If a foreign company has a permanent establishment in Germany, the company's profits must be distributed between the parent company abroad and the permanent establishment in Germany. For this purpose, the permanent establishment is treated as an independent company. The Ordinance on the Application of the Arm's Length Principle to Permanent Establishments pursuant to Section 1 (5) of the Foreign Tax Act (BsGAV) specifies this fiction of independence and sets out rules that must be taken into account when apportioning profits.
Against this background, two decisions were issued by the German Federal Fiscal Court (BFH) on December 18, 2024 (case no. I R 45/22 and I R 49/23) regarding Hungarian corporations that maintained a permanent establishment in Germany (construction and assembly work and meat cutting). Both permanent establishments were responsible for the entire provision of services themselves and carried out an independent determination of profits. The tax authorities determined the profits of the permanent establishments as “routine activities” on the basis of a cost-based transfer pricing method in accordance with the provisions of the BsGAV without further examination of the profit split submitted.
In contrast, the BFH does not consider the scope of application of the BsGAV to be open at all, as Section 1 (5) AStG is not a profit determination provision, but an income correction provision. It is precisely not an independent general provision according to which, in the event of the existence of domestic and foreign permanent establishments, a (re)allocation of profits would always have to be carried out in accordance with the principles described therein without determining the method used by the permanent establishment.
In addition, the BFH states that the BsGAV only applies if the service relationship between the domestic permanent establishment and the foreign parent company is not considered at arm's length and this in turn is causal for a reduction in income in Germany.
The rulings restrict the cases in which the BsGAV can be applied. However, uncertainties remain. It is therefore eagerly awaited whether the rulings will be published in the Federal Tax Gazette and thus become binding for the tax authorities. In any case, the independent determination of profits will be strengthened in cases where services are provided independently by the domestic permanent establishment, even if this may only be enforced in legal proceedings.
