Adjustment of branch profit only if terms do not meet arm’s length test

The Nuremberg Tax Court decided that the provision of Sec. 1 (5) in conjunction with Sec. 1 (1) of the Foreign Tax Act regarding the arm's length principle for cross-border determination of the income of a permanent establishment is not relevant and, to this extent, the ordinance on the allocation of profits of permanent establishments (Betriebsstättengewinnaufteilungverordnung) is also not applicable if there is no transfer pricing issue between a domestic permanent establishment and its foreign parent.


For fiscal years beginning after 31 December 2012, the so-called Authorized OECD Approach (AOA) is applied in Germany for purposes of the allocation of the profits of permanent establishments. According to the AOA, permanent establishments are (largely) treated as legally independent companies for the determination of profits. The local implementation of the AOA took place in Section 1 (5) of the Foreign Tax Act (FTA).

The plaintiff, a Hungarian parent company with its registered office and management in Hungary (comparable by type to a limited liability company), operated a German permanent establishment in 2017, the year of dispute. It provided contract work in the form of installation and assembly services to domestic third parties. The tax office increased the profit of the permanent establishment for the assessment period 2017 on the grounds that this was a domestic routine permanent establishment for which the profit was to be calculated on a cost-plus method based on Section 32 of the ordinance on the allocation of profits of permanent establishments (Betriebsstättengewinnaufteilungverordnung - BsGaV).


The Nuremberg Tax Court did not agree with the opinion of the tax authorities. According to the court, there were no indications that the service relationships between the Hungarian parent company and its German permanent establishment had been overcharged. There was no legal basis for the application of the cost-plus method in the case at hand.

Both Section 1 (5) in conjunction with Section 1 (1) Foreign Tax Act presuppose, first of all, that the terms of the business relationship do not meet the third-party comparison test. Therefore, these provisions in the Foreign Tax Act cannot be invoked and thus the BsGaV is not applicable as there are no indications that the service relationship between the domestic permanent establishment and the foreign parent company is not at arm's length. To the extent that payments were made to the parent company, these were merely cost reimbursements (e.g., Hungarian social security fund) that were passed on without a markup. In particular, the tax court rejected the view of the tax office as unfounded. There was no sufficient legal basis to support fictitious (notional) mark-up rates between the domestic permanent establishment and its foreign parent.


Nuremberg Tax Court, decision of 27 September 2022 (1 K 1595/20); the appeal is currently pending before the Supreme Tax Court (case ref. I R 45/22).

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