ol.10no.19)835 Perspective German Transfer Pricing on the Move: Legislation, Guidance By HEINz-KLAUS KROPPEN, STEPHAN RASCH, AND istrative principles on cost sharing agreements," replac- g parts of the 1983 principles and the income allocation provision for permanent establishments. Most recently, the administrative principles on second have been final Documentation nain focus in 2002 will be transfer pricing docu- which has been under review since April blished a first draft on the tation and ecting representatives ditional guida Germa with globalizati ties on some tr es, De. .30,1999 0,2/23/00 Pric try of Fi- (10 Trans- him, 9 Transfer Heinz-Klaus, Ei Internationale 5 ff. See for com. manager wit ntants (Dw), dated pricing group pp.483 the draft can be found in 9 TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 2-6-02
836(o.10,No.19) PERSPECTIVE and the burden of proof would shift to the taxpayer; pany is able to obtain from abroad (e.g, from a subsid- a the tax authority might threaten to prevent the tax- However, the Tax Court held, German law does not payer from going to competent authority axpayers to prepare special doct In der to defend its tax position. Therefore, a taxpayer has Court Rulings only to present transfer pricing documentation if it has prepared such documentation anyway. Otherwise the axpayer is only required to provide oral information Ministry officials initially planned to finalize the ad- and answer auditor ministrative principles within 12 months of their circu- rs questions lation. But those plans were unexpectedly put on hold because of two rulings by the German Federal Tax Court that explicitly dealt with documentation require- I appears that 2002 will be an especially eventful ments. The first decision, dated May 10, 2001, held that the lack of a transfer pricing document law precludes year for German transfer pricing. Officials are the government from penalizing taxpayers for failing to document their transfer prie ing method ready to move forward on documentation The May decision was confirmed in October 2001 when the Court explicitly concluded that under the Ger requirements and guidance for advance pricing man Corporate Tax Code, taxpayers are not required to provide special documentation concerning how their agreements, competent authority matters, and the transfer prices were developed in order to disprove al legations of hidden profit distributions. 0 The mention transfer of functions and risks of hidden profit distributions in the tax code constitutes in a transfer pricing audit, i provision to adjust income There seems to be no doubt that the Federal tax October ruling Court's findings on German tax law and documentation are correct. Since German tax law is a"formal law? In the second decision the Federal Tax court inves- that comes into existence via a legislative procedure tigated in detail all rules that might obligate the tax- and ranks above administrative principles decreed by payer to provide transfer pricing documentation to ciples would not impose a mandatory obligation onthe tions. The court concluded that under existing law the Therefore, administrative guidelines without law to taxpayer is only required to keep accurate books and is back them up would be meaningless further obligated to provide all documents, records business papers, and other documentation that already The lack of specific statutory documentation require- exist and are available to the company or that the com- ments and the postponement of the administrative prin ples is creating uncertainty for German taxpayers and uthorities.However, to introduce a mandatory obliga 9 German Federal Tax Court decision dated May 10, 2001 on would require a change in German tax law. Never- trieb 200l, pp. 1180 ff. (10 Transfer Pricing eless there is a strong feeling among tax officials that Report167,727/01) documentation principles should be published as soon See Kroppen, Heinz-Klaus and Eigelshoven, Axel; Interna- is possible with only minor adjustments to provide tional Transfer Pricing Journal, 2001, pp. 226 ff. Internation uidance to auditors, who since Jan. I have had pos ale wirtschaftsbriefe, Fach 3 Deutschland Gruppe 1, pp. 1745 ible access to electronic data. The guidelines might be ff.Becker,Helmut,Internationale Wirtschaftsbriefe, Fach 3 useful in organizing their data searches Deutschland, Gruppe 1, pp. 1765 ff. Strunk, Gunther and Ka- ninski, Bert, Internationale Wirtschaftsbriefe, Fach 3 Deut- schland, Gruppe 1, pp 1749 ff. Legislative Prospects Decision dated Oct. 17, 2001-I R 103/00, Der Betrieb 2001, pp 2474 f (10 Transfer Pricing Report 597, 11/28/D) ch n a clearly indicated that the authorities are working Reliable sources within Germanys tax authority or a detailed analysis see Kroppen, Heinz-Klaus; Ras stephan,and Roeder, Achim, Tax Notes International 2001, on a proposal to introduce transfer pricing documenta pp 1111 ff. tion requirements into German tax law. 3 But other is- Also see Andresen, Ulf, "The Federal Tax Courts Land- sues are creating doubts about whether the legislation nark Decision: Hidden Profit Distributions and the Arm's- will be introduced in 2002, such as whether the govern ength Principle"(10 Transfer Pricing Report 753, 1/ 9/02) ment will seek documentation legislation during an Wehnert,Oliver and Stalberg, Peter "The Federal Tax Court s election year. Strategically speaking, it seems unlikely ecision: CreatI Pricing Environment, " (10 Transfer Pricing Report 760 hat the government would introduce such legislation 1/9102) before the September election because of potential in For an unofficial translation of the court decision, see 10 Transfer Pricing Report 735, 1/9/02 the senate of the Federal Tax Court, which deals with transfe Kroppen, Heinz-Klaus and xx Notes In pricing cases, 90 percent of all transfer pricing adjustments in Wirtschaftsbriefe, Fach 3 Deutsch 1769ff Germany are based on the provision that governs hidden profit Axel, TWB distributions. Refer to Wassermeyer, Franz, IStR (2001), p. Fach 3 Deutschland Gruppe 1. Pl IWB Fach 3 Deutschland Gruppe 1, pp 1765 tt: Cker, Helmut 2602 Copyright 2002 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
PERSPECTIVE (Vol.10,No.19)837 position Thus, one cannot assume that statu- Any legislative proposal that would lead, at least in tory provisions will be introduced before 2003 directly, to a change in the burden of proof would have It is, therefore, much more likely that the Ministry of to be reviewed in light of existing constitutional prin Finance in 2002 will first publish new administrative ciples. Accordingly, German officials may consider an principles concerning documentation. However, these other approach, such as some kind of"safe harbor dministrative principles will probably be irrelevant be- Under one scenario safe harbor rules would reduce the cope of an audit, provided the taxpayer meets pre a They might outline that there is no mandatory re- scribed documentation standards. To avoid doubt, it quirement for the preparation of documentation, i.e., should be clarified that such safe harbor rules would in hat the taxpayer is not forced under law to prepare no way lead to"risk free"tax audits. Any safe harbor transfer pricing documentation in advance This may proposal would have to take into account a major prin esult in a situation in which German legislation may ciple in German tax law that all taxpayers are audited not contain specific documentation rules in the near fu- on equal terms ture Under this principle, taxpayers complying with The May and October decisions might lead taxpay documentation rules would certainly have to be audited ers to be less inclined to create special transfer pricing in the same way as taxpayers not complying with the documents.However,in the authors'view, this should rules. Nevertheless, by fulfilling the requirements a tax not necessarily be the dominant strategy for a taxpayer. payer would receive a kind of legal certainty that its If there is legislation, the proposal could taken sev- documentation was sufficient. Such an advantage eral forms. One possibility is a proposal to overturn the should not be undervalued since transfer pricing issues Federal Tax Court decisions by introducing a new sec- have become one of the most important issues, if not tion in the German General Tax Code that requires spe the most important issue, in recent tax audits cific documentation to be prepared for transfer pricing An increasing number of tax audits that has led to mentioned in the first draft, such a provision likely payers face significant risks as tax authorities have would not include a list of documents that taxpayers made sustainable transfer pricing adjustments. It could may want to maintain. Those specifications could be covered by accompanying administrative principles be extremely helpful for multinational enterprises to avoid lengthy, in-depth audits by complying with poten The legislations drafters would have to take into ac tial documentation standards count the fact that an amendment of the general Tax Code as binding law must fulfill minimum requirements In addition, as required by European law, Ge ax authorities would related to constitutional law. It is imperative logue of documentation standards to ensure that t cross law be sufficiently precise concerning the rights and obligations. But it is questionable border transactions are treated the same way as trans pure"requirement in the General Tax Code stating a actions taking place within German borders. that documentation must be prepared would be as pre E v Possible sanctions, safe Harbor From a European perspective, it seems to be a waste of time for each country to tinker with transfer pricing Another question is the kind of sanction that would documentation requirements, forever burdening tax- be triggered if a taxpayer does not comply with a docu- payers with various requirements. Most of the time, mentation obligation. A documentation provision would these are time-consuming and also costly for the tax- payer. The European Commission recommends that fall under the obligation of the taxpayer to cooperate member-states follow a common approach on docu erate, this could result in a reduction of the degree of mentation in order to agree on these requirements in an What should not be lost is that the entire purpose of ustment is warranted. A major principle of German tax the arm's-length test is to put related parties on the facts of the case (cf. section 88 German General Tax same level as unrelated parties. Unrelated parties,by Code) the nature of their relationship, do not have to prepar Another provision, Section 162 of the German Gen- transfer pricing documentation. If the tax authorities in eral Tax Code, states that tax authorities have the right oduce new documentation rules, they would probably to estimate the tax base in the event the taxpayer fails force the related taxpayer to spend millions on docu to cooperate. Failure to maintain documentation also mentation material. As a consequence, related taxpay could lead to a reversal of the burden of proof taxpayer would be obliged to cooperate in order to avoid an estimation. This, however, would not be in line Heinz. Klaus. Rasch Achim, Tax Notes International, 2001, pp. 1lll ff the same with the conclusion of the Federal Tax Court's October Internationale Wirtschafts briefe, Fach 3 Deutschland Grupp 2001 ruling. I, pp. 1787ff 6 However, in light of the lack of qualified auditors and the absence of available funds to conduct audits whether such Another opinion has been stated by German practitioners equal treatment is a realistic assumption must be critically dis Oliver Wehnert and Peter Stalberg, who believe that the legis- cussed lation is not an issue of particular political importance and See European Commission Staff Working P therefore, that the German government may indeed be willing Taxation Internal Market, "SEC (2001)1681, dated introduce a change in German tax law in 2002 although gen- 23,2001,pp.346f Transfer Pricing Report 599. ral elections are held (10 Transfer Pricing Report 762, 1/9/02) 11/28/01; 10 Transfer Pricing Report 602, 11/28/01) TAX MANAGEMENT TRANSFER PRICING REP ORT ISSN 1063-2069 BNA TAX 2-6-02
830o.10.No.19) PERSPECTIVE ers are not on the same level as independent parties; in parties involved in the transaction. 22 The Federal Tax re r antaged since they conse- quently have fewer resources to spend on operational Court recognized this problem and introduced the doubled"prudent business manager looking at both leeds such as research and development and market parties to a transaction. As a result, it is accepted that generally the latter standard is in line with the arm's- Moreover, it seems reasonable that new documenta. ngth principle. Certainly, this change in jurisprudence on rules, including, for example, requirements for needs to be considered in the update of the 1983 regu- transfer pricing studies, are only acceptable for the tax lations payers if they receive more certainty in their dealings with the tax authorities for the money spent on docu- European Law Implications mentation ut there is more to the ned Income Allocation Law ecognizing the developments in german tax law. One must also consider the implications of European law The 1983 administrative regulations adressing in. thogh s there is no tendency to fully harmonize ec ome allocation also likely will be amended. This will violate binding European law. In this context, it is in the not only affect national tax law, but also the application countries'vital interest not to breach the four funda- of allocation provisions in tax treaties. One important step is to analyze the decisions of german tax courts. in mental freedoms provided by the treaty establishing the particular those that have been rendered by the Federal European Union Tax Court. During the last two decades, there have the German Foreign Tax Code. In a June 21, 2001 profit distributions, which is only mentioned, but not cision, the German Federal Tax Court24 had to decide whether the limited application of Section 1 meets the defined in detail in German tax law. 9 Rules governing requirements of prevailing European law.25 The appli- hidden profit distributions have mainly been developed cation of this provision is limited to cases where"busi- mandatory that the judicial rulings be taken into ac. ness relationships extending to a foreign country"exist count when interpreting the allocation provisions. Section 1 requires determining an arms-length price However, German tax law provides that in the event as Prudent Business Manager sets are withdrawn from one business and are trans ferred to another domestic business, the so-called par most 30 years, the courts have used the"prudent busi- profit element, whereas the arm's-length price as re ness manager standard"to decide whether payments quired by Section 1 generally contains a profit markup ade between related parties are conditional upon the shareholder relationship. It has been debated whether Consequently, more tax might become due if Section I applies. The court concluded that this different taxa this test could be consistent with the arm's-length prin- tion might violate the taxpayer's right of free movement ciple used in other countries'legislation, tax treaties, of services (Article 43 of the EU Treaty) as well as the of the German Foreign Tax Code. The main argument freedom of establishment (Article 37 of the EU Treaty) because comparable circumstances are taxed less when as that the prudent business manager standard, devel a domestic transaction takes place than in cross-border oped in 1967, is a one-sided approach, investigating only whether the"prudent and diligent business man. Justice will soon have to deal with the issue ger"of the company would have agreed to the trans The described changes due to necessities in both na ction. 21 This approach disregarded the view that the tional and EC law might lead to significant changes in other party to the transaction needs to be investigated, o, since the negotiation process of a transaction is ba he statutory basis as well. a potential scenario would sically determined by the conflicting interests of both 2 For a detailed analysis, see Kroppen 18 Also see Kroppen, Heinz Becker, Helmut; Kroppen, Heinz-Klaus(Edits. s: Rasch. Steph temationgle verrech oeder, Achim, Tax Notes International 2001, pp. 1111 ff. Verlag 1997/2001 EU Commission staff also stressed this aspect in its working Der Be. trieb 1994, pp. 1105; Becker, Helmut, Der Betrieb 1996, pp. Cf. section 8, paragraph 3, German Corporation Ta asch, Stephan, Konzernverrechnungspreise im evant whether income is distributed or not. hidden pro t idis: I tto-Schmidt Verlag, 2001 According to the EU treaty, there are four so-called"fun- tributions as well as distributions of any kind on participating certificates which involve the right to partici damental freedoms": the right of free movement of persons, ervices, and capital, and the freedom of establishment in liquidation proceeds of the corporation do not reduce in- DStR 2001, pp 1290 ff. For a detailed analysis, see Eigelshoven, Axel, TWB Fach For a detailed analysis, s ee Kroppen, Heinz-Klaus, Ei-3 Deutschland, Gn gelshoven, Axel, and Roeder, Achim, in: Robert Feinschreiber (Edit ) Transfer Pricing International: A Country-by-Country ationales Steuerrecht 2001, pp. 113 ff. Dautzenberg Guide (New York: John Wiley 2000), sec. 24-2. forbert; and Gocksch, Sebastian, Betriebs Berater 2000, pp i See decision of the Federal Tax Court, dated March 16 1967BStB.1967Ilpp.626 Cf. section 4 paragraph 1 and section 6 paragraph l of the german Income Tax Code 2602 Copyright. 2002 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs TMTR ISSN 1063-2069
PERSPECTIVE (vol.10,No.19)839 include unifying the differing arms-length principles, I pany is not within the scope of the provision. Section 1 as set forth in Section 1 of the Foreign Tax Code, and in of the Foreign Tax Code is only applicable in the second the hidden profit distribution provision, which is the legree(i.e,, the rules for hidden capital contribution most important provision for allocating profits between and for hidden profit distribution take precedent affliates. As described above, there is no major differ- In fact, these regulations and Section l us sua ly apply nce between the "double prudent and diligent busi- when the rules for a hidden capital contribution do not less manager standard used in preventing hidden profit distributions and the arms-length principle, as This generally arises cases where the benefit received et forth in Section l. This would also be consistent by a foreign subsidiary does not constitute tangible or with the internationally accepted arm's-ler tangible property. One possibility under discussion ciple, as outlined in Article 9 of the OECD Model would extend the scope of the hidden capital contribu- Treaty. tion rule to the use of property and the rendering of ser vices. Consequently, the relevance of Section I would be reduced even more. The provision might then be ap licable in cases only when the definition of a related it seems reasonable that new documentation rules arty is broader than under the provisions dealing with including, for example requirements for transfer hidden profit distributions or hidden capital contribu tions. In fact, such a change could simplify the use of ncome allocation provisions, and this should be the pricing studies, are only acceptable for the first goal to be achieved when changing the law taxpayers if they receive more certainty in their However, broadening the scope of a capital contribu- tion and using the arms-length price as the general dealings with the tax authorities for the money valuation standard also could mean that if the owner of a corporation works for the corporation without a sal- spent on documentation ry, the owner could face additional tax liability based on a fictitious salary, while at the same time the corpo- ration has a deduction. Therefore much work still must be done to reconcile the different standards in German However, that would only be going half-way. Taking tax law nto account different measurement standards in ger. man tax law, the govermment should consider modify Transfer of Functions and risks ing the hidden capital contribution and withdrawal pro The German Ministry of Finance recently pr visions under Section 4, paragraph 1, of the German In- draft on the transfer of functions and risks come Tax Code that uses the"partial value"standard One aim might be to abandon the standard altogether multinational group of companies. The draft because partial value is generally limited to replace xpected to be circulated in March, covers the ment costs and does not necessarily include a profit el- ement, while the arms-length price contains a profit a a manufacturing activity abroad component. To conform German tax law with EC law aa distribution function to a foreign country; and determining appropriate transfer prices should use the a service operations overseas. arm's length principle--including For a transferred manufacturing activity, the draft component-as the sole standard generally distinguishes between building up a com- The major obstacle foreseen here is that such a gen pletely new foreign production company, the treatment eral standard will face severe objections from family of transactions after having transferred the production activity to the foreign affiliated company, and the trans- company car or the taking of a business asset from the fer of tangible and intangible assets to a foreign affli business for personal consumption is taxed on a cost ated production company. basis, whereas under a revised system, the arm s-length For a transferred distribution activity the draft dis- principle would govern and a profit markup would have cusses whether it is acceptable to transfer a distribution to be added erritory to a full-fledged distributor without compensa Moreover, it analyzes whether it is necessary to Hidden Capital Contribution compensate the restructuring from a full-fledged dis- For the sake of clarity and completeness, it is neces- ributor to an undisclosed (acting in the own name, but sary to discuss enlarging the scope of the hidden capi- (acting in the name and on the account of the princi- tal contribution provision. a hidden capital contributior pa). It explicitly states that in the course of a restruc- is to be assumed if a shareholder or a related party of turing from a distributor to an agent not only are busi- without proper consideration and the contribution is/ mee opportunities transferred, but also risks related to conditional upon the shareholder relationship. How- ever, because of a 1987 Federal Tax court decision For services transferred to a foreign country, the only the transfer of tangible or intangible property is draft says the service fee paid for the services rendered ubject to a hidden capital contribution. 27 The use of ter the transfer of the service function must be exam- property or the rendering of services to a related com ined to determine whether the fee satisfies the arm's length standard and whether the transfer of intangibles has taken place in the context of the transfer 27 Decision dated Oct. 26, 1987, GrS 2/86, BStBL 1988 Il, pp 348ff The term"transferring a function"is also defined and the underlying reasons for a transfer are analyzed TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 2-6-02
840(Vol.10,No.19) PERSPECTIVE Furthermore, the consequences of transferring func- The draft guidelines' comments on the APa proce- tions and risks are described from a civil and tax law dure mainly refer to the handling of the APArequest on point of view. he level of the national tax authorities that are in APA Guidance r吧a nance as well as the Federal Tax office would have to Ministry officials also are considering whether to ad-be involved dress other transfer pricing issues through revised documentation administration guidelines, such as aPAs and taxpayer obligations under the competent authority Competent Authority rocess. Ministry officials are currently discussing Under a competent authority draft circular, released whether additional guidance could be issued as part of in April 2000, taxpayers would be required to disclose documentation guidelines or separately 2eMac山门20hoe: The draft would esta由 sh the documentation competent authority procedures, including a highe ains a commentary on Germany's APA procedure. The andard of cooperation than under domestic tax audits raft also would require the tax to perform(10 Transfer Pricing Report 14, 5/2/01) their own fact finding before issuing an APA. Thus, the The proposed guidelines further make it clear that authorities may need to conduct almost a full-fledged uncooperative taxpayers can be denied competent au audit if the last audit of the taxpayers transfer pricing sues is outdated. It is likely that requiring an audit wil income based on its own estimates if taxpayers do not severely limit the number of completed APA cases be- cooperate or do not provide adequate documentation. cause there is not enough field audit staff at a local level to handle the increased work The draft spells out taxpayer rights in a competent uthority procedure, saying a timely opportunity must be given to inform affiliated enterprises and foreign tax administrations about intended domestic adjustments There is a strong feeling among tax officials that The proposal would also permit taxpayers to comment on factual and legal findings. All competent authority documentation principles should be published agreements would be subject to the taxpayers consent as soon as possible with only minor adjustments to Databanks provide guidance to auditors, who since Jan. 1 One further issue broadly discussed is the use of da tabanks for transfer pricing purposes. This issue has have had possible access to electronic data. The been in the news lately. The EU Commission also st gests creating a transfer pricing databank to help estal guidelines might be useful in organizing their data lish uniform documentation requirements. 30 It should recognized that the number of intragroup transac- searches tions have clearly increased over tl ne last years. This as certainly reduced the number of comparables that could be identified from transactions of unrelated com- panies. Furthermore, the available commercial data The intention to limit work for the authorities is als bases financial information tends to be too aggregated reflected in other parts of the draft APA guidelines. Ac Moreover, German tax authorities have in the been reluctant to recognize the use of profit-based cording to the draft, APAs are aimed at reducing the methods. The comparables obtained from the existing could be interpreted to mean that APA negotiations are databases usually provide profit comparables. In this re- spect, it is helpful that the German tax authorities are to be routine. This view seems to be supported by yet starting to acknowledge profit- based methods. 2 Addi another statement in the guidelines: "APAs are to be confined to basic cases. Though the meaning of this tionally, representatives of accounting firms have statement is somewhat unclear, the expression"basic cases"could be interpreted as only cases of significant complexity or where high amounts of taxable income y s double taxation treaties could b be extended to cover multilateral APAs as well. In this trade takes place between affliated companies. For a discus. respect,the German tax authority would view the apa sion in detail see Rasch, Stephan, Konzernverrechnungspreise procedure as falling under Article 25, paragraph 1 of he OECD model treaty of 1992 logne: Dr, Otto-Schmidt Verlag, 2001), pp.12f owever, despite the growing acceptance of pro methods, the authors do not believe german tax au See Kroppen, Heinz will publish this or any draft administrative principle f such methods cials had indicated there could German Transfer Pricing Do Transfer Pricing Report 122 entation, APA Guidelines, "(9 to formally recognize use of the profit-split method (9 Pricing Report 312, 9/20/00) Copyright c 2002 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
PERSPECTIVE o.10.N.19)841 started sorting out which information should be pro- vided by the databases and how the existing level of in Taxpayers, on the other hand, should keep in mind formation could be extended and amended that the current lack of certainty and the absence of documentation obligations might change totally. They should consider preparing minimum documentation. It This article began by referring to other countries'ef remains unclear when new legislation will be intro. duced. One thing is relatively certain: most European forts to enact transfer pricing legislation. Certainly, one tax authorities already possess documentation require. area. However, Germanys workload is remarkable. and ments. German tax authorities may decide that they now recent Federal Tax Court rulings have increased cannot protect Germany's revenue base without similar hat workload Taking into account the dependency on requirements. It appears inevitable, therefore, that nd the connection to EC law, the German legislature is there will be some kind of transfer pricing documenta well-advised not to issue administrative principles or statutory provisions prematurely tion provision in German tax law TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 2-6-02