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International operating groups often centralize administrative services to save costs and benefit from standardized processes. One challenge lies in the correct fiscal allocation of costs, as these services often benefit multiple companies within the group. In particular, in inbound cases, the fees for centralized services are regularly challenged by the German tax authorities. This article provides recommendations and a practical example regarding bundled service allocation at the parent company.

Virtually every internationally operating group centralizes administrative services in areas such as finance, taxation and law, human resources, and IT. These functions do not belong to the core business of the company, yet they are essential. Consolidating these activities can lead to significant savings due to their uniformity. Additionally, organizational aspects play a role, as the corporate group can benefit from standardized processes � for example, in the form of a common IT environment. However, difficulties arise when it comes to determining who should bear the costs of such services. The challenge lies in the proper tax allocation of costs, as these services are typically provided across multiple companies, making it difficult or even impossible to delineate the activities for the individual group company. The preparation of transfer pricing documentation (and especially a Master File or benchmarking studies) are good examples of such services.

The German tax authorities are bound by special regulations for the allocation of centralized services within the group and largely follow the international standard of the Organisation for Economic Co-operation and Development (OECD). Routine services are typically compensated based on the cost-plus method (meaning cost reimbursement with an additional profit element). The so-called 'routine services with low value-added' have a supportive character and are not part of the company's core business. They are provided without the use or creation of significant intangible assets, and no significant risks are controlled or arise. For such services, the tax authorities accept the application of a profit element of 5% of full costs without the need for comparable data evidence, provided this is applied uniformly within the group. The allocation of costs to individual service recipients can then be carried out through a cost contribution. Direct allocation of service costs per group entity (e.g., through timesheets) is recognized as hardly feasible in corporate practice. It is therefore possible to distribute overhead costs to companies using appropriate allocation keys. For IT services, common distribution keys include the number of PC workstations or software licenses; for HR services, the number of employees is often chosen as an appropriate allocation key.

In principle, when allocating services within a multinational group, it should be demonstrated that the services were actually rendered. It must also be shown whether the services benefit the recipient. This also implies that the services do not include shareholder activities, which encompass activities of the parent company that serve the control and management of its subsidiaries. However, for low value-adding routine services, simplifications apply as prescribed by the OECD, which the German tax authorities follow. For example, tax authorities are expected to refrain from examining the proof of benefit (also known as the benefit test).

It is common that the parent company consolidates the central services for the group. In inbound cases, where the parent company is located abroad, tax audits frequently challenge the fees that allow the service-receiving company to deduct operating expenses for tax reduction purposes.

In the present case, price increases in the group allocation were observed during the tax audit period. The tax auditor inquired about the reasons for the additional costs and requested evidence that additional services were provided. This posed challenges for the company for the following reasons:

• The German company was acquired, resulting in a change of the parent company and thus the service provider over time. Documents and information from the previous group management were difficult to obtain due to the acquisition and the significant time gap between the assessment period and the tax audit activities.
• Documents and information from the new group management were withheld due to the discreet corporate policy. From the perspective of the group management, calculation details for the group allocation contain confidential data (such as salaries of the parent company's management), which the local management should not have access to.
• From the perspective of the German tax audit, the services partially included shareholder expenses. Differentiating shareholder expenses from administrative activities is often not clear-cut and can be interpreted differently; this can apply to areas such as business development or controlling.
• The tax audit declared a hidden profit distribution, which leads to dividends and thus to withholding tax on capital gains. A transfer pricing adjustment according to Section 1 of the Foreign Tax Act, which only results in an off-balance adjustment, is generally subordinate to the hidden profit distribution.

The question remains how to protect against adjustments due to the allocation of management fees. Evidence of the services provided and calculations of the fees must be presented to the tax audit, and in practice, it is hardly possible to defend against excessively detailed and extensive requests for evidence, even when applying the simplified approach for low value-adding routine services, as these are matters of discretion and individual case decisions. Additionally, there are increased cooperation obligations in cross-border situations. The argument that the data is confidential is not valid due to tax secrecy in Germany.

It is therefore advisable to promptly, i.e., at the latest upon receipt of the services, collect documents or request them from the group management. This includes written contracts, invoices with detailed service descriptions, and calculation bases. Ideally, the group management should prepare centralized transfer pricing documentation, which should be requested early on. Confidential data can, if necessary, be collected directly by the tax advisor from the foreign group management and forwarded directly to the tax audit.

If the documentation by the group management is insufficient, local records of the received services can also be prepared. To demonstrate that the fees are at arm’s length, the group entity can refer to third-party offers from service providers or personnel costs of appropriately qualified employees.

In tax audit practice, group allocations are frequently examined and detailed evidence is required. This can be labor-intensive and regularly necessitates centrally prepared documentation with the support of the service provider in inbound cases. This should be addressed early on, as the possibilities to prepare documentation locally are limited.

Publication Date:

30 May 2025