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In 2013, the German legislator enshrined the Authorised OECD Approach (AOA) in German law via changes to Art. 1 Foreign Tax Act (FTA). However, the law left many questions unanswered. On October 10, 2014, the Upper House of German Parliament has consented to the Federal Ministry of Finance’s final version of its regulation: the “Betriebsstättengewinnaufteilungsverordnung – BsGaV”. The ordinance is based on the authorization included in new Section 1(6) of FTA and will be applied to financial years starting after December 31, 2014.
The BsGaV has significant impacts on the allocation of profits between parent company and PE. PE is effectively treated as an independent entity. The profit allocation is performed in a two-step approach.
Firstly, activities carried out by the PE are analysed based on the functions and risks assumed by it. The decisive factor in allocating these profits is the “significant people function” (SPF). The classification of SPF depends on where it is carried out. The general principle is that every PE shall bear its own risks, in particular those arising from any function of its assigned staff.
The determination of SPF is the basis for all further assignments and finally for determining an appropriate share of profit. It is from the determination of SPF that the balance sheet for a hypothetical subsidiary for the PE is prepared, allocating respective assets, equity and liabilities to the PE.
Furthermore, the location of SPF is important for analyzing the amount of endowment capital. German PEs determine their endowment capital following the “purchase-price-allocation-method”; in contrast, foreign PEs have to use the “minimum-capital-method” and then convince plausibly that those amount of endowment capital is necessary. For a German PE, a low endowment capital generally leads to high liabilities and consequently a high domestic interest expense. On the contrary, an excessive endowment capital of a foreign PE means the liabilities of foreign PE are too small and less interest expenses arise in the German parent company. The endowment capital has to be determined at the beginning of each financial year, any subsequent changes has to be adjusted accordingly.
Secondly, every contractual relationship between parent company and PE are analysed to examine whether any fictitious dealings exist, as if the PE was an independent legal entity under arm’s length condition. In this respect, the Transfer Pricing Guidelines are used analogously. The effect of any fictitious contractual relationship is disregarded in determining the profit allocation to PE.
The result of this two-step approach is an auxiliary calculation which comprises the assets, endowment capital and other liabilities attributable to the PE; and, a genuine revenue and expenses after adjustments for fictitious contractual relationship.
The new BsGaV-regulation and requirements confront taxpayers with a significant increase of administrative expenses, due to the complexity in the preparation of auxiliary calculation. Nevertheless, the recording of accounting transactions for PE should be adjust immediately in order to meet the requirements of the new BsGaV-regulation.
