The German tax authorities, particularly the Federal Central Tax Office (Bundeszentralamt für Steuern - BZSt), have increased their focus on examining the operations of intra-group data centers located in Germany. Their scrutiny centres on two principal aspects:
- The transfer pricing methodologies applied for intra-group compensation related to the provision of computing capacity (including server capacity).
- The assessment of whether the use of computing capacity in a German data center constitutes a permanent establishment (PE) for foreign content providers.
Value Contribution of Intra-Group Data Centers
In transfer pricing practice, the provision of computing capacity within a group is typically classified as a routine activity to which no substantial value creation is attributed. This is also the case for technology companies that require this computing capacity to deliver their digital products or virtual services to customers. The required data capacity are assumed to be a fundamental factor of the business model; however, they do not represent a significant value creation factor. Based on our experience, intra-group data centers are usually compensated using a cost-based approach plus a mark-up appropriate for routine functions.
The tax authorities, however, see a significant value contribution in intra-group data centers and regularly argue that intra-group data centers located in Germany are of significant importance to the business model itself and are not easily interchangeable. From their perspective, the location makes a substantial contribution to market success, even if the on-site HR functions are limited. Therefore, the tax authorities believe that compensation for the provision of capacities should also consider the scalability of the business model operated using such capacity. This would be appropriately achieved, for example, if compensation were calculated based on the external customer revenues of the content provider.
The challenge for both sides is that comparable uncontrolled price data to justify the appropriateness of the compensation in these cases is difficult to obtain. Intra-group data centers, with their unique function and risk profile, are not comparable to third-party providers, since there is typically no market risk in the intra-group context due to the assured sale of capacity. Pricing information from third-party providers, which might be somewhat comparable, is also not publicly available and therefore cannot be easily analysed for comparability.
Conclusion:
Taxpayers using domestic intra-group computing capacities should prepare for more stringent transfer pricing audits by analysing and documenting the function and risk profile of intra-group data centers more in greater detail. They should also assess the appropriateness of the chosen compensation using alternative remuneration methods, such as Return on Assets Employed or based on the volume of capacity used. Where practical for the taxpayer, it is advisable to apply for a bilateral mutual agreement procedure to eliminate any double taxation arising from potential adjustments to compensation.
Domestic server permanent establishment of foreign content providers
Under national law, as defined in Section 12, sentence 1 of the Fiscal Code, and established case law, a permanent establishment requires a business facility or installation with a fixed connection to the ground that is of a certain duration. The business facility or installation must serve the activities of the enterprise, and the taxpayer must have more than temporary control over it. Personnel are not generally required for a permanent establishment to be assumed.
From an international perspective, it is crucial to assess the situation under the applicable Double Taxation Agreements (DTAs) between Germany and the countries where, for example, the counterparty of the intercompany agreements for data center operations (i.e. the content provider for the computing capacity) is located. Often, DTAs do not significantly differ from OECD guidelines regarding the criteria for setting up a permanent establishment. However, this requires a detailed review based on the specifics of each case.
In the cases we have seen, a German tax audit assumes that these criteria are met for foreign content providers, even if the data center is not owned by the foreign content provider but by a separate German legal entity, and the foreign content provider only has virtual access to the computing capacity.
In our view, the assumption of a permanent establishment of a server should be critically examined based on the individual facts of each case, particularly concerning the extent of control over the fixed business facility.
If a permanent establishment of the content provider in the German data center is assumed, the next step is to assess the quantitative impact. This involves using the Authorized OECD Approach as outlined in the OECD's “2010 Report on the Attribution of Profits to Permanent Establishments,” along with German principles for the allocation of permanent establishment profits and the German regulations set out in Section 1 of the German Foreign Tax Act (AStG) and in the German Ordinance on the Allocation of Profits of Permanent Establishments (“Betriebsstättengewinnaufteilungsverordnung”).
For this assessment, both international and domestic law agree that significant HR functions are a decisive factor for attributing potential profits to a permanent establishment, with domestic law focusing even more on the physical presence of such significant HR functions. In the case of assumed permanent establishments without any local physical significant HR functions, the quantitative impact should be fairly low, at least under current domestic law.
Conclusion:
If the tax audit assumes a permanent establishment of the foreign content provider in domestic computing capacities, we recommend challenging this assumption critically, as international and domestic law do not provide for clear guidance of the assumption of a permanent establishment in virtual business models.
In case the German tax authorities insist on the assumption of a permanent establishment for the foreign content provider in Germany, we recommend applying for a bilateral mutual agreement procedure to eliminate any double taxation arising from this assumption but also to create awareness internationally for the approach the German tax authorities are taking.
Our KPMG Transfer Pricing Experts would be pleased to assist you with any questions you may have.
Publishing date:
27.03.2025