1000(Vol.8no.23) Analysis German Cost Sharing Guidelines: An International Comparison By DR. HEINZ-KLAUS KR AND DR. ACHIM ROEDER,M mmenda- ments he global e, though they ice particu- ates som nd Great and widely connection w pricing o reign arrangeme tion for E ange of com lin guidelir istrative pr principles w the German changes of tl 15y widely of the germa German tax breaking new guideline 1German 1983-5 fiscal Amsterdan 2German 1999-VB4- text see: 8 Tra ing quoted as content see International- Robert, ed.: New 3 Menck, Einku denen Unternehm recht,1984/1985p y the Dr. Heinz-Klaus F the adminis- national partner ane is manager with Deloitte& Touche's' German transfer pricing group cing Report 44, 5/22/96. 9.p.382ff 322-00 Copyright 2000 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs. Inc. TMTR ISSN1063-2069
(vol.8,No.23) .23)1001 trative principles, but also proposed a st on and incorporation of elements of the Ithough OECD guidelines and German administra es rega ding cost contribution tive principles are similar in scope, one marked differ Chapter Vill of the OECD guidelines-which ence is stressed in the german tax literature while the September 1997. ECD neatly separates the two different type aring arrangements in two different paragr markup of 5 percent would be common practice and in one definition. It is sometimes maintained that foreign service provider. Comments on the draft rightly to inappropriate results in analyzing whether or not a eait icizmd this margie as be ing inconsistent with other profit m吧 must be charged within the pool from a tablishments, in which a 5 to 10 percent margin was The question of profit markup leads again to the pool ent& Though the 5-percent benchmark has not been in- sharing scheme replace a market transaction by setting luded in the final version it may, together with the other figures, serve as a first indication of a cost plus might be explained by the transaction cost approach, s margin range that would usually be acceptable to the In legal terms the pool members form something like a German tax authorities civil law partnership ( BGB-Gesellschaft) 14 However, as Definition and Scope under the U. S regulations, this institution is not recog Of Cost Sharing Arrangements nized as a partnership for tax purposes. From the rman tax administrations point of view the denial of Under U.s. regulations a cost shari market transactions has another consequence. The ger- man guidelines generally prohibit, a markup an agreement under which the parties agree to share the costs of developing one or more intangibles, in pro- risks. I. The only profit element that may be charged is ests in the resulting intangibles. If the arrangement is respective capital market interest rate for de- a qualified cost sharing arrangement, each participant posits:. 7 The denial of profits among the cost sharing Thus the issue whether the pricing of the license is the rationale of a profit-free service flow within asing arm’ s length car The U.S. definition is much more restrictive than ei institution. Besides, payments under the cost: sharing arrangement could be interpreted to replace own costs ther the definition included in the OECd guidelines or of the service recipient for which in turn an additional the new German definition. Under the OECD guidance markup would not be applicable a potential cost contribution arrangement may cover a Obviously, the above would lead to inappropriate re- wide range of joint activities. In fact, the oEcd de- sults in cases where companies: would devote: substan scribes two different types of arrangements. The first tial parts of their activities to the pool at costs that oth type is consistent with the U.s. regulations in that it in rwise could have demanded a profit-bearing market nce in transactions with third parties. The german cording to the OECd is the most common type of cost principles avoid such a situation in two ways. First, they would inclu nly allow auxiliary activities to be conducted within joint funding or sharing of costs and the cost sharing, arranovides must not make up the ma- risks, for developing or acquiring property or for ob- dvertising cam jority of its economic activity. However, the principles do not provide a clear yardstick to decide when an aux w German iliary activity is no longer auxili principles also allow cost sharing arrangements for parable returns on assets might n analysis of com- er the first indication eral definition in para. 1.1 of the German cost sharing keep the pool members as. homogeneous as and seek to admit only pools of equals. This issue is Into for lated parties operating crossborder to jointly obtain or roduce assets, services, or rights for the parties'mu- tual benefit. In doing so the parties to the agreement be- w-Fachnachrichten 8/1999, p. 383. f Coase, The Nature of the R&D Cost Sharing: An Economic Approach. in Intertax voL. 25(1997).p. 419 sung von Konzen oder ohne Gewinnaufschlag im Hinblick auf die Link of Allocations to Expected Benefits"(6 Transfer pricing 1990, p 2. 400 Report340,351,10/1/97 。Res:514827(18199p.385 5 Para. 1.1 Cost Sharing Principles and Regs. 51.482- 7(a)1 CD guidelines, chapter VIIl, para. 6. 6 Para. 2.2 Cost Sharing Principles OECD guidelines, chapter VIIl, para. 7. 18 Para. I 1 Cost Sharing Principles X MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 TM32200
1002vol.8,No.23) Membership provided in the text. The German tax authorities explic itly deny that a patent exploitation company may join ticipant must meet three requirements Is ontrolled par- The U.S. regulations provide that a an R&D pool of manufacturing companies, since the in terests of a patent exploitation company are supposed a reasonably anticipate that it will derive benefits to be different from those of a manufacturing com- from the use of the covered intangibles; pany. The same applies for combinations of produc tion companies and holdings. 8 In fact, this combina a substantially comply with the accounting require- tion may cause considerable problems at a practical ments;2°and level as currently a single holdin pate in an R&D pool instead of a number of its mant i substantially comply with detailed documentation facturing subsidiaries. From an administrative point of and reporting requirements wiew smaller pools can be managed more easily .All While the documentation and reporting requirements things equal, an increase in the membership will in will be dealt with later in chapter VI the focus in the fol- crease the tax induced costs of the participating parties lowing will be on the first requirement. As indicated above, this provision, will lead to a ovided for a narrow rather: homogeneous composition of cost sharing ar- interpretation of use. Under the originally proposed rangements participants, thus avoiding situations active conduct rule a controlled taxpayer was required where a profit markup for the services rendered to the to"use or reasonably expect to use the covered intan-I pool would seriously have to. be considered under amples suggested that the term" was restricted to the actual physical use of an intangible and would not include its econc g to taxpay Allocation: of Costs, Anticipated Benefits cerns, the IRS amended the final regulations and elin The cost allocation is generally based on an alloca- nated the active conduct rule. The amended version tion of the benefit each participant expects. In this re- now requires a controlled taxpayer only to reasonabl nticipate that it will derive benefits from the use of the spect German and U.S. rules agree. intangibles. 2 That meanis-that a controlled taxpayer is rect measurement of the anticipated benefits Also, both sets of rules provide for the dire ccause of the manner in which it proposes to use the efits from exploiting the covered intangible directly or indirect measurement of the benefits that would ap Thus an r&d pool may for instance consist of produc. proximate the distribution of the anticipated benef tion companies as well as of patent exploitation compa nies without their own production facilities xamples mention estimated units used, produced or sold, sales, and: operating profit. In addition the ger an rules explicitly mention the number of employees ditional income generated or costs saved from the use. the wage total, the invested capital, etc. of the: covered intangibles. This corresponds to the take the form of cost savings or income increases s benefits must be the most reliable measure of such ben However, a major difference between U Sand german key, i.e. the anticipated benefits, must be the most ob- "use."The German principles stipulate that only parties jective one in the individual case. Only if several keys that use services from the pool in an economically iden- ppe cretion tical the taxpayer to select a key. In other words, it is implic qualify for a participation in the cost sharing itly assumed that the best method for measuring the an- scheme.. From the explanation, it appears that an eco- nomically identical way of use would mean that the par ticipated benefits can be objectively determined ties show a high degree of similarity in their interest for The U. S. rules are more specific in that respect. From participating in the respective pool. That would suggest heir perspective the reliability of a taxpayers estimate embers must derive structurally of anticipated benefits is based on the completeness similar benefits from their participation in the cost shar and reliability of the data and the soundness of the ing arrangement. It would not be sufficient that their sumptions used in the projections. 30 As with the "best enefits can be measured reliably in a currency method rule"in the final Section 482 transfer pricing but would also stem from a comparable source, ther increases in license income or reductions of regulations, there is significant room for the IRS to sea ond guess unprepared or poorly prepared taxpayers 3 istrative costs. This is also supported by the examples The German principles demand that the reliability of the benefi ejections must be verified regularly and djusted if there have bee ast to the U.s. regulat chark for §1.482-7(c)(1)(Dec.19, 22Regs.1482-7(c)(1)( Preamble to Revision of Section 482 Cost Sharing Regu- 28 Para. 1. 2 Cost Sharing Prince les lations, 61. Fed. Reg. 21,955(May 13, 1996). Regs. 51.482-7(D(1); para. 3. 1 Cost Sharing Principles. Para. 1.1 Cost Sh 26 Para. 1. 2 Cost Sharing Principles gs.§ 32 Para. 3. 3 Cost Sharing Principles 3-22.00 Copyright 2000 TAX MANAGE EMENT INC, a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
vol.8,No.23)1003 materiality,(i.e. 20 percent), is not provided. More- German content requirements also stre audit and over, the U.s. regulations allow retroactive adjus access rights of the German participants .38 The German a ments,whereas the German tax authority is tradition- participants must be granted access to the relevant ally rather reluctant to accept such a mechanism. In documents and records of the service provider In addi- stead it is claimed that if reviews are conducted in due tion, the type and extent of the inspection of accounts time the adjustments would only affect future periods. 3 have to be stipulated in a qualifying cost sharing agree nt. These requirements must be seen in a historical Elements of qualified Arrangements, context. In the experience of the German tax auditors Documentation Requirements se with the poor access of German subsidiaries to the documentation of its foreign parent To be classified as a qualified company. anng arrange- ment, the written agreement must ts regarding form and with certain cost sharing rules to any arrangement that in substance U.S. requirements show a high similarity in this re- spect. 35 The arrangements must administrative principles on cost sharing do not provide for such a recharacterization An analysis of the documentation requirements be contemporaneous with the formation(and any shows some minor differences. 0 Again, the German revision) of the arrangement tax authorities'obsession with p access to cost include two or more controlled or uncontrolled and benefit-related data is highlighted, or to put it more participants neutrally, the shortcomings of mixing R&D and non R&D arrangements are reflected. While the U.S. regu- a provide a method for sharing costs in respect of lations simply state that the total costs incurred in con- each participant,'s share of anticipated benefits, and nection with the cost sharing arrangement and the costs m provide for adjustments of cost shares to account borme by each controlled participant must be docu- mented the german guidelines prescribe the necessary The document itself (or under German rules also ap- formation in much more detail. The annual settlement pendices, enclosures or additional agreements)must in- f the arrangement-incurred costs must include an clude emized list of the total expenses in respect of cost cen- rs and m a list of participants and any other related benefi their allocation to the participants as well as a canes classification of direct and indirect costs according to cost types such as labor costs, travel expenses, office rent. etc u the method used for sharing costs and the circum stances requiring an adjustment to cost shares due to On the level of the service recipient, it must be mented that the services have actually been received and benefits have been gained. The documentation may on of each participants interest in the take the form of monthly, quarterly, or annual reports in Germany this applies only on services or projects, relevant correspondence, re for R&d cost sharing) earch reports, lists of patent applications, press re m the duration of the agreement; and Conclusion the conditions requiring, and cons agreements in Germany change the exor cost sharing As shown above, the new principl modification or termination of the arrangement sting rules and deviate from the U.S. regulations in some significant the scope of the R&D project, including the intangible likely to have a significant impact on existing agree- or class of intangibles intended to be developed. 6 The ments. Companies that are presently engaged in cost German principles are not as explicit on that point, but sharing agreements in germany must review those ar due to their broader scope appear to include this re- rangements immediately and make whatever modifica- uirement under the documentation of anticipated ben tions are required by this new regime before the end of efits. In illustrating the anticipated benefits, this docu mentation should also include descriptions of the 000. 4 To the extent that an existing agreement in- project scope, e. g, by project reports or target descrip pool under the new rules, such agreements might need tions. 37 to be terminated In any event, it is clear that extensive review is warranted 3Regs.§14824((2)(i)(D) 3s p ra, 3. 3 Cost Sharing Principles. 36 pegs. 51.482-7(b), para. 5.1.1 Cost Sharing Principles. 38 Para. 5. 1. 1 no. 7 and no 11 Cost Sharing Principles. gs.51.482-7(a)(1) gs.§1482-7(b)(4)〔i) 47 Para. 5.1.3 Cost Sharing Principles Regs. 51.482-7Q: para 5.1.4 Cost Sharing Principles 1 Para. 8 Cost Sharing Principles TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 M32200
