Reprinted from Worldwide Tax Daily, 13 November 2002,(2002 WTD 219-1 taa daily Germany Introduces Draft Transfer Pricing Documentation and Penalties Legislation by Heinz-Klaus Kroppen and Stephan rasch price agreed to by the related parties is not an Heinz-Klaus Kroppen, LL.M. and arms-length price Stephan Rasch are with Deloitte & Touche The court also held that if price ranges exist and Copyright o Deloitte Touche, 2002 the tax authorities are entitled to make an adjust- ment because the agreed price is outside the range price may only be adjusted to the highest or low 3 The German legislature has published a compre- est point of the range that is the most beneficial to ensive draft tax law that includes new transfer pric- the taxpayer ng documentation requirements. The draft relates to It is not surprising the tax authorities opposed an important transfer pricing decision that Ger- the decision and have struggled to find an adequate many's Supreme Tax Court made in October 2001. response. 2 With the government's reelection, a first The court held that German law does not include doc- draft of a comprehensive revision of the German tax umentation requirements regarding how prices be law has been prepared and attempts to address the tween related parties are determined, and the bur-problem den of proof is on the tax authorities to show that the Documentation Requirements The draft law adds a new third paragraph to sec tion 90 of the General Tax Code(abgabenordnung AO). The new paragraph requires the taxpayer to DEcision dated 17October ref no: 103/00, Der Betrieb prepare documentation for transactions with related (hereinafter: DB)2001, pp 2474 ff; for an analysis of the decision 2001, pp. 1111 ff, 2001 WTD 237.11 or Doc 2001-30307 (8 origi. transactions and the economic and legal basis for set al pages), Kroppen/Rasch/Roeder, Internationale ting the price. according to the explanatory notes Wirtschaftsbriefe(hereinafter: IWB)F 3 Deutschland Gr. 1, pp. the taxpayer must prepare written documentation or 10(2002,no.19,pp.835,836f; Wassermeyer,DB2002 ff; Becker, IWB F 3 Deutschland Gr. 11, pp. 1765 ff Kuckhoff/Schreiber, IWB F. 3 Deutschland Gr. 1, pp. 1863 ff. Baumhoff, Internationales Steuerrecht, pp. 751 Bernhardt/Weinreich, International Transfer Pricing Journal 2002, pp 67 ff; Vogele/Bader, Tax Planning International Trans- Cf. Kuckhoff/Schreiber. IWB F. 3 Deutschland Gr. 1 1863,1881f Tax Notes International
Germany Introduces Draft Transfer Pricing Documentation and Penalties Legislation by Heinz-Klaus Kroppen and Stephan Rasch The German legislature has published a comprehensive draft tax law that includes new transfer pricing documentation requirements. The draft relates to an important transfer pricing decision that Germany’s Supreme Tax Court made in October 2001.1 The court held that German law does not include documentation requirements regarding how prices between related parties are determined, and the burden of proof is on the tax authorities to show that the price agreed to by the related parties is not an arm’s-length price. The court also held that if price ranges exist and the tax authorities are entitled to make an adjustment because the agreed price is outside the range, the price may only be adjusted to the highest or lowest point of the range that is the most beneficial to the taxpayer. It is not surprising the tax authorities opposed the decision and have struggled to find an adequate response.2 With the government’s reelection, a first draft of a comprehensive revision of the German tax law has been prepared and attempts to address the problem. Documentation Requirements The draft law adds a new third paragraph to section 90 of the General Tax Code (Abgabenordnung — AO). The new paragraph requires the taxpayer to prepare documentation for transactions with related parties addressing the facts and circumstances of the transactions and the economic and legal basis for setting the price. According to the explanatory notes, the taxpayer must prepare written documentation on Tax Notes International 1 Reprinted from Worldwide Tax Daily, 13 November 2002, (2002 WTD 219-1) worldwide tax daily Heinz-Klaus Kroppen, LL.M. and Stephan Rasch are with Deloitte & Touche. Copyright © Deloitte & Touche, 2002. 1 Decision dated 17 October 2001, ref. no: 103/00, Der Betrieb (hereinafter: DB) 2001, pp. 2474 ff; for an analysis of the decision see, inter alia: Kroppen/Rasch/Roeder, Tax Notes Int’l, 10 Dec. 2001, pp. 1111 ff, 2001 WTD 237-11 or Doc 2001-30307 (8 original pages), Kroppen/Rasch/Roeder, Internationale Wirtschaftsbriefe (hereinafter: IWB) F. 3 Deutschland Gr. 1, pp. 1787 ff; Kroppen/Rasch, Tax Management Transfer Pricing, Vol. 10 (2002), no. 19, pp. 835, 836 f; Wassermeyer, DB 2002, pp. 2465 ff; Becker, IWB F. 3 Deutschland Gr. 11, pp. 1765 ff; Kuckhoff/Schreiber, IWB F. 3 Deutschland Gr. 1, pp. 1863 ff. Baumhoff, Internationales Steuerrecht, pp. 751 f; Bernhardt/Weinreich, International Transfer Pricing Journal, 2002, pp. 67 ff; Vögele/Bader, Tax Planning International Transfer Pricing 03/02, pp. 7 ff. 2 Cf. Kuckhoff/Schreiber, IWB F. 3 Deutschland Gr. 1, pp. 1863, 1881 f
Reprinted from Worldwide Tax Daily, 13 November 2002,(2002 WTD 219-1 comparable data and provide other information rele- also states that the taxpayer may refute that vant to determining the arms-length character of the presumption prices. The taxpayer must also justify how the price was determined If the tax authorities are permitted to estimate ncome under amended section 162 paragraph 2 AO If the draft becomes law, industry demands will and there is a range of acceptable prices, the draft have been rejected. Industry demanded that compa- law allows the tax authorities to estimate the taxable nies should only be required to document their think- income up to the point in the range that is the most ng when they set the prices and should not be re- disadvantageous for the taxpayer This power raises quired to provide comparable data from data banks serious constitutional questions. When a law con- and external consultants. The explanatory notes flicts with the freedom rights of individuals, the Co state that the draft legislation is consistent with the stitution usually requires that anu f erned by the current documentation requirements of most oECd sure limiting those freedoms is gov d non-OECD countries' and some of the penalty re- principle of proportionality. The measure restricting imes. The current EU initiative is important in rec- the freedom rights of the taxpayers must be drafted onciling differing rules, at least within the European in the least restrictive manner ? Union, and in providing taxpayers with harmonized documentation rules. 6 If the draft law is enacted, taxpayers should con temporaneously prepare the documentation required The draft also requires the taxpayer to prepare under section 90 paragraph 3 AO. If the documenta contemporaneous documentation. Therefore, the tion satisfies the law, the tax authorities are then un question of whether to prepare documentation when able to estimate the tax base, and the burden of proof t is requested on audit would become moot because remains with the tax authorities. However, if the tax the draft law favors preparing current, ongoing docu- payer does not prepare documentation, the tax au mentation. The law also states that documentation thorities may estimate the income must be presented within 60 days after the authori ties issue their request It is unclear under the draft law how the tax au thorities will be able to adjust income to the highest t of the when the tax Noncompliance/Burden of Proof refute the presumption of non-arm's-length prices by The draft also changes the current section 162 proving that the prices are indeed at arms length paragraph 2 AO, which addresses the right of the tax Do the rights of the taxpayer to rebut the pre the tax authorities are also able to make an estima- sumption trump the rights of the tax authorities to tion when the taxpayer does not fulfill the documen- ties permitted to adjust to the highest point within tation requirements of proposed section 90 para- the range established by the taxpayer as the graph 3 AO arms-length range because the taxpayer has not ful The draft adds a new paragraph 3 to section 162 filled its documentation obligations under section 90 Ao that provides that if the taxpayer does not submit paragraph 3 Ao? It remains to be seen how this con the documentation required under section 90 para- flict is resolved graph 3 AO, there is a presumption that the income of the German taxpayer has been reduced because of Penalties related-party transactions. However, the draft law The draft law also includes a new paragraph 4 to section 162 Ao that contains a penalty provision. If the tax authorities have the right to estimate the tax base under section 162 paragraph 3 AO, they must also impose a surcharge ranging from 10 to 20 per 1111, 1113, 2001 WTD 237-11 or Doc 2001-30307(8 originai cent of the adjusted tax base. However, the tax au pages) thorities should refrain from imposing a surcharg Inter alia: Australia, Belgium, Canad the taxpayer was not at fault. rea. New Zealand. the Netherlands. Poland The surcharge provision raises serious questions States and Venezuela First, it is not based on a percentage of the additional Canada, china. nin dian. Kors. Poland Thailand. the United Kingdom, and the United States EU Commission"Company Taxation in the Internal Market, SEC(2001), pp 346 ff; see also: Kroppen/Rasch, Tax Management Transfer Pricing, Vol. 10(2002), no. 19, pp. 835, 836 f 'See Kroppen, in: Becker/Kroppen (eds )Handbuch Kroppen/Rasch, IWB F. 5 Niederlande Gr. 2, pp. 351, 359 Internationale Verrechnungspreise,(Koln: Dr. Otto-Schmidt Rasch/Roeder, IWB 28 Nov 2001, pp. 1081 f. Verlag, 1999), 0 7. 30, note 9 Tax Notes International
comparable data and provide other information relevant to determining the arm’s-length character of the prices. The taxpayer must also justify how the price was determined. If the draft becomes law, industry demands will have been rejected. Industry demanded that companies should only be required to document their thinking when they set the prices and should not be required to provide comparable data from data banks and external consultants.3 The explanatory notes state that the draft legislation is consistent with the current documentation requirements of most OECD and non-OECD countries4 and some of the penalty regimes.5 The current EU initiative is important in reconciling differing rules, at least within the European Union, and in providing taxpayers with harmonized documentation rules.6 The draft also requires the taxpayer to prepare contemporaneous documentation. Therefore, the question of whether to prepare documentation when it is requested on audit would become moot because the draft law favors preparing current, ongoing documentation. The law also states that documentation must be presented within 60 days after the authorities issue their request. Noncompliance/Burden of Proof The draft also changes the current section 162 paragraph 2 AO, which addresses the right of the tax authorities to estimate the tax base. Under the draft the tax authorities are also able to make an estimation when the taxpayer does not fulfill the documentation requirements of proposed section 90 paragraph 3 AO. The draft adds a new paragraph 3 to section 162 AO that provides that if the taxpayer does not submit the documentation required under section 90 paragraph 3 AO, there is a presumption that the income of the German taxpayer has been reduced because of related-party transactions. However, the draft law also states that the taxpayer may refute that presumption. If the tax authorities are permitted to estimate income under amended section 162 paragraph 2 AO and there is a range of acceptable prices, the draft law allows the tax authorities to estimate the taxable income up to the point in the range that is the most disadvantageous for the taxpayer. This power raises serious constitutional questions. When a law conflicts with the freedom rights of individuals, the Constitution usually requires that any government measure limiting those freedoms is governed by the principle of proportionality. The measure restricting the freedom rights of the taxpayers must be drafted in the least restrictive manner.7 If the draft law is enacted, taxpayers should contemporaneously prepare the documentation required under section 90 paragraph 3 AO. If the documentation satisfies the law, the tax authorities are then unable to estimate the tax base, and the burden of proof remains with the tax authorities. However, if the taxpayer does not prepare documentation, the tax authorities may estimate the income. It is unclear under the draft law how the tax authorities will be able to adjust income to the highest point of the range when the taxpayer has the right to refute the presumption of non-arm’s-length prices by proving that the prices are indeed at arm’s length. Do the rights of the taxpayer to rebut the presumption trump the rights of the tax authorities to estimate and adjust income? Or are the tax authorities permitted to adjust to the highest point within the range established by the taxpayer as the arm’s-length range, because the taxpayer has not fulfilled its documentation obligations under section 90 paragraph 3 AO? It remains to be seen how this conflict is resolved. Penalties The draft law also includes a new paragraph 4 to section 162 AO that contains a penalty provision. If the tax authorities have the right to estimate the tax base under section 162 paragraph 3 AO, they must also impose a surcharge ranging from 10 to 20 percent of the adjusted tax base. However, the tax authorities should refrain from imposing a surcharge if the taxpayer was not at fault. The surcharge provision raises serious questions. First, it is not based on a percentage of the additional 2 Tax Notes International Reprinted from Worldwide Tax Daily, 13 November 2002, (2002 WTD 219-1) 3 Kroppen/Rasch/Roeder, Tax Notes Int’l, 10 Dec. 2001, pp. 1111, 1113, 2001 WTD 237-11 or Doc 2001-30307 (8 original pages). 4 Inter alia: Australia, Belgium, Canada, China, France, Korea, New Zealand, the Netherlands, Poland, Portugal, Slovak Republic, South Africa, Thailand, the United Kingdom, the United States, and Venezuela. 5 Specific transfer pricing penalties apply, for example, in: Australia, Canada, China, India, Korea, Poland, Thailand, the United Kingdom, and the United States. 6 EU Commission “Company Taxation in the Internal Market,” SEC(2001), pp. 346 ff; see also: Kroppen/Rasch, Tax Management Transfer Pricing, Vol. 10 (2002), no. 19, pp. 835, 836 f; Kroppen/Rasch, IWB F. 5 Niederlande Gr. 2, pp. 351, 359 f; Rasch/Roeder, IWB 28 Nov. 2001, pp. 1081 f. 7See Kroppen, in: Becker/Kroppen (eds.) Handbuch Internationale Verrechnungspreise, (Köln: Dr. Otto-Schmidt Verlag, 1999), O 7.30, note 9
Reprinted from Worldwide Tax Daily, 13 November 2002,(2002 WTD 219-1 taxes, but on a percentage of the adjustment. There Effective Date fore, a taxpayer may still need to pay a surcharge If enacted, the documentation requirements and even if an adjustment does not lead to additional other transfer provisions will apply to all business taxes, for example, the case of losses. The penalty years starting after 31 December 2002 that the U.s. IRS issued new penalty regulations. 8 Conclusions It is not surprising that the german legislature has responded to the October 2001 decision of the s preme Court with legal documentation requirement Although many questions remain unanswered, in =动二 ussed at the time the cluding constitutional issues, taxpayers ought to pre- Tax Notes International
Tax Notes International 3 Reprinted from Worldwide Tax Daily, 13 November 2002, (2002 WTD 219-1) taxes, but on a percentage of the adjustment. Therefore, a taxpayer may still need to pay a surcharge even if an adjustment does not lead to additional taxes, for example, the case of losses. The penalty provision goes beyond the U.S. penalty provisions that the German tax authorities criticized at the time that the U.S. IRS issued new penalty regulations.8 Effective Date If enacted, the documentation requirements and other transfer provisions will apply to all business years starting after 31 December 2002. Conclusions It is not surprising that the German legislature has responded to the October 2001 decision of the Supreme Court with legal documentation requirements. Although many questions remain unanswered, including constitutional issues, taxpayers ought to prepare contemporaneous documentation that comports with the proposed legal requirements. ✦ 8 The temporary U.S. regs were discussed at the time the OECD guidelines were drafted, see Runge, IStR 1995, pp. 505 ff; Werra, IStR 1995, pp. 457 ff; Werra, IStR 1994, pp. 483 ff
