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The German Ministry of Finance published draft legislative regulations for determining profits of permanent establishments |
The draft provides details about how taxpayers should allocate functions, assets, risks, opportunities and advantages.
The draft incorporates a statutory implementation of the OECD approach, which departs from the traditional, more flexible allocation of functions and assets, which has been based on the nexus of functions and assets with the business of the permanent establishment.
"Instead, the PE shall be taxed as if it were a separate and independent enterprise. Hypothesised transactions between headquarters and permanent establishments shall be subjected to the same transfer pricing rules as transactions between corporate entities," said Stephan Schnorberger of Baker & McKenzie.
Schnorberger said the draft, if enacted, will reinforce risks for international groups inadvertently having to declare unintended permanent and agency establishments.
"This is primarily because the allocation of functions, assets and risks uses the undefined and vague criterion of the significance of people functions. There is an attempt to allow flexibility to business but we are concerned the guidance is too timid to give business a strong basis or allocation decisions," he added.
Allocations of assets and intangibles may migrate inadvertently between different parts of the enterprise and thereby create capital gains.
"The far reaching rejection of pro-forma contracts between headquarter and permanent establishment may be true to the OECD approach, but seem to put PE structures at a disadvantage compared to corporate entity structures," Schnorberger concluded. "The draft tries to accommodate the specifics of industries operating with construction and assembly establishments by aggregating practical dealings between headquarter and PE and allowing a specific cost-based remuneration of the PE. Yet, it unnecessarily intends to make that conditional on the permanent establishment exercising a routine activity."
However, Alexander Voegele of NERA Economic Consulting, thinks the draft will move Germany from an isolated position to the consensus of the OECD: "Overall the decree is a positive change that should give taxpayers more security from double-taxation; but rules designed to tackle abusive schemes are so extensive that taxpayers will have to reconsider all structures."
But he said improvements to the draft should be considered before it is enacted into law.
"Assets and profits are to be fully attributed to the PE with the most relevant peoples function, rather than pro-rata between all contributing PEs. Also the rules on the attribution of allotted capital and interest make explicit distinctions between PEs in Germany and abroad, which is likely to cause concerns on the European level. Lastly, a PE is still not treated like an actual legal entity when it comes to financing."
