Practical Applicability of Section 153 (4) AO to Transfer Pricing Matters – Part 2

After addressing the new challenges arising from Section 153 (4) of the German Fiscal Code (Abgabenordnung, AO) in Part 1, this second part focuses on the practical applicability of Section 153 (4) AO to transfer pricing matters.

The decisive factor is whether an “underlying set of facts” exists within the meaning of the provision. Under strict interpretation, the rule covers only uniform, recurring transactions with mandatory subsequent effects in later years. A distinction is made between facts with lasting effects and those that permanently recur. Lasting effects exist, for example, when a company acquires a building and the resulting depreciation must continue in later years. A case of permanent recurrence, however, is present when similar facts arise periodically on a recurring basis. This would apply when intra-group services are newly agreed and remunerated each year, as each tax period is based on a new transaction. In the former case, the mandatory continuation of records is likely to apply; in the latter, it is not.

In this context, the following examples illustrate situations in which Section 153 (4) AO may trigger reporting and amendment obligations for transfer pricing adjustments.

Example 1:

A German company receives a long-term intra-group loan with a fixed interest rate from company N located in the Netherlands. Furthermore, it pays royalty fees under a ten-year license agreement without an adjustment clause to the same company. In a tax audit, both the interest rate and the royalty rate are assessed as not being at arm’s length and are increased; the amended assessments become final.

Under a strict interpretation of the requirement concerning the “underlying factual circumstances,” Section 153 (4) AO applies only to uniform, concluded transactions with compulsory ongoing effects. Long-term intra-group financing and licensing contracts with fixed terms, as shown in the example above, may constitute such lasting facts. Both the interest and royalty rates are set at the time of contract conclusion and remain unchanged during the term. Payments in subsequent years are therefore based on the same legal relationship and are not required to be re-determined on an annual basis.

If different arm’s-length terms are agreed and implemented during the audit and become final, a reporting obligation may arise for open subsequent years where the contractual basis remains unchanged.

Practice recommendation: For long-term intra-group financing and licensing agreements, it should be examined whether amended tax assessments can be kept open procedurally (for example, via appeal) or negotiated through alternative dispute procedures to avoid automatic carry-forward effects.

Example 2:

The German holding company H provides centralized management services to its subsidiaries, including the Austrian company T. Based on a 2008 study, a 40 percent shareholder cost allocation has not been recharged since 2009. In the 2016–2018 audit, the tax authorities agree to reduce the allocation to 25 percent as a compromise. The question is whether Section 153 (4) AO applies in subsequent years.

For centralized management services, shareholder costs are generally determined annually based on updated allocation keys and expected benefits. There is no single, unchanging set of facts. The reduced allocation agreed in the audit represents a compromise within the range of estimation and does not constitute a fact that would bind subsequent years. Therefore, no uniform set of facts with logically inevitable continuing effects is present.

Practice recommendation: A continuation obligation under Section 153 (4) AO likely does not apply. However, we recommend proactively disclosing this in future tax returns and explaining why the provision of Section 153 (4) AO does not apply.

Example 3.1:

The German manufacturing entity P supplies specialized components to its French distribution company F and applies a cost-plus method. The tax authorities, however, consider both entities’ existence of value contributions and demand the application of a profit-split method, resulting in a different allocation of profits, even though the underlying business transactions have not changed.

Example 3.2:

The German company U provides a group-developed dating platform to its US affiliate V. In years 01–03, U charges a 9 percent cost-plus markup. The audit requires a profit split equivalent to a 12 percent markup. For years 04–05, U nevertheless continues to apply the 9 percent markup.

In both examples, the core issue is the agreement on a different transfer pricing method. Determining the appropriate method involves both factual assessments and tax assessment of the functional and value‑creation analysis. Section 153 (4) AO however focuses on lasting factual circumstances; legal assessments do not fall under its scope. Consequently, a method decision does not constitute an ongoing factual circumstance.

Practice recommendation: In Example 3.1, a recurring fact exists, so Section 153 (4) AO likely does not apply. In Example 3.2, although the contract continues, the relevant issue—method selection and the underlying functions and risks—is a tax assessment and therefore also does not fall under Section 153 (4) AO. However, we also recommend proactively disclosing this matter in this case and providing a justification as to why we consider the provision pursuant to Section 153 (4) of the German Fiscal Code (AO) not to be applicable.

In conclusion, the decisive factor for determining correction obligations under Section 153 (4) AO is whether a lasting or continuous set of facts exists. Agreed interest rates on intra‑group loans, as well as fixed royalty rates in long‑term agreements, may constitute such enduring facts and thereby create a requirement for continuation (into subsequent years)—particularly where contractual terms and functional profiles remain unchanged. In these cases, it may be advisable to keep audit findings procedurally open or to consider initiating an appeals procedure. By contrast, annually determined allocations of shareholder costs should generally not create a lasting fact; a one‑time agreement reached during a tax audit typically would not lead to ongoing reporting obligations under Section 153 (4) AO. Likewise, when transfer pricing methods are changed, the key consideration remains whether the underlying situation represents a lasting fact or merely a recurring circumstance. However, in these cases we recommend disclosing the facts and providing a justification as to why, from the taxpayer’s perspective, the provision pursuant to Section 153 (4) of the German Fiscal Code (AO) does not apply. Overall, distinguishing between enduring and annually renewed facts is essential for ensuring accurate and consistent tax compliance in the future.