731 navis The German Move to Transfer Pricing Documentation, Penalties BY STEPhan RASCH AND ACHIM RoEDER decisions, no special documentation requirements exist hen Germany issued the first draft administra- for transfer pricing, and this lack of law precludes the tive principles on transfer pricing in April 2000, i German government from penalizing taxpayers for fail- business community imagined that the country within caused at least some problems for the German tax au tation and related penalties e cess the information they needed to correctly assess transfer pricing and threatened to undermine future Recent legislation proposed Nov, 4 and Nov. 20 transfer pricing adjustments. Second, the current bud ould establish documentation requirements and im pose penalties and fines for those who fail to turn over European Union Monetary Union reference value of the requested information. The Nov. 4 proposal calls for three percent of gross domestic product in 2002. As a penalties of 10 to 20 percent of a transfer pricing adjust- consequence, the German government has had to take ment if an adjustment is warranted and the taxpayer measures to increase the tax revenue. german tax au cannot produce contemporaneous documentation. The thorities likely fear losing revenue to countries that Nov 20 proposal allows tax examiners to impose penal ties of up to two million euros(approximately $2 mil- have transfer pricing documentation requirements in place, as taxpayers will tend to comply first with those lion) on taxpayers who fail to meet documentation re countries' requirements quests within 60 days. What led the German govern- Against this background, the authors describe the re- ment to introduce harsh documentation requirements cent german draft tax legislation and provide an analy into law and, even more surprising, to implement pen- sis of the rules that can be expected during the first half alties for non-compliance of200 First, tax authorities had to put earlier documenta tion guidelines on hold after the German Federal Tax transfer pricing provisions Nov, 20, but the proposed tax leg man documentation requirements. According to these German parliament before it becomes law. This process parliamentary process likely will lead to some changes Principles for the Audit of Income Allocation between In ternationally Affiliated Enterprises with Respect to Income Ad- justments, Procedures and Binding gs(administrative principles aung bill. However, the main transfer pricing ppear to be fairly settled es on procedures) ransfer Pricing Report 116, 3/22/00: for an analysis see 9 Documentation Requirements Transfer Pricing Report 122, 3/22/00; Kroppen, Heinz- Klaus nd Roeder. Ach Section 90 of the German General Tax Code gener see Institute of Certified Public Accountants (dW) dated April ing to the existing section 90 paragraph 1, the taxpayer 3, 2000, Wirtschaftsprufung 2000, pp 483 ff. is required to cooperate with the tax authorities in their 649,11/1302;11 Transt ivestigation of the facts necessary to determine its tax- ing Report 688, 11/27/0 able income. The existing section 90 paragraph 2 re- Federal Tax Court de ed May 10, 2001 s3/01, Der Betrieb 2001, pp. 1180 ff (10 Transfer lates to the scope of the requirements for cooperation ort 167, 7/27/01)and decision, dated October 17, 2001-I R when events occur outside the german territory. In .03/00, Der Betrieb 2001, pp 2474 ff. For coverage see inter these cases, the German taxpayer is obliged to clarify alia: Kroppen, Heinz-Klaus, Rasch, Stephan, and, Roeder lotes International, 2001, pp. 1111 ff; Kropper Heinz-Klaus, Rasch, Stephan, and, Roeder, Achim, Internatio Baumhoff, Hubertus, Internationales Steuerrecht 2001, pp 745 1737 Wr wabsetsheivefr. Frach. r utethlan doGr pp. 2465: Gisc, Dietmar. Die steer iche Betriebsprcufaung 2001. p:. 36 Kuckhoff, Harald and Schreiber, Rolf, Internationale See Kroppen, Heinz-Klaus. Rasch, Stephan, and,Roeder Wirtschaftsbriefe, Fach 3 Deutschland, Gruppe 1, pp. 1863 ff /02: Kropp Heinz-Klaus, and, Eigelshoven, Axel, International Transfer Dr. Stephan Rasch is a manager and Dr Pricing JournaL, 2001, pp 226 ff; Becker, Helmut, Internat Achim roeder, M.A., is a director with deloitte ale wirtschaftsbriefe, Fach 3 Deutschland, Gruppe l, pp 1765 Touches European Transfer Pricing Group 1749f in Dusseldorf. Unless otherwise noted, sections cited are from the ger- man General Tax Code TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 12-11-02
734 (vol.11,No.16) ANALYSIS in draft section 90 paragraph 3 are not fulfilled. Under According to draft section 162 paragraph 4, sentence the most recent draft, whether to impose a penalty is 2, if a taxpayer does not submit transfer pricing docu not left to the discretion of the tax authority. A penalty mentation as defined in section 90 paragraph 3 of the is mandatory if the compliance duty stemming from draft, the imposition of a surcharge would depend on draft section 90 paragraph 3 is not satisfied. This could the amount of the adjustment. If no income adjustment lead to the double burden of an unfavorable income es- was applicable, a penalty should not be considered. An timation and a comprehensive penalty. This undoubt income adjustment is, for instance, not applicable if the edly violates the principle of proportionality, and the transfer prices were correct. However, if under the pro- ax law encroaches upon the rights of the taxpayer. Any osed legislation the documentation was submitted af- intervention should be limited to the least possible bur- er the 60 days allowed in draft section 90 paragraph 3 den for the taxpayer, which obviously would not be the sentence 5, i.e., a delayed submission, the surcharge to case if a double sanction applies be imposed could be limited to a maximum amount of 2 If the taxpayer is able to present some documenta million euros tion that might reduce the determined range of prices the tax authorities are obliged to consider these docu The latter surcharge applies regardless of whether an income adjustment takes place. This conflicts with ments. The tax authorities are not allowed to perform arbitrary estimations the aforementioned penalty when documentation is not presented at all. If in such a case an adjustment does not apply a penalty is not imposed. a delay in submit Penalti ting transfer pricing documents is thus punishe harshly than not bringing forward any documents at all As already indicated, Germany's decision to luce penalties looks like a paradigm shift. In 1995, undetermined. Neither the tax authorities nor the tax called six country group-Austria, Belgium, France, payer know the amount at which the penalty should be ettled. Further, the penalty is not consistent with the Germany, Sweden, and Switzerland-strongly opposed surcharge for the late filing of a tax return. According the draft U.S. penalty regulations. The group argued to section 152, paragraph 2, in the latter case a maxi that income would shift into those countries with the mum surcharge of 25,000 euros might be imposed.This most comprehensive documentation and penalty regu- lation. Although the surcharge mentioned in draft sec- mount relates to the refusal of the tax return as a 0 e (steuerliche Nebenleistung) in the sense part of theta retum. Th吗at灯 er's refusal to pre lowing the compliance duties concerning transfer pric of the punishment a taxpayer is facing if it fails to pre- are and submit only parts, i.e., the transfer pricing paragraph 4 reads: documentation of the whole tax return This cannot be reconciled with the principle of proportionality If a taxpayer infringes his documentation require- urthermore, the german tax legislator should heed lents according to section 90 paragraph 3 a su the implications of European tax law. Section 152 con harge on tax has to be set. This comprises in the cerning the delayed submittal of the tax return relates sense of paragraph 3 at least 10% and at most 20% to the delayed presentation of documents for domestic of the surcharge on the income of the business re- income allocation, while the documentation for transfer lations according to section 90 paragraph 3, which pricing purposes is by its very nature related to cross result from the application of paragraph 3. In case border transactions. The harsh penalty for cross border of a delayed submission of the respective docu transactions compared with the domestic surcharge entation required by section 90 paragraph 3 sen- might therefore lead to a breach of the four fundamen- tences 1 and 2 the surcharge may amount to tal f ms provide hing the e 2, 000.000 Euro. When setting a surcharge in accor- ropean Union since fore taxpayers are treated less ance with sentence 3 not only its aim of making favorably than domestic ones the taxpayer fulfill his documentation require Systematically, the draft law itself treats the penalty ments on time in the scope of section 90 paragraph as so-called tax-related additional services. Taking into are to be taken into account, but especially the account the ratio legis of the draft penalty regulation, the taxpayer should be obliged to prepare its documen- prolonged delay, also the duration of the ex- tation. Again, section 152 seems to aim at the same ob. ceedance. The surcharge need not be set if the jective by requesting the taxpayer to timely file its tax non-fulfillment of the requirements seems justifi- return. It seems unjust that the latter leaves the imposi able according to section 90 paragraph 3. The neg- tion to the tax authorities'discretion while the former is ligence of a legal representative or of an assistant tive. Both regulations should be based on the equals the taxpayers own negligence. The sur- same principles charge should regularly be determined simulta Conclusion The penalty regulation is excessive and inconsistent with existing legislation Although the German government has formally ac- epted the draft, tax legislation must be enacted by the Lower House of the german Parliament and the Federal 13 Cf. Seer. Roman Council. The bill is now in Parliament, and additional Wilhelm, abgabenordnung,(Cologne: Dr. Otto Schmidt Ver- changes are expected before it is enacted. Some practi
ANALYSIS 733 rables. A comparable uncontrolled price method, for i draft legislation extends the tax authorities right example, requires a level of product comparability that lowing an estimation if the documentation re is almost nonexistent pt for so-called internal ments laid down in the new section 90 paragraph CUPs. Other transactional methods require detailed in ot carefully attended to formation about accounting practices applied by the The draft tax legislation also adds two new para comparable company because those affect gross mar- gr raphs to section 162 covering the right of the tax au gins. Such information is rarely available. Thus, it is of thorities to perform a disadvantageous estimation of the en difficult to apply a transactional method, and the axpayer's taxable income and the introduction of sur cost of application is often prohibitively high. Although charges in German transfer pricing legislation. Draft he tax authorities have been reluctant to accept the use section 162 paragraph 3 states of the transactional net margin method, which they do not consider a true transactional method, it may be If a taxpayer, who is on business terms with re- come an option in Germany lated persons abroad in the scope of section I paragraph 2 Foreign Tax Code, infringes his docu- Decree-Law mentation requirements according to section 9o paragraph 2, or if he does not submit the documen tation required according to section 90 paragraph A Deviating from the draft of the tax legislation issued Ma. 4, the bill now provides the right of the Federal 3, it is refutably assumed that his income from nistry of Finance to enact a decree-law. These these business relations has been reduced because decree-laws are passed by the Federal Ministry of Fi of his relatedness. If in such a case the income can nance rather than enacted in the usual legislative pro only be determined within a certain scope, espe- cedure for so-called formal laws However, the decree ially on the basis of price ranges, this scope may law requires the approval of the Federal Council. Sig be fully used to the disadvantage of the taxpayer in nificantly, such a decree-law constitutes binding law for the event of an adjustment both the taxpayer and the tax authorities as well as for The right to estimate the taxable income up to the tax courts. Contrary to such a decree-law, the 1983 oint in the range that is the most disadvantageous for taxpayer. The German government obviously wants to proportional o o principles governing the allocation of income between the taxpayer is problematic. Generally, any measure related parties across borders, 0 which are currently in taken by the government is governed by the principle of effect, are binding on the tax administration but not the When the tax authorities are entitled to estimate the dd a different kind of legal weight to transfer pricir income the auditors are free to draw their conclusions issues under the new law, but it is still unclear exactly from the non-compliance of the taxpayer. If the audi- what will be covered. One might only assume that the tors, after having investigated all the facts,believe, the decree-law will lay out the general requirements of the transfer prices are not arms length they are allowed to necessary documentation. It could specify: in general estimate the tax base. If certain information is then not terms which documents should be submitted by the tax- available, the auditors are allowed to base their estima- payer to describe the"economic and legal facts. "The tion on the facts they believe are the most reliable.The draft administrative principles on procedures together tax authority may exercise its power of discretion and with their attachments already contain an extensive list determine the basis and the amount of the adjustment of documents that-according to the tax authorities- without having to furnish exact evidence. The underly dit. It appears that these lists will not be included in the of the taxpayer is that the party concealing or withhold decree-law,but that the Federal Ministry of Finance in- ing evidence must not take advantage from hi s behav. tends to publish the administrative principles as an ad- ior. 12 In effect, the estimation is a surcharge for the tax ditional source of guidance authorities' uncertainty about the facts and circum Draft section 90 paragraph 3 does not define specifi- stances of the case lly what the taxpayer must document for the determ By implementing the tax authorities right to esti nation of appropriate prices and other agreed terms of mate the taxable income up to the point of a potenti business with related parties. Because the legislator price range, the surcharge caused by the foremen claims something from the taxpayer that is not pre- tioned uncertainty would in a sense be predetermined to the most disadvantageous point for the taxpayer. We able to follow the statutory instruction. doubt that this statutory entitlement would interfere with the taxpayer's constitutional rights Estimation of Taxable Income Draft section 162 paragraph 4(discussed in detail below) provides that penalties shall be he tcoraithotitese he existing section 162 paragraph 2, on the taxpayer if documentation requirements only if the taxpayer does not cooperate with them. The i See Kroppen, Heinz-Klaus, in: Becker, Helmut and Kroy 9 The European Commission has emphasized this aspe too. See Commission Staff Working Paper, Company Taxation ngspreise cologne: Dac hitto-Snchmidk yerka s and Lang. in the Internal Market, COM(2001)582 final, pp 263 ff Joachim, Steuerrecht.(Cologne: Dr. Otto-Schmidt verlag er of the Federal Ministry of Fir ated 23 Feb 202)§4note209f ruary 1983. IV C5-S1341-4/83. For an English translation Federal Tax Court decis ated 15 February 1989-X of the text see Kroppen, Heinz- Klaus and Eigelshoven, A R 16/86, Federal Tax Bulletin 1989 part II, pp. 462 ff. s Tax treatment ansfer Pricing section 2.3. 1 of the draft administrative principles on (IBFD, Amsterdam 2002), ch. 8.2. dures TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 12-11-02
732o.11,No.16) NALYSIS the circumstances and supply the necessary documen- sponse to the tax authorities' request If the authorities ary evidence Before the German Federal Tax Court's then argue the documentation should have been pre- decision,the tax authorities argued, based on section 90 pared when the transaction took place, the evidence paragraph 2, that the taxpayer must provide the neces- value of the prepared documentation could be chal sary documents for transfer pricing purposes. In the af- lenged Discussions with tax auditors indicate that they termath of the decision the german government began widely view retrospective documentation as less reli onsidering how to implement statutory documentation able. Organization for Economic Cooperation and De- equirements. The explanatory notes to the recent draft velopment Guidelines provide an appropriate approach legislation now state that whether the tax authorities n this context. Note 5, 15 of the guidelines states that are still able to demand documentation from the tax the tax authorities should limit the amount of informa payer is uncertain based on existing section 90 para ion requested at the stage of filing the tax return graph 2.6 Therefore, a new paragraph 3 should be in Moreover, the guidelines clearly state that it would be cluded in section 90. The proposed text of the new draft unreasonable to require the taxpayer to submit docu- provision in section 90 paragraph 3 reads as follows (3) In circumstances that concern transactions that the transfer pricing has been determined appropri with reference to matters abroad a taxpayer has to ately. Thus, the German legislator would be well ad generate contemporaneous documentation about vised to clarify the wording of a potential new section the manner and content of his business relation 90 paragraph 3 in light of the recommendation of note ships with related parties in the scope of 81 para- 5.15 in the oECD Guidelines graph 2 Foreign Tax Code. The documentation duty especially comprises those economic and le- Intercompany Transactions gal facts that are important for the determination of appropriate prices and other agreed terms of Sentence l of draft section 90 paragraph 3 stipulates usiness with related parties, To ensure a consis- that "in circumstances that concern transactions with tent jurisprudence the Federal Ministry of Finance reference to matters abroad" contemporaneous docu n accordance with the Federal Council will be ar mentation must be generated. It is not clear how"cir- horized to determine the manner and extent of the cumstances that concern transactions with reference to documentation requirements that will have to be matters abroad"are defined provided, The submission of the documentatio The draft. also fails to clarify whether the taxpayer conforms to section 97 provided that paragraph 2 must prepare documentation about third parties'com parable data. Sentence: 2 of draft section 90 paragraph documentation: should be submitted within a pe 3 points: out only that the documentation duty: espe- cially comprises those.. facts that are important for the determination of appropriate prices"(emphasis Thus, the proposed regulation would require the tax- added). According to the explanatory notes to the draft payer to s generate contemporaneous documentation bill, the German government takes the position that the a record all details regarding the economic and legal taxpayer should provide third party comparables to jus- m submit its documentation within 60 days of the tax If the draft tax legislation becomes law, the request authorities’ request of the business community have not been successful Based on the Federal Tax Court decision, companies It should be pointed out that the current wording is should only be required to document the considerations inexplicit and undetermined in content they used at the time when setting their prices. The Fed- Documentation eral Tax Court ruled that the taxpayer is obligated only to proving the facts: to show the price agreed on, how If the tax law requires the taxpayer to provide docu the parties agreed on it, and which functions and risks mentation contemporaneously, it is not entirely clear vere assumed by which party. However, according to from the bill whether the documentation must be pre the Federal Tax Court, the taxpayer need not prove its pared when the transaction takes place, when the tax rices are arms length. Instead it held that the tax au payer files its tax return, or when the tax authorities ini thorities must prove prices are not arms length before tiate an audit. In a number of countries the deadline to aking an adjustment. This would require the tax audi. prepare the documentation coincides with that for filing r to collect the comparable data and undertake th the annual tax return. pricing analysis The German legislator should clarify its understand Obviously, the draft legislation will overrule the ing of the term"contemporaneous "Alack of guidance court's position. The German government intends to ef- in this area could lead to long disputes with the German fectively reverse the burden of proof and shift the re tax authorities-particularly because it is not clear what sponsibility for determining and documenting its trans sanctions the tax authorities would impose when the r prices. Thus, the taxpayer will have to provide com taxpayer has prepared its documentation only in re- parable data by using databanks, external consultants and other sources. The underlying problem when using databanks is the availabilit hird party compa- page 83 of the" Draft legi Australia, Brazil, Canada, China, India, Mexico, Portugal, South Africa, the United Kingdom, the United States, and ven International 2002, pp. 666 ff. Kroppen, Heinz-Klaus ezuela require documentation to be filed with the annual tax sch, Stephan, Internationale Wirtschaftsbriefe, 13 No
ANALYSIS Vol.11,No.16) be reduced, as it seems excessively high com graphs 2 nd 4 should be postponed. Nevertheless, with other penalties under german tax law ccording to the bill, the sections 90 and 162 will be ap It remains unclear what precisely the taxpayer will plicable for all fiscal years starting after the 31 of De- ave to do to adequately document transfer prices un cember 2002 For agreements covering continuous obli der the new provisions. Considering the experiences of gations that have been concluded before 31 December the past regarding the issuance of non-binding admin 2002 and are still effective at that time, the documenta istrative principles, the German government should tion of the economic and legal facts must be prepared consider the possibility that enactment of the decree- by 30 June 2003. Thus, the taxpayer should prepare to law could take some time. Accordingly, the first appli produce adequate documentation for German transfer cation of final sections 90 paragraph 3 and 162 para- I pricing purposes TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063.2069 BNA TAX 12-11-02
