In a previous issue we already provided information on changes in the area of transfer pricing rules that would result from the transposition of the EU Anti-Tax Avoidance Directive (ATAD). In this edition of our newsletter we have turned our attention to the implementation of the so-called DEMPE concept for intangible assets in the context of transfer pricing. With the introduction of Section 1(3c) of the External Tax Relations Act (Außensteuergesetz, AStG), for periods starting in 2022, the German government has, for the first time, provided a definition of the term ‘intangible assets’ as well as a guideline for determining the allocation of income derived from transferring such assets or making them available for use.
New legal rules based on EU requirements
Up to now, cross-border taxation has not been directly regulated in the AStG in cases where intangible assets had been transferred or made available for use within a group as well as where remuneration had been paid for functional contributions made to value creation. However, in this regard, the so-called DEMPE concept has been part of the OECD Transfer Pricing Guidelines already since 2017. In the wake of the above-mentioned EU Directive, Germany was therefore required to transpose the concept into national law. The aim of this is to ensure that group profits are taxed worldwide where the actual value added is also created by the group companies achieving this.
Implementation of the DEMPE concept in Section 1(3c) AStG
If a group company in Germany assumes a function connected with the
- Protection and
of intangible assets, or if this company bears the corresponding risks then Section 1(3c) AStG prescribes an appropriate remuneration for this that then has to be taxed in Germany. This would not apply if these functions were merely being financed. Consequently, while the financing has to be appropriately remunerated, the income derived from the intangible asset may however not be taxed. The background to this is that the DEMPE concept in the OECD Transfer Pricing Guidelines is based on the value-adding functions of the development, enhancement, maintenance, protection and the exploitation of intangible assets. For the first time, the national legislator has provided a definition, based on cumulative criteria, of intangible assets as assets that
- are neither physical assets, nor equity interests, nor financial assets,
- can be the object of an accounting transaction but without having to be separately transferable, and
- can be factually or legally attributed to a person.
Please note: These could be, for example, patents, know-how and trade secrets, trademarks, trade names and brands, contractual rights and state concessions, etc.
Determining the right to tax
In order to be able to ultimately ascertain which group company is entitled to the income from the exploitation of a particular intangible asset, it is first necessary to determine its owner/holder. In order to avoid subsequent add-back estimates to or correction of the income, it has to be apparent from the requisite functional and risk analysis, which must be carried out for transfer pricing documentation purposes, precisely
- which DEMPE functions were performed by the owner/holder or other group companies,
- which assets were employed for this purpose and
- who has assumed which risks.
Even if the ownership position is the starting point for determining the right to tax, nevertheless, it is possible that no income for taxation will remain there. This is because, in the future, the attribution of earnings derived from intangible assets will ensue solely on the basis of the DEMPE concept. Consequently, there will be cross-border allocation and taxation of earnings based on the above-mentioned functions and risks as well as on the assets employed in the sense of an economic approach.
Although, the legislation does not specify which transfer pricing method should be used to determine the remuneration for the functional contributions made to the value creation by the individual group companies. In the opinion of the fiscal administration, the most appropriate transfer pricing method should always be used to calculate the remuneration. To select the method it will first be necessary to perform a detailed functional and risk analysis so as to be able to determine the functional characterisation of group companies in cases where intangible assets are made available for use.
Recommendation: When intangible assets are transferred, in the absence of arm’s length comparators a hypothetical arm’s length test will frequently have to be applied. Unlike the case of a transfer of a function, here, the price adjustment clause would have to be taken into account during the following seven years. This can be avoided if such a clause is contractually agreed.
Impact on practice
For each group company involved, a detailed review should be carried out of the existing transfer pricing documentation with respect to the DEMPE functions performed and the risks as well the assets that are employed in relation to intangible assets. To begin with, all the transactions in the group companies that involve the transfer of intangible assets or making them available for use should be identified by means of an analysis of the facts and circumstances. This also includes an analysis in terms of the risks that are assumed when performing the DEMPE functions. Subsequently, it is necessary to identify the legal ownership as well as the rights, obligations and risks that have been assumed on the basis of existing contracts between the group companies. Next, it will be necessary to identify the group companies that perform the DEMPE functions, use assets and assume or control
risks. If the earlier analysis of the facts and circumstances has been completed then the insights gained have to be compared with the actual circumstances in the group as well as with the existing transfer pricing documentation.
At the end comes the determination of the appropriate transfer pricing method for the calculation of the arm’s length price for each transaction that has been analysed according to the contributions of the group companies to functions, assets and the risks assumed in relation to the individual intangible asset.
Conclusion: By introducing the DEMPE concept into national law, the lawmakers have for the first time created legitimacy for determining transfer pricing in the case of intangible assets. In view of the lack of more precise legal or administrative specifications, there will be both room for manoeuvre and potential for conflicts in the implementation for the group companies affected. A divergent interpretation by the countries concerned entails the risk of double taxation that could result in a mutual agreement procedure. Therefore, advice and documentation will be required in the run-up.