
The dispute concerned a German limited liability company (GmbH) that was active in a multi-stage production process in the field of cutting and machining technology, primarily for customers in the automotive sector. The associated labour-intensive manufacturing processes were under strong economic pressure due to the high cost of energy. For this reason, the managing director and sole shareholder of the GmbH founded another corporation in Bosnia-Herzegovina in 2007 and subsequently outsourced part of the production - which was no longer profitable in Germany - to this company. The GmbH supplied the material required for production and bought back the resulting semi-finished and finished products. From 2013, the Bosnian company also supplied its own customers directly.
Federal Fiscal Court comments on fundamental questions
After the tax office had made transfer price adjustments for the prices between the German and Bosnian companies in the form of hidden profit distributions, the GmbH filed an action with the Munich Fiscal Court (see blog post from 13 May 2020). The appeal subsequently lodged by both parties was successful; the Federal Fiscal Court overturned the judgement and referred the case back to the Fiscal Court for a hearing and decision. Although the legal issue will now continue in the second instance, the Federal Fiscal Court's decision already provides some important insights for practitioners:
- The Federal Fiscal Court has once again confirmed that Section 1 AStG is only applicable on a subsidiary basis to other income correction provisions (here: hidden profit distribution) and is only applicable if and to the extent that the other provision orders corrections to a lesser extent.
- The Federal Fiscal Court confirmed that in the case of contract manufacturing, the supply of materials by the client and the repurchase of the finished products can be recognised as part of an overall assessment and that the material costs do not have to be included as non-value-adding costs in the assessment basis when applying the cost-plus method.
- In contrast to the tax authorities, the Federal Fiscal Court apparently assumes a less detailed interpretation of the term "function". The Federal Fiscal Court only wants to regard production for a customer as a relevant function if this can be regarded as independent production within the company and therefore as an organic part of the company.
- Finally, the Federal Fiscal Court also comments on the consideration of location advantages and requires an allocation based on the respective functions, risks, assets used and realistically available alternative courses of action. However, it remains unclear whether this involves a deviation from the statutory presumption of orientation towards the "mean value of the area of agreement".
Further decisions will follow
It is to be welcomed without reservation that the Federal Fiscal Court has, for the first time, taken a position on controversial issues relating to the transfer of functions. From the perspective of the companies concerned, it is particularly encouraging that the Federal Fiscal Court apparently interprets the essential criterion of "organic part" for the delimitation of a function in the sense of independence, although the explanations on this have unfortunately remained rather brief. Further decisions by the highest German tax court are likely to follow; for example, an appeal is pending under case number I R 43/23 on the judgement of the Lower Saxony Tax Court of 16 March 2023 (see blog post of 9 August 2023).