122(Vol.9,no.4) Analysis Draft German Transfer Pricing Documentation, APA Guidelines DR. HEINZ-KLAUS KROPPEN LL.M., This article examines the draft document and draft AND DR. ACHIM ROEDER, M. guidelines for requesting and negotiating an advance pricing agreement with Germany. Ithough Section 9.2 of the ciples on Transfer Pricing of 1983 contains sor basic documentation rules, Germany, unlike . Documentation United n ot have ext The draft guidelines together with its attachmen rules. This situat contain long list of specific documents that could be matically hen conducting a In April, the r pricing audit. The documents an auditor could transfer pricing comments tion betw descriptions of products and services; Respect to I that affect prices; ing Rulings. ond step in th explanation of market conditions; pricing guid gendas for board and directors'meetings; nutes of board and directors' meetings; arket studies, product studies, and project present for tax authorit ment, togeth rules for the forth what coc proposed r audit pra d budget documents; cumentsiments; German wirts e determination of prices do d budget deviation and IVC5. Kropper eb sites and the reau of ing, Ams etail ev- Gerr IV B4-S134 8 Transfer cost sharing 3/22/00);for Klaus, Eig 5 An Text section of th Dr. Heinz-Kla national tax part M.A., is manager with De German transfer pricing oid lan- authori- 61400 Copyright 2000 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
ANALYSIS (vol.9,No.4)123 Customs, Insurance Documents written down their actual policy. Under the draft rules German companies should document the major pricing In the past, it was unusual for the German tax au factors in a formalized pricing policy, since the author thorities in a transfer pricing audit to review customs ties in fact expect a pricing policy audit documents as well. This was surprising, since the The authors have not seen a single german taxpayer customs value is determined on the basis of pricing who has a summary list of all related-party tangible for transfer pricing. The draft guidelines explicitly men ffiliate, readily available. The preparation of docu- tion customs audit reports as documents the e tax au ments that detail related-party transaction flows are tors may request so that the taxpayer should also study burdensome and make the related-party transactions and analyze the customs implications when setting transparent to the tax authoritic transfer prices for tax purposes and vice versa The conflicting goals of the customs and tax author ties may cause difficulties for taxpayers. While customs Pricing Methods authorities regularly like to establish a high sales price Taxpayers belonging to an international group of to the German affiliate as a basis for a higher customs companies sometimes take different transfer pricing value, a higher sales price will lead to higher acquisition positions in different countries and try to defend their costs for the German company and consequently a ing decisions on a country-by-country basis. It is wer profit for income taxation, which can lead to a so not unusual for those taxpayers to use profit-base transfer pricing problem The draft also explicitly mentions insurance docu hem into more traditional, transaction-based methods ments as a record that the tax auditor may request In- in countries where profit-based methods were not well surance documents can be dangerous in transfer pric accepted( e. g, to turn a comparable profits method ing audits because they often contain information about(CPM) into a modified resale price method) the value of assets that is based on totally different prin In the future, a taxpayer must use caution in defend- ciples than those used for setting prices for transfer ing its transfer prices in different countries and should ricing purposes. In past transfer pricing audits, even coordinate the approach, since under the new draft efore taxpayers were required to submit these docu guideline les, documents prepared for the tax authorities ments, the tax authorities confronted them with valua in other countries might end up in the hands of the Ger tions based on insurance documents to support an ad man tax authorities even without the german tax au- justment,e.g, when major assets or businesses had thorities explicitly asking for foreign transfer pricing documents. Taxpayers should prepare documentation Contemporaneous Documentation payers should use similar documentation reports to Requirements avoid major discrepancies-even in the format and the ording of the documentatio Taxpayer planning and budget process docume cluding explanations about the deviation between Timing of Documentation plan/budget and actual results and a description of the remedial measures taken by the taxpayer, are impor- Under the draft guidelines, documents not required tant in German transfer pricing audits. to be provided at the beginning of the audit must be The importance of planning and budgeting docu- submitted without undue delay within an "appropriate ments stems from a 1993 German Supreme Court deci- period of time. " However, the guidelines do not define ion in which the court held that a distributor had to be an appropriate period of time. able to provide budgeting and planning documents The draft guidelines also contain a major change in These documents must demonstrate that the taxpayer the approach of the tax authorities on when documen- planned for a reasonable profit within an appropriate tation must be prepared In the past, it was common(al timeframe following the introduction of a new product though it was never advisable) for taxpayers to start oo In a new approach for the German tax auditors, the preparing documentation and evidence for their pricing ft guidelines would require taxpayers to submit cer only after the tax auditor requested the information tain documents at the beginning of an audit even with- The documentation submitted was based specifically on out a specific request. It is questionable whether the tax the questions of the auditor. The draft guidelines would authorities have a sufficient legal basis under existing quire contemporaneous and ongoing documentation German tax law to request these documents. The docu- of all facts and circumstances that are relevant for the ments that may have to be submitted include allocation of income between affiliated companies (Sec ■ a group chart; 2.2.3.) a financial statements for gr The documentation would have to be prepared at the m the taxpayers pricing polic time the price was determined or, at the latest, when the aa summary of all deliverie d services with re- actual transaction took place, and not when the audit lated parties, separate for each year under audit and for had started and the documents had been requested each party; and Therefore the draft rules would require much more dis- a documents that have been prepared for tax au- cipline from taxpayers, who would have to set their thorities of other coun transfer prices in a transparent way. At the same time, The group chart and financial statements are usually taxpayers would have to consider how to document ailable in every international group. However, many their price setting process and how to ensure that the roups do not have formal, written pricing policies be- documents will be retained within the company until cause they set prices on an ad hoc basis or have not the tax auditor comes in several years later TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063.2069 BNA TAX
124 (vo.9,No.4) ANALY SIS ll. Cooperation Requirements thorities are targeting with this rule. In the past, there were two scenarios in which german ers argued In Section 2 of the draft guidelines, the German tax foreign evidence and documents were irrelevant and authorities explain how they expect a taxpayer to coop- therefore did not have to be provided The first was when a foreign production company an extended obligation to cooperate with the tax au- supplied goods to a German distribution company, ased on the application of the resale price method with parties in foreign countries. The taxpayer would (RPM. The German authorities wanted to obtain docu have to provide materials that establish the facts and entation about the cost structure of the foreign pro- duction company. Taxpayers rejected the request for The taxpayer would be required to obtain evidence and foreign documents by arguing that the cost structure of documents from foreign countries and to use all legal the foreign production company was totally irrelevant and factual means to fulfill these obligations (Sec. for determining whether the price for the German dis- tribution company based on the RPM was arms length to cooperate, taxpayers must The foreign producers cost structure was irrelevant make available to german authorities evidence and because the RPM only requires the distributors resale documents that are contained in the books and records price and cost of goods to calculate the gross margin or on the electronic data processing(EDP) system of a This is because only the resale price and an arms- foreign affiliate(Sec. 2. 1. 2.) length gross margin are important to establish whether Ag in the past, many taxpayers in transfer pricing audits an RPM price is arm's length. One may speculate that claimed that they could not obtain foreign do the tax authorities have drafted the new rules to estab- ments because their foreign affiliate was not willing to lish a basis for also requesting the cost structure docu provide those documents to the German company. The ents of the foreign production company. Even under the draft rules it is questionable whether the foreig draft guidelines would make it explicit that the taxpayer producer's cost structure could be deemed relevant in evidence from a foreign affiliate. The German taxpayer would be required to direct The second situation covers cases in which. for ex the foreign affiliate to provide all necessary information ample, a central European production entity supplied to before entering into any transaction (Sec 1.3. That different related distrib might mean that a German taxpayer has to stipulate in French and a german distribution company. In such a its contracts with related parties for the delivery of ase the German tax authorities would request pricing goods or services that the related party will provide all information, documents, and records of the French af- relevant information, evidence, and documentation filiate. This request was rejected for two reasons request a the information was totally irrelevant for establish ing the arm' s-length character of the prices for the Ger Retaining Affiliates'Documentation man affliates: and a since the affiliated production company and the The draft guidelines makes no exceptions for secrecy French distribution company were related parties,the ganization for Economic Cooperation and Development be required to provide the information, even if provid- (OECD) Model Treaty because it was not third-party in ing it to the german taxpayer would be a criminal of- organon fense abroad. The obligation of foreign affiliates to pro The provision in the draft guidelines could be inter vide documentation also is not affected if foreign docu- preted as strengthening the German authorities' activ mentation retention periods have elapsed before the ity to request foreign related-party transaction informa German retention period is over. The German taxpayer tion, such as the French pricing information in the case is required to secure full access to the foreign data The draft guidelines, however do not make clear ex ctly how a german taxpayer is supposed to fulfill this I Profit-Based Methods obligation. It hardly seems realistic to expect a foreign taxpayer to ship its entire documentation to Germany The draft guidelines also contain specific rules for after domestic retention laws have expired solely to pre taxpayers who use either a combination of transaction serve access for the german authorities Such a re based methods or a profit-based method. widely use quirement would probably not be admissible under the CPM-or the OECD's transactional net margin method German constitutional rule of proportional measures (TNMM-is not considered an acceptable method in Therefore, even a limited requirement to retain foreign Germany and therefore these draft rules will be appli documentation will likely pose a substantial additional cable in all cases where CPM is used to set transfer burden on the german taxpayer. prices. The draft guidelines state that when non transactional methods are used, the taxpayer must take Determining Documents'Relevance reater care to ensure that the necessary documents and evidence are collected and can be easily verified by The draft guidelines also claim that if the facts and the tax authorities circumstances at a foreign affiliated company are rel- Under the draft document the tax authorities can re- vant for the audit of the transfer pricing of a german quest that the taxpayer cooperate in verifying that the axpayer, the extended obligation to cooperate also in prices determined under the non-transaction-based ludes those foreign facts and circumstances(Sec. method would also be plausible using a transaction 2. 1. 4. ) It is not entirely clear which cases the tax au based method (Sec. 2.2.4.) 61400 pyright o 2000 TAX MANAGEMENT INC. a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
ANALYSIS (vo,9,No.4) This provision shows the German tax authorities issuing a ruling already presupposes that the applicant change of attitude. In the past, a taxpayer essentially has a vested interest in obtaining this ruling was free to use the method it found appropriate and had The tax authorities must therefore see that the re only to support the correctness of the method (includ sults of the ruling are necessary information to the ap ing a combination or mixture of standard methods) plicant. From the tax authorities'point of view, an ap The draft would put a substantial additional burden on plicant's interest, however, only exists when the future taxpayers that do not use a straightforward tr tax treatment of an event is legally unknown or uncer based method. The tax authorities'approach also can tain Judgment of the facts, taking into account official be viewed as a further deterrent against the widespread practice and case law, must appear doubtful from the use of CPM in Germany, even though CPM is widely perspective of an objective third party. The self sed in other countries. imposed restriction to basic cases is lifted only if, fol lowing a tax audit, the application of the transfer pric I. Advance Pricing Agreements ing method established as a result of the audit will be agreed upon for future fiscal years. The draft guidelines further contain one chapter with The draft guidelines also say that APAs should be two sections on APAs(Sec. 3. 1 and Sec. 3. 2.) that refer routinely bilateral. One hopes that this provision would not be applied in a strictly literal sense and will to the legal foundation for the accords and contain a tended to cover multilateral APAs as well. In this re- commentary on Germany's APA procedure. The gen eral perception among practitioners is that the German spect the German tax authority would view the tax authority provides a rather meager contribution to procedure as falling under Article 25, para. l of the an increasingly important issue OECD model treaty of 1992 APAs are receiving increasingly more attention by The draft guidelines' comments on the APa proce- dure mainly refer to the handling of the APa request on ments for avoiding transfer pricing disputes ar the level of the national tax authorities that are in volved. After the taxpayer applies for an APa by filing a assumptions in the OECD APA guidelines in Ne request at its local tax office, the Federal Ministry of fi nance as well as the Federal Tax Office would have to 1999 e involved This has been a major obstacle for APA ne- The German draft somewhat disappointingly does gotiations in the past because in some cases the tax au not really offer anything new on APAs. It would not change current policies in that German tax authorities thorities were represented by more than 20 persons would be entitled to negotiate an APA or, more pre- hich considerably hindered any progress. Though the draft guidelines concede that applications c cisely, to issue a ruling in the wake of a tax audit From made in both jurisdictions involved, a simultaneous au- the point of view of the tax authorities, issuing a ruling eems to be the main area of application for APAs dit should be avoided. Also, the taxpayer can at any However, the draft guidelines would also allow for time withdraw its application. However, the German APAs in cases that are not attached to or following a tax nd foreign tax authorities may decide to continue their audit. Therefore, the legal status quo remains negotiations and come to an agreement without further interest or involvement by the taxpayer In addition, the draft would require the tax authori ties to perform their own fact finding before issuing a transfer pricing APA. Thus, the authorities may need to V Consequences of Non-Compliance conduct almost a full-fledged audit if the last audit of he taxpayer's transfer pricing issues is outdated. It is The draft guidelines also would specify the conse- kely that requiring an audit will severely limit the quences should the taxpayer not fulfill the cooperation number of completed APA cases because there are not or documentation obligations under the new rules. The enough field audit staff at a local level to handle the in- draft document does not include penalties for non creased work compliance as specified in other countries, e.g., in the United States with Section 6662 regulations. However Determining Whether APA Can Be Granted the tax authorities ate that in a case of non compliance the taxpayers results can be estimated for +e The intention to limit work for the authorities is also tax purposes and that the burden of proof changes to flected in other parts of the chapter. According to the the taxpayer In normal transfer pricing cases, the burden of proof double taxation in individual cases only. That could be is usually with the tax authorities. The taxpayer can be interpreted to mean that APA negotiations are to be forced to comply with the regulations by using the mea- routine. This view seems to be supported by yet another sures described in the German code of procedures,e.g statement in the guidelines: " APAs are to be confined to fines(see Sec. 2.3 basic cases. Though the meaning of this statement is somewhat unclear, the expression "basic cases"could Rules for Income Adjustments The rules for income adjustments are detailed in the where high amounts of taxable income are at stake. first chapter of the draft guidelines(Sec.1.1.1.f) This interpretation would also correspond with the cur rent guideline covering tax authority rulings. Therefore, which enumerates the different legal provisions on which an income adjustment may be based. These pro- visions address the deemed dividend and the deeme 6 Cf Kropp Klaus, Eigelshoven, Axel, in: Interna- contribution issue if corporations and their sharehold tional wirtsch fe 2000, p. 163 f. Also see 8 Transfer rs are involved The draft guidelines would allow ger- Pricing Report man officials to accept an adjustment in the usually less TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 1063-2069 BNA TAX 6-14-00
126o.9,No.4) ANALYSIS costly form of an account receivable or an account pay the case of an initial deemed contribution an ad- able, provided the other jurisdiction in the transfer pric ditional repayment of equity capital will be deemed These qualifications might lead to combined tax effects ment according to Article 9 of the OECD Model Treaty that are worse than leaving the original deemed divi of 1992. Any adjustment must be attributed to the year dend as it was in which the non-arm's-length price influenced the tax- ble income Taxation of an adjustment would be based on the V. Conclusion type of income subject to the adjustment(Sec. 1. 2. 1.) This rule would generally apply to taxpayers with dif- ferent types of income. As far as corporations are con cerned, the rules governing trading income should usu- identified that are likely to be contained in the final ver ally be applicable. If the adjustment would lead to double taxation the relevant rules on the avoidance of sion of the guidelines, Probably the most significant fea double taxation would be applicable as we ture for German taxpayers is the emphasis on detailed and contemporaneous documentation. This new focus The guidelines also would confirm the German tax on contemporaneous documentation, affects large authorities policy of rejecting adjusting payments. If groups of the intermational business community with di. non-arms length prices are adjusted by payments that do not qualify under the strict rules for set-off pay rect investments in Germany. In the past, many German ments, taxation would be based on the two gross pay taxpayers with multinational operations neglected pre- aring even basic transfer pricing documentation. nents, rather than on their net effect. In practice this may, for example, affect year-end compensation pay German documentation practice is about to change ments that are often referred to as"marketing contribu both dramatically and broadly. But it still remains to tions seen if the german tax auditors will view the wealth of These payments are admissible in some jurisdictions detailed documentation material specified in the draft even if they are not clearly agreed to beforehand. From be carefully assessed on its own merits the German tax authorities point of view, such pay- audit situation. It would not be helpful if, based on the ments would lead to a double violation of the arms begin routinely request iary, for example, is that instead of curing a deemed ing documentation that is not available in a taxpayer,'s dividend the German subsidiary may end up with an ad- ditional deemed contribution as well 61400 Copyright o 2000 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs, Inc, TMTR ISSN.2069