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Intangible in the context of transfer pricing: Introduction of the DEMPE approach into German law

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In the course of the Withholding Tax Relief Modernisation Act (Abzugsteuerentlastungs-modernisierungsgesetz) the new Sec. 1 para. 3c was incorporated into the German Foreign Tax Act (Außensteuergesetz, FTA). This paragraph deals with the treatment of intangibles from a transfer pricing point of view. With this amendment, a definition of intangibles was included into domestic law and the DEMPE approach already known in the international context was implemented.

What is the DEMPE approach?

DEMPE as an acronym stands for Development, Enhancement, Maintenance, Protection and Exploitation in relation to a respective intangible asset. According to the DEMPE approach, these areas of activity are of major importance when it comes to the allocation of income resulting from intangibles in accordance with economic value creation.

The DEMPE approach was developed at OECD level within Actions 8-10 of the BEPS Project, which had the aim to align transfer pricing outcomes with value creation between associated enterprises in order to ensure that transfer prices reflect the economic circumstances of a transaction. In 2017 the DEMPE approach was adopted in the current version of the OECD Transfer Pricing Guidelines.

Incorporation of the DEMPE approach into domestic law

The new version of the FTA applies from the assessment period 2022 onwards. With regard to the DEMPE approach, the legislator stated that the implementation into domestic law only contains a clarification of the previously applicable principles. Therefore, the German tax authorities may apply the DEMPE approach in procedures relating earlier open assessment periods.

What is required under the DEMPE approach?

Subsequent to the allocation of economic ownership for tax purposes, the owner of the intangible asset shall perform an analysis of DEMPE functions and risks (functional analysis). The purpose of such analysis is to determine whether associated enterprises – whether alone or in cooperation - have (i) performed individual or even all DEMPE functions, (ii) borne and controlled the associated risks in this context and (iii) used assets for this purpose. If the owner of the intangible asset outsources functions, in addition to the mere exercise of the activities by associated enterprises, the possibility of control over these activities by the owner (or another group company) and the actual exercise of this control are also decisive for determining the appropriate remuneration.

Depending on the circumstances of the individual case, the different DEMPE areas (Development, Enhancement, Maintenance, Protection and Exploitation) might have different strong significance, depending on the respective contribution to the intangible value creation.

Based on the data obtained from the functional analysis, arm's-length transfer prices are determined for the DEMPE contributions of associated enterprises. For this purpose, the most appropriate transfer pricing method (e.g. comparable uncontrolled price method, resale price method, cost plus method, transactional net margin method or transactional profit split method) for the individual case should be applied. The selection of the transfer pricing method depends on the underlying function and risk profile of the companies involved and is applied in accordance with the general transfer pricing rules. There is no limitation to particular transfer pricing methods. Especially, the mere fact of the performance of DEMPE activities by more than one group company does not result in the automatic application of a specific transfer pricing method.

What needs to be done by taxpayers?

Taxpayers should comprehensively review their existing transfer pricing documentations to ascertain whether they already apply the DEMPE approach and meet the new requirements under German domestic law. If that is not the case, additional analyses might be required to clarify or supplement existing documentation. In particular, the following key questions could serve as a guideline:

  • Have all intangibles covered by the newly inserted definition been identified as such?
  • Is there an adequate functional analysis in place that specifically displays DEMPE contributions of associated enterprises per intangible, taking into account their functions performed risks assumed and controlled and the assets used?
  • Does such functional analysis meet the requirements of the new administrative guidelines Verwaltungsgrundsätze Verrechnungspreise recently published by the German tax authorities or the OECD transfer pricing guideline, in particular with regard to the verification, which group companies bear risks related to intangibles?
  • Is the relevance of the DEMPE contributions for the intangible value creation presented in a comprehensible and transparent way?
  • Does the applied transfer pricing method for remunerating the DEMPE contributions by associated enterprises represent the “most appropriate transfer pricing method” principle according to the new Verwaltungsgrundsätze Verrechnungspreise?