ARUG II and possible points of contact with transfer pricing

In order to verify the aforementioned approval and publication requirements within the framework of ARUG II, Deloitte offers a service which assesses the obligations from both a legal and a transfer pricing perspective. As part of this service offering, the Deloitte Transfer Pricing Team conducts a market conformity check by using the common transfer pricing methods and, based on the results, Deloitte Legal performs a legal assessment of the relevant approval and publication requirements as well as the possible exemptions.

I. Background

Based on Directive (EU) 2017/828 of 17 May 2017, on 14 November 2019, in its second and third reading, the German Parliament (Bundestag) passed the draft of ARUG II, which, among other things, regulates approval and publication requirements under stock corporation law for transactions between listed companies and related parties. The main intention of the EU Shareholder Rights Directive is an improvement of the involvement of shareholders in listed companies and facilitating cross-border information sharing as well as enabling shareholders to exercise their rights. In addition, greater transparency is to be created with regard to transactions with related parties in order to safeguard the interests of the company and the other shareholders.

The deadline for transposing the above-mentioned EU Shareholder Rights Directive into national law already ended on June 10, 2019. The implementation in Germany was delayed because the Federal Government was initially unable to agree on the regulations on the remuneration of the Management Board, which also had to be implemented. In the absence of a special transitional regulation, the new rules on related party transactions apply immediately from January 1, 2020, i.e. not for financial years ending prior to or on December 31, 2019.

II. Related Party Transactions and Supervisory Board approval requirement

Pursuant to the newly-introduced Sections 111a to 111c of the German Stock Corporation Act (AktG), the approval of the Supervisory Board must be obtained prior to the conclusion of transactions with related parties, i.e. so-called "related party transactions", if these transactions exceed a certain materiality threshold. In addition, all relevant information on these transactions (including at least information on the nature of the relationship with the related parties, the names of the related parties and the date and value of the transaction) must be published without delay. By contrast, transactions with related parties within the meaning of ARUG II are not considered to be transactions with related parties if they are carried out in the ordinary course of business and under usual market conditions. A further important exception applies to transactions with subsidiaries which are directly or indirectly wholly owned by the company. In these cases, the approval of the Supervisory Board is not required.

In detail, the regulations on Related Party Transactions are as follows:

• Transactions with Related Parties
  The newly introduced Section 111a (1) sentence 2 AktG defines related parties in terms of the international accounting standards (IAS/IFRS), wherein parties are generally deemed to be "related" from a direct or indirect holding of 20 percent of the voting rights. This is in contrast to the transfer pricing-relevant regulations of § 1 para. 2 AStG, which assume a "related party" from a direct or indirect participation of at least 25%.
• Reservation of approval if a materiality threshold is exceeded
  The previous approval of the Supervisory Board is required if the economic value of the transaction (in itself or on an aggregated basis) with the same related party exceeds 1.5% of the total assets, i.e. the sum of fixed and current assets, according to the most recently audited annual financial statements of the company. If the company is the parent company, the total assets of the company are replaced by the total assets of the group.
• Exception "usual market conditions"
  Transactions that are conducted in the ordinary course of business and under usual market conditions are not considered related party transactions. Consequently, no approval of the Supervisory Board is required for these transactions and there is no obligation to publish them.

Usual market conditions are generally determined by means of a third-party comparison. For a third-party comparison, a transaction between independent third parties must be used. This assessment must first be based on actual market conditions, which may be determined with the help of market information. If a market price can be determined, it must be used as a basis. If this is not the case, estimated values may be used. In this context, usual market conditions may also be assessed by the standard industry conditions if the transactions are considered to be normal in the respective industry.

From the statements of ARUG II with regard to the above-mentioned exception, it can therefore be concluded that usual market conditions must primarily be demonstrated either (1) by market prices or (2) by way of another third-party comparison. If market prices are not available and it is not possible to determine usual market conditions by means of a third-party comparison, (3) an estimate can be made. In this case, other terms of the transaction, such as the term or the sales volume, must also be taken into account.

III. Possible use of transfer price methods for the market conformity check

For the purposes of ARUG II, transfer pricing methods may under certain circumstances be applied for the market conformity check of a transaction to be carried out under the exemption, which can avoid the requirement for approval by the Supervisory Board and the associated publication requirement for certain transactions. This is due to the fact that third-party comparisons in the field of transfer pricing are regularly carried out and serve to analyze whether transactions within a group of companies have taken place under comparable conditions (including prices) as would have been agreed upon by third parties (so-called arm's length principle).

Since usual market conditions are to be reflected primarily by means of market prices (1), the internal and external comparable uncontrolled price method ("CUP method") can be used within the framework of common transfer pricing practice. When applying the CUP method, prices are used as a comparison criterion to examine the arm's length nature of transactions between related parties. An external CUP requires the examination of prices agreed between two independent companies for a comparable transaction. By contrast, an internal CUP requires a comparable internal transaction in which the goods or services in question are purchased from or provided to third parties.

As the CUP method requires a high degree of comparability with regard to the transactions to be compared, such as product comparability or market conditions, it may not be possible to have a direct external or internal CUP. However, in order to be able to carry out a corresponding third-party comparison (2), comparability may be achieved by means of certain adjustments if factors influencing the price deviate. In order to eliminate the influence of these deviating factors on the price, price adjustment calculations can be carried out in practice, for example, with regard to the differences in quantity of the goods and services to be compared, since prices often depend on the quantity provided.

In cases where neither market prices nor third-party comparisons can be determined, an estimate (3) can be made in accordance with the provisions of ARUG II. For these estimates that serve to assess the usual market conditions of a transaction under ARUG II, other transfer pricing methods may be applied. It remains to be seen to what extent the determination of estimated values via the use of transfer pricing methods will be reflected in further practical examples.

IV. Conclusions

The provisions of ARUG II on related party transactions, which came into force on January 1, 2020, stipulate that in certain cases the approval of the Supervisory Board must be obtained for transactions with related parties and a number of details must be published without delay. This approval and publication requirement does not apply if the transactions are conducted in the ordinary course of business and under usual market conditions. In order to perform this market conformity check, transfer pricing methods may be applied under certain conditions, as third-party comparisons are regularly carried out for transfer pricing purposes.

For the market conformity check within the framework of ARUG II on the basis of transfer pricing methods, the internal and external CUP method has been employed recently in practice. If no direct market prices are available, adjustment calculations of the transactions to be compared may be undertaken for the purpose of carrying out a third-party comparisons. The extent to which the use of other transfer pricing methods may be appropriate for the determination of estimated values in connection with the provisions of ARUG II is yet to be determined.

Failure to comply with the new provisions of ARUG II may result in a fine or even in the possibility that the discharge of the executive bodies may be challenged. We therefore recommend that listed companies examine the relevance of these regulations with regard to their transactions with related parties in order to assess whether the Supervisory Board's approval is required for the transactions in question and whether they require publication or whether any exemptions can be made use of.

In order to perform such a review, the companies concerned may rely on a joint two-step approach developed by Deloitte Transfer Pricing and Deloitte Legal. In this two-step approach, the Deloitte Transfer Pricing Team in the first stage conducts the market conformity check and Deloitte Legal in the second stage prepares the legal assessment of any resulting approval and publication requirements.