226 ITPJ NOVEMBER/DECEMBER 2001 GERMANY Landmark Federal Tax Court Decision: No Transfer Pricing Documentation Requirements under Tax Law Dr Heinz-Klaus Kroppen' and Axel Eigelshoven? INTRODUCTION significant atten- ture, as the and low be f payers requested by ta of Finance that will enfo OPERATION BACKGRO COURT g for almost two ules. These rules ussions and were sentatives authorities leading transfer mated an data of fo authorities of 10 May 2001, Der Betrieb 2001, at 1180 nate b secrecy. The lshoven, 7 International Transfer Pricing Jo the transfer lated its dut ly draft of the administrative principles is published in Tax Manage- Pricing (2000), at 116
NOVEMBER/DECEMBER 2001 pricing advisors. Moreover, the draft guidelines were sent IV. DOCUMENTATION REQUIREI to industry representatives and to some other associ- ACCORDING TO THE SUPREME TAX COURT ations.The draft administrative principles require that DECISION taxpayers prepare extensive information as follows an overview of the taxpayer's business environment In its decision, the Federal Tax Court held that there are no in overview of the organizational structure of the tax tributions under Sec. 8 Paragraph 3 of the Corporate payer's business and of the group an overview of the activities performed by each entity for the adjustment of income. The Supreme Tax Court involved in a transaction with the taxpayer; investigated in detail all rules which might lead to an obli an overview of inte gation of the taxpayer to provide documentation. The an explanation of the contribution of each entity in the court concluded that under the existing law, the taxpayer is value added chain only obliged to keep accurate books and that the taxpayer the transfer prices that the 1 a description of the transfer pricing method or transfer is able to receive from abroad(e. g. from its parent com- pan where the company did not use the standard methods, However, according to the Federal Tax Court, there is no will allow the tax authorities to review the method obligation in the tax code that requires the taxpayer to pr chosen by the taxpayer pricing method is inng the extent to which the transter mentation if the taxpayer has prepared such documenta- fanatic herefore, the taxpayer must present transfer pricing doc he with the arm,'s length stan- tion anyway(i.e. not in response to any request of the tax thorities)and if it thus is available to the taxpayer Oth an analysis of the intercompany transaction and the erwise the taxpayer is only obliged to provide oral infor- As a result it will be much more difficult for the and delivery terms), intangibles employed by the par- with any documentation requirements imposed by them. If where the determination of the arm's length transfer the taxpayer is able to meet its relatively limited documen price is based on financial data of independent com- panies,all relevant information should be made avail. use their own tools to sanction the taxpayer. able The tax authorities will therefore be confronted with two an explanation of any special considerations(e.g busi- main problems. First, because the burden of proof rests ness strategies) with the tax authorities for an income adjustment, they are analysis of the comparable third-party transactions, at a disadvantage if the taxpayer's umstances cannot taking into account special factors such as financial be clarified with certainty. Only if the taxpayer does not information on finalized or intended advance pricing quality of the evidence that the tax auditors need to pro greements; and vide might be reduced. Second, as a general rule an esti- information which was provided by the taxpayer to mate of the tax base is only permissible if the taxpayer has ther tax authorities on intercompany transfer prices violated its duties to cooperate. If a taxpayer has not vio The documentation guidelines were intended to supple- ated an obligation to document its transfer prices, the tax ment the documentation rules which were already pul authorities will have to prove that the price set by the tax- lished for cost-sharing g arrangements payer was inappropriate. Up until now, the tax authorities have almost always adjusted the income based on rules of If the documentation requirements are not met or if the thumb. This type of income adjustment is hardly accept taxpayer applies an inappropriate transfer pricing method, able where the tax authorities are allowed to estimate the the tax authorities argue in their guidelines that their bur- income because of a violation of the documentation den to further investigate the case and the quality of the quirements; it is certainly unacceptable if the tax author evidence which is necessary to adjust the income, is ities have to determine the arm, s length transfer price reduced. Moreover, the tax authorities believe that the bur- However, under the Federal Tax Courts ruling the den of proof no longer rests with them. Finally, if the e tax- uirements for documentation are reduced significantly payer does not comply with its duty to provide informa- so that a violation will rarely occur and therefore the tion, the tax authorities might threaten to block the taxpayer from going to competent authority. As the list of tems is very extensive, it is evident that- if one would follow the interpretation of the law by the tax authorities pril 2000, WPg 2000, at 483: for further details see Kroppen, Eigelshoven the tax authorities can rather easily circumvent its burden Roeder, Internationale Wirtschaftsbriete, Fach 3 Gruppe 2, at 925: Kroppen and of proof and would be frequently allowed to estimate the goese, sx. sanfgemedminasser Pricing 2e o), atst arms length transfer price 1999, BStBI 1999I. at 1222: see Kroppen and Roeder, European Taxatio 2000).at381 @2001 IBFD Publications BV
NOVEMBER/DECEMBER 2001 authorities in many cases will not be allowed to estimate V. PROVIDING RECORDS OF A FOREIGN the taxpayer's income PARENT COMPANY example. One of the most difficult issues in international Within the scope of the extended duty to cooperate of Sec ansfer pricing is the determination of s jcense fee necessary foreign evidence. In doing so, the taxpayer must licence fees. In many cases the tax authorities required the must clearly show the foreign facts and must provide all was determined. In the past, the taxpayer has often not exhaust all legal and other possibilities for obtaining the foreign evidence. Therefore the taxpayer must even try to generated analysis to determine an arm's length royalty. obtain information from related parties. Through imposing The license fee was often determined from a pure busines perspective and little or no documentation was prepared this extended duty to cooperate, the legislature intended to ing, arguing that the taxpayer violated docu- the tax authorities to investigate outside german borders transfer pr requirements. Although the tax auditors often In the decision of the Federal Tax Court, the tax authorities mentation red presented significant adjustments, the justification for requested cost information of the foreign parent company these adjustments was often poor. In most cases the audit- in order to estimate the appropriate transfer prices. The ors did not use any reference to third-party information. taxpayer claimed that it had no means(legal or otherwise) For example the tax auditors might determine an"arms to obtain this information from its parent company. The length license fee"through reference to a lower license fee Tax Court of Dusseldorf accepted the arguments of the which was used by the taxpayer in the past, or to a lower taxpayer and agreed that, in general, the local taxpayer has license fee which is paid by a related party to the licensor no legal power-eg through its shareholder relationship (even if different geographic markets are concerned), or to demand information from a shareholder. The tax author which are collected in a database maintained at the Federal payer should have requested that it be granted the right to scence fees) ver. the Federal Tax Court referred in this matter to the It is also common to apply the so-called prudent business arm's length principle and argued that an obligation would only be acceptable if a third party would have requested manager test Under tax law, the prudent business manager the right to demand documents from the other party to the test is based on hypothetical assumptions which often seemingly allow the tax authorities to build up their own transaction theories on third-party dealings without any reference to Although not explicitly mentioned by the Federal Tax third-party transactions. This proceeding will now be Court, one must assume that the taxpayer will be obliged more difficult for the tax authorities. If the tax authorities to obtain documentation if a transfer pricing method is wish to adjust a taxpayer's transfer prices, they will now based on actual costs(e.g. when tual cost-plus be forced to determine an appropriate price and not just method is used or if the parties agreed on cost sharing and refer to a violation of documentation obligations and pre- shared the costs based on actual figures). However, the sent a rule of thumb to adjust the income Federal Tax Court emphasized that in a normal buy-sell Moreover, the taxpayer is well advised not to agree to an be able to demand cost accounting information from its amount. In the case at hand, the Federal Tax Court allowed supplier. Therefore, the Federal Tax Court concluded that the use of an estimation of the transfer prices only, because the taxpayer did not violate its obligation because the tax the taxpayer accepted that the transfer prices were not authorities were not able to prove that the taxpayer had the arm's length in principle and only disputed the amount. means (legal or otherwise)to demand the documentation Thus. it will now be much easier for the tax court to from its parent company adjust the income and to justify an income adjustment The Federal Tax Courts decision will also enhance the VI. CONSEQUENCES OF THE DECISION ossibility for a taxpayer to receive suspension of a tax assessment. The Federal Tax Court emphasized in former In practice, the tax authorities often request endless trans- decisions that suspension of tax assessment is to be fer pricing information from the taxpayer based on lengthy granted if serious reasons exist which at least hint that questionnaires provided at the beginning of an audit. 10In there are arguments for the taxpayer's. It is not a prerequi- the past the taxpayer often generated the information site that the arguments for an income adjustment domi- requested by the tax authorities in order to make sure that nate.As long as the facts have not been finally clarified the tax authorities could not claim that the company vio- and the taxpayer is accused of violating its duty to cooper- lated its right to cooperate. As mentioned above, the tax ate, there are always serious doubts as to whether the tax payer was often afraid that a violation would open the pos assessment is covered by law. Since there is always con- sibility for the tax authorities to estimate the tax base or troversy concerning certain factual elements when deter ng appropriate transfer prices, a suspension should ly be granted See Federal Tax Court decision of 20 May 1997, BFHNV 1997, at 432. 10. For a translation of the questionnaire, see Kroppen and Eigelshoven, in The Tax Treatment of Transfer Pricing( Germany chapter ), at 156 Q 2001 IBFD Publications BV
NOVEMBER/DE DECEMBER 2001 TPJ that they would be able to shift the burden of proof to the Moreover, one should bear in mind that the documentation taxpayer. The taxpayer will now be able to use the Federal requirements and the burden of proof are only important if Tax Court's decision in tax audits as an effective shield to the taxpayer chooses to rely on German tax courts and not resist the endless demands of the tax authorities for infor- on competent authority or arbitration. In a competent mation and documentation regarding transfer prices authority proceeding, the rules regarding the burden of proof and documentation requirements are of lower For planning of arm's length transfer prices, the taxpayer importance because the competent authorities follow a should, however, not rely on the decision. Apparently, the Ministry of Finance is considering a change of the law in more pragmatic approach and are concentrating on the adjustment itself and not on formalistic aspects. However, modifications will probably include the documentation German tax courts are rarely used to solve transfer pricing equirements and, even more important, a change of the cases because taxpayers are not able to prevent double burden of proof in cases involving a violation of the nev taxation in a tax court setting unless the taxpayer wins 100 law on documentation. Therefore, the position of the tax- per cent. Of course, taxpayers rarely achieve total victory payer might even be worse than before the issuance of the in transfer pricing cases. Even in the Federal Tax Court Federal Tax Court's decis ruling, the court emphasized that the taxpayer's income will be adjusted. INDIA Transfer Pricing rules Dinesh∨erma . INTRODUCTION The Finance Act 2001(hereinafter: the Finance Act) intro. Application of this method requires identification of the duced new transfer pricing legislation which came into orce as from I April 2001. In some of the provisions Incontrolled transaction. Adjustment is made thereafter ntroduced by the Finance Act, reference was made to any difference between the controlled and the uncon additional rules which were to be prescribed by the Cen olled transaction or the enterprises which are party to tral Board of Direct Taxes(hereinafter: the Board ). The such transactions which would materially affect that price he price arrived at after making the adjustments for dif- Board has now issued Notification 34, inserting Rules 10a ferences if any is to be treated as the arms length transfer to 10E and Form 3CEB in Income Tax Rules, 1962, laying pric down rules in respect of statutory provisions included in Sections 92C relating to transfer pricing methods, 92d Resale price method submitted by taxpayers. This article will provide an The price pa first to be identified and for similar goods or accruing to an uncontrolled enterprise services is to be deducted from the price. From this price, I. APPLICATION OF TRANSFER PRICING expenses incurred by the enterprise in connection with the METHODS RULE 10A purchase of goods or services are further to be deducted This rule relates to application of the five transfer pricing ethods referred to in Section 92C of the Income tax Act Officer of the Indian Revenue Service, posted as C oner of Incom tax, The au The guidance provided is concise and limited to a descrip-Documentation,Amsterdam.The ssed in this article are the authors tion of three to fiv length price under each method. The manner of applica- 2,, The Finar the Income tax Act, 1961. For a detailed discussion of these provis/0/n4f Sce- ig in tion of the methods is in consonance with the guidelines Transfer Pricing Regulations", 8 International Transfer Pricing Journal 3 issued by the OECD, although no reference is made to the (200 OECD guidelines in the rules he Income Tax Rules. 1962 as amended from time to time contain rules ious sections of the Income tax Act, 1961. These rules constitute what is alled'subordinate legislation' which is only placed before the parliament and 4.50808(E)of 21 August 200ent @2001 IBFD Publications BV