In October 2012, the highest German tax court passed a landmark decision on “substance over form.” Effectively, the German tax authorities will be severely limited in applying formulistic arguments to transfer pricing cases. Previously, the German tax authorities could make transfer pricing adjustments if the contractual basis between related parties was deemed insufficient. If costs were charged without a valid contract or if the contract did not specify exactly how the prices were determined, a field tax auditor would usually deny the deductibility of such costs entirely—even if the prices were actually at arm’s length.

According to the new decision, this will no longer be possible in certain situations, specifically when the relevant tax treaties contain corresponding clauses such as the OECD model treaty. In these instances, a simple failure of taxpayers to produce appropriate contracts would not be sufficient to warrant adjustments, if the corresponding transfer prices are demonstrably at arm’s length.