Relocation of functions -
Understanding tax traps when expanding abroad
In the course of expansion abroad, functions performed in Germany are often relocated to more cost-effective countries. The focus is usually on the competitiveness of the company. Tax reasons play a secondary role.
The relocation abroad triggers tax consequences in Germany with the so-called relocation of functions.
In this article, I will explain everything you need to know about relocating functions and what you need to bear in mind.
Overview
Relocation of functions - what does this mean?
A transfer of functions always occurs when a function previously performed by a company is transferred to a related party abroad (§ Section 1 (3b) AStG ).
If this is done free of charge and the profit of the German company is reduced by the transfer of functions, the taxable profit in Germany is adjusted.
It must therefore be ensured that an arm’s length purchase price is agreed for the transferred function, including the associated opportunities and risks as well as the transferred assets or other benefits.
This regulation is based on the following question:
Would you transfer an operational function of your company to a third party without demanding a purchase price?
Definition of a function
In the Functional Relocation Ordinance(FVerlV) from 2022, the tax authorities commented on the principles of functional relocation.
Accordingly, a function is a business activity that combines similar operational tasks and is carried out by certain units or departments of a company. The decisive factor is therefore whether there is an organic part of the company that is transferred to an affiliated company.
These include, for example
- the production
- the distribution
- Marketing
- research and development or
- the administration.
Evaluation of the so-called transfer package
If a function, including the associated opportunities and risks, is transferred to an affiliated company, a so-called transfer package is transferred.
This means that not only the individual assets, but also the underlying advantages and disadvantages must be taken into account when evaluating the transfer package.
In the case of restructuring within a group of companies, it is regularly difficult to use comparative values for the transfer of functions due to the individual circumstances. In these cases, the so-called hypothetical arm’s length comparison should be used as a benchmark.
The valuation of such a transfer package, i.e. the transferring economic unit, generally requires a valuation in accordance with the principles of business valuation. Capital value-oriented methods can be used for the valuation(§ 2 FVerlV).
It should be noted that in the case of a transfer of functions, a double income-oriented valuation must be carried out:
- The transferring company then values the economic unit transferred as a result of the transfer of functions; this value acts as a minimum value for the hypothetical unification process.
- The acquiring company, on the other hand, values the transferring economic unit taking into account its own profit expectations and cost structure. This value serves as the maximum value for the settlement process.
Within this range, the so-called agreement range, the price for the relocation of functions is to be determined, which most likely corresponds to the arm’s length price.
If the taxpayer cannot provide sufficient reasons for determining the arm’s length price, the mean value of the agreement range is decisive.
The evaluation of the transfer package is complex and in practice often offers points of attack from the tax audit.
Exceptions for relocation of functions
Individual assessment instead of transfer package
In deviation from the principle of evaluating the function as a whole (transfer package), the legislator has standardized an individual evaluation (cf. § Section 1 (3b) sentences 2 and 3 AStG )
The prerequisite for this is that
- Neither material intangible assets nor other benefits are the subject of the transfer of functions
- The acquiring foreign company only performs the transferring function vis-Ã -vis the German transferring company
- The remuneration for performing the function is determined according to the so-called cost-plus method.
In principle, an individual valuation can be carried out if the function is transferred to so-called routine companies.
Function duplication
There is no relocation of functions if there is no restriction at the German company within 5 years of the foreign company taking up the function.
This includes cases of duplication of functions. The function is not “completely” relocated abroad, but is additionally established there. The original function remains in Germany.
In practice, the regulation requires intensive monitoring. This is because if there is a restriction at the level of the German company, a retroactive transfer of functions is assumed.
Mere sale or transfer of use
If assets are sold to an affiliated company or transferred for use, this does not constitute a transfer of functions.
Nevertheless, an appropriate transfer price must be determined for this transaction.
Documentation & reporting obligations
In cross-border constellations, there is an increased obligation to provide documentation and cooperation. Failure to do so may result in sanctions.
Relocations of functions are exceptional business transactions that must be documented promptly (cf. 90 para. 3 sentence 5 AO ).
In addition, corresponding contractual agreements should be concluded between the affiliated companies.
In principle, a transfer of functions is a notifiable cross-border tax arrangement that must be reported to the tax authorities under the additional requirements of Section 138d AO.
Price adjustment
The price adjustment clause(Section 1a AStG) allows the tax authorities to make a subsequent adjustment under certain conditions if the companies involved have not made any arm’s length adjustment arrangements for the sale of the transfer package.
In this case, the price must be adjusted if there is a significant deviation in the transfer price based on the first 7 years after the transaction was concluded. The transfer prices applied would have to be reviewed accordingly. This requires a new valuation.
If a price adjustment clause is agreed, it must be checked whether it complies with the arm’s length principle.
It is generally advisable to include a price adjustment clause in the contract in order to avoid an adjustment by the tax authorities.
PRACTICAL TIP
- In practice, the issue of the relocation of functions is often underestimated. However, it is a significant issue, particularly with a potentially high tax burden for the German company.
- At the same time, coordination with other countries is required to ensure that the transfer package is accepted abroad. Otherwise there is a risk of double taxation.
- First of all, ask yourself: What specific task should the foreign company fulfill? What assets are needed from Germany?
Are you planning to expand abroad with your company and need tax advice?
I will be happy to support you in planning and implementing a tax-optimized structure.
Please feel free to contact me!
Disclaimer
The article uses simple language for better understanding and is also abbreviated with regard to the individual conditions required by law.
This article does not constitute legal or tax advice, but is for general information purposes only. Every situation is individual, so I always recommend professional advice to avoid tax disadvantages.
Last updated October 11, 2024
