AUGUST 2000 EUROPEAN TAXATION 38 What's Going On In... GERMANY Changes in Cost-Sharing Guidelines Dr Heinz-Klaus Kroppen* and Dr Achim Roeder** 30 December 1999 German transfe Ministry of is matter and did not include a as to the acceptability of cost-shar- 1983 transf ment c the adm The tinued to and ac lerChry fone/Ma of the ch any pitfalls planning o 9article ing a compa and new G Starting from and new p upon. Appli lighted and p OECD this article will guidelines in or EVOLUTION SHARING y1983-ivc5- return on o English transla- that the prehensi 1999-4 For an English Pricing Report 21 payers unde fir mulrinationale nal guideli 999), at 64 et se of the Adm tional verbundene 1984/1985,(Herne At that time themselves on breaking new und with the release of , ed. OECD (Paris: OECD cost-sharing guidelines. Also, fer. IDW. eport 2000 International Bureau of Fiscal
EUROPEAN TAXATION AUGUST 20C Probably the most remarkable change to the April draft charge the services in question. The maindifferenc. from a practical point of view was the abandonment of an between the two altematives may be seen in the applica explicit profit margin for the provision of services from a tion of a profit mark-up. While any transaction charged nally, the draft stipulated in Paragraph 1. 7 that a mark-up arm's length remuneration (i.e. a mark-up); the new guide of 5% would be common practice and in accordance with lines basically only allow the recovery of costs for services 's length standards if charged by a foreign service rendered between the parties to a cost-sharing agreement provider. Comments on the draft nightly criticized this margin as being inconsistent with other tax administration The question of profit mark-up leads again to the pool con- 5% to 10% margin was mentioned for services provided to pool concept it may now be regarded as formingthe con- been included in the final version, it may, together with the participants of the cost-sharing scheme replace a market res, serve as a first indication of a cost-plus mar- transaction by setting up an association or-in economic g that would usually be acceptable to the tax tems -an institution. In economic theory, such behaviour author explained by the transaction cost approach, In legal terms the pool members form something like a civil The extent of the change between old and new rules can law partnership(BGB-Gesellschaft) 1 However, this insti already be indicated on a purely formal level if one com- tution or association is not recognized as a partnership for pares the number of paragraphs that are included in the tax purposes. 13 respective texts. While in 1983 fourteen paragraphs seemed to be sufficient to cover the topic, the 1999 guide From the tax administrations point of view, the denial of doubled in size. The old text consisted of four main chap- the refusal of a profit mark-up by supporting the argument ters dealing with the definition and scope of the guide wetly the only profit element that may be charged l lines, the content of cost-sharing agreements, the fulfil- ited to a portion of the cost of the equity capital employed ment of these agreements, and basic documentation equirements. The new guidelines consist of eight mai by the bers in rend bering services within the pool parts, covering not only the above but also paying special Obviously this profit would have to match comparably attention to, for instance the determination of the alloc- small returns on low-risk investments. In fact the new able amount the allocate d special issues such as late entry or early withdrawal. rules stipulate that the respective capital market interest rate for deposits must be applied. The denial of profits mong the cost-sharing arrangements participants would DEFINITION OF COST-SHARING thus fit neatly into the rationale of a profit-free service ARRANGEME flow within a single institution. Besides, payments under the cost-sharing arrangement could be replacing own costs of the service recipient, for which in turn an additional mark-up would not be applicable. ally admitted cost-sharing arrangements for research and Obviously, the above would lead to inappropriate results development costs as well as for the costs of intra-grou in cases where companies devote substantial parts of their administrative services. However, the application of qual- activities to the pool, at costs that otherwise could have ified agreements used to be limited to situations in which demanded a profit-bearing market price in transactions only a uniform assessment of the services was possible or with third parties. The new cost-sharing guidelines avoid if it was difficult to ascertain the costs incurred to the, such a situation in two ways. First, they only allow auxil- iary activities to be conducted within the cost-sharing for both R&D and non-R&D activity. According to the provides must not make up the majority of its economic general definition in Paragraph lI of the new guidelines, activit a cost-shaning arrangement is an agreement that is entered However, the new guidelines do not provide a ing cross-border in order to jointly obtain or produce 8. Administrative Principles, Para. z. .chnachnichten 8(1999), at 385 assets, services, or rights for the parties 'mutual benefit. In 9. See Alexander Vogele and Unf Freytag, "Kembereiche der peven pru loing so the parties to the agreement become members of 240gsgrundsatze zu Kostenumlagen", 9 intemationales Steuerrecht&(2000, a cost-sharing pool. The pool concept is explicitly men 10. Administrative Principles, Para. 7.1.2. tioned in the new guidelines and is central to an under-11. See Ronald HCoase,"The Nature of the Firm",in4Economica(1973),at standing of the guiding principles of the new rules 390 et seq. For an example of an application of the transaction cost approach to ng, see s Compared to the past situation, there seems to be a signif- Sharing: An Economic Ap ntly broader scope to employ qualified cost-sharing 12. See Amdt Rapa arrangements. Because the former restrictions to cases Gewinnaufschlag im Hinblick auf die Organisation multinational er k oder obn with specific valuation problems no longer exist, tax payers in fact have the option to either structure their 13. New Cost Sharing Guidelines, Para.1.1 transactions as cost-sharing arrangements or to separately 15. New Cost Sharing Guidelines, Para.2. - 2000 International Bureau of Fiscal documentation
AUGUST 2000 EUROPEAN TAXATION clear yardstick for determining when an auxiliary activity situations where a profit mark-up for the services rendered Is no longer auxiliary. An analysis of comparable returns to the pool would have to be seriously considered in light on assets might offer the first indication in this respect. of arm,s length aspects Second, the guidelines try to keep the pool members as homogeneous as possible and seek to admit only pools of equals. This issue is analysed below. SIGNIFICANCE OF ANALYSIS OF COSTS AND BENEFITS MEMBERSHIP IN COST-SHARING ARRANGEMENTS It is partly claimed in the literature that the most prominent hanges in the new rules apply to the allegedly new bene fit analysis. Though it' is true that more text has been Under the new guidelines, participants in a cost-sharing devoted to the subject, one might question if there hay pool must be pursuing similar interests. With this concept been changes in essence. The old rules simply stated that if OECD rules. The old guidelines did not contain an explicit under the agreement. z Also, the old rules stipulated that referred to the cost allocation among members of one necessarily reflect their relative benefits under the cost- roup of companies. In this regard, two partly offsetting sharing scheme. 23 Taking this into account, even under the effects can be observed On the one hand the new guide- old rules some kind of benefit analysis would have bee lines increase the potential scope of cost-sharing arrange- necessary to determine the proper allocation key even costs would generally be possible, while, on the other nent review thereof was not required on and the perma- hand, the number of eligible members is restricted. The new set of rules stipulates that costs are to be allocated The question to be solved now is how the term similar on the basis of the benefit that each pool member may interest"can be defined on an operational level. The expect. The rules provide for the direct or indirect mea- guidelines suggest that benefits may take the form of cost surement of the anticipated benefits Measured on a direct wever, it is stipulated basis, the anticipated benefit would be determined by the that only parties that use services from the pool in an eco- amount of additional income generated or costs saved. If nomically identical way qualify for participation in the such a direct approach is not possible, an indirect mea- cost-sharing scheme. From the explanation, it appears surement of the benefits that would approximate the distri- at an economically identical use would mean that the bution of the anticipated benefits among the grude est- rties show a high degree of similarity in their interest in could be used. Examples in the guidelines includ pants anticipating in the respective pool. That would suggest mated units used, produced, or sold; sales; and operating similar benefits from their participation in the cost-sharing. such as the number of employees, the wage total, and arrangement. It would not be sufficient that their benefits invested capital can be measured reliably in a currency amount, but they However, the method used for measuring anticipated ben- would also have to stem from a comparable source(e.g. efits must be the most reliable measure thereof. The new either increases in licence income or reductions of admin- Principles stress that the allocation key (i. e the anticipated istrative costs). benefits)must be the most objective one in the individual This is also supported by the examples provided in the text case. Only if several keys appear to have the same qualit of the new guidelines. The tax authorities now explicitly is it at the discretion of the taxpayer to select a key. in deny that a patent-exploitation company may join an r&d other words, it is implicitly assumed that the best method pool of manufacturing companies, since the interests of a for measuring the anticipated benefits can be objectively rom those of a manufacturing company. The same The reliability of the benefit projections must be verified applies for combinations of production companies and at regular intervals and adjusted if necessary. An adjus holding companies. 20 In fact, such combination may cause e ment becom cessary if there have been material single holding company may participate in an r&d pool changes. In contrast to the us regulations for instance From an administrative point of view, smaller pools can be managed more easily. All things being equal, an increase in the number of members will increase the tax-motivated 17.. New Cost Sharing Guidelines, Para. 1.1. costs of the participating parties. Also, combinations of 18. New Cost Sharing Guidelines,Para.1.2. production and distribution companies might now be more 19. New Cost Sharing Guidelines, Para.1.2. 21. See Alexander Vogele and Christian M. Scholz, "Nutzen-Analyse im rab- As indicated above, the similarity of interests that is hr5(200),at155 required will lead to a rather homogeneous composition of 22. Administrative Principles, Para. 7.4.1, No I participants in cost-sharing arrangements, thus avoiding 23. Administrative Principles, Para.7.2.1.No. 4 2000 International Bureau of Fiscal Documentation
384 EUROPEAN TAXATION AUGUST. 200E vided?. Moreover, the US regul lations allow retroactive This fact pattern may actually be the standard situationin adjustments; whereas the German tax authorities have tra- many international M&A cases if the pooled esearch ditionally been rather reluctant to accept such a mecha- activities of the restructuring groups are put together. Itis nism. Instead it is claimed that if reviews are conducted in remarkable as well that the tax authorities do not requir due time the adjustments would only affect future peri- an exact match in value of the two sets of know-how. In One significant difference vis-a-vis the old guidelines is involved to find an appropriate solution and avoid disad the introduction of a test comparing the"cost-sharing vantageous profit realization. cheme and individual transaction. The tax authorities In cases that do not fall under the exception described willing to join or continue participation in a cost-sharing. sidered. Members of an existing pool would not gnnt any vices at lower costs in direct transactions, In that way, the member, but new members would rather have to pay a tax authorities are abstractly, prescribing a certain actual licence fee. This fee should normally be tax deductible and behaviour to the taxpayer and are thus also setting an would not result in an asset. Since the importance and thus implicit ceiling on the taxpayer's deductible expenses. It the value of the prior research results usually decreases might be questionable if such a requirement is in fact in over time, the licence fee should gradually phase out over granted a considerable degree of freedom in determining what the taxpayer deems appropriate or necessary activ ities and the legal framework of these activities. DOCUMENTATION REQUIREMENTS It would not be acceptable if the new rules were to be To be classified as a qualified cost -sharin for any single service request that the taxpayer could not. the written agreement must comply with certain require Such a requirement would make the use of cost-sharing chemes impossible. Also, the test demanded by the new arrangements must be in writing and contemporaneous idelines corre comparable uncontrolled ith the formation(and any revision) of the arrangement. price method. A comparison of prices could only be The new rules explicitly identify a number of items that and the potential service obtained directly were identical The document itself or its appendices, enclosures or addi- should rather be understood as a tool that can be used by the tax authorities against abusive cases. Under normal names of pool members and beneficiaries circumstances it should be acceptable to demonstrate the a detailed description of the contractually agreed ser- vIces general benefit and the use of an appropriate allocation a determination of the costs to be allocated, method of cost calculation and possible deviatio a determination of the benefits expected by the partic. TREATMENT OF BUY-IN PAYMENTS a determination of the allocation key a description of how initial contributions of pool mem Completely new to the cost-sharing guidelines is the sec- bers will be determined and allocated w participants seek membership in the type and extent of inspection of accounts; an existing pool, especially in an r&d pool. In such a provisions regarding adjustments that will be made if he new entrant would participate in the results of the circumstances change over the course of the agree. men research or development work that had already been per- formed but would not have participated in the costs that the contractual duration of the agreement; provisions regi had been incurred. In such a case, unrelated parties would garding the termination of the agreement the entry of new members and the withdrawal of mem usually require a compensation payment from the new agreements on the access to documents and records One question that arises in this context is how the buy-in regarding the expenses and services of the service provider; and guidelines state that the new member would generally have to show the payment as an asset in the new member's 2s. Us Treas Reg. Sec. 1.482-4(D(2)D)D) balance sheet (i.e. as an acquired intangible)and amortize 26. New Cost Sharing Guidelines, Para. 3.3 it appropriately in subsequent years. However, there is an 27. New Cost Sharing Guidelines, Para.3. important exception to this rule. If the new member would 28, Helmut Becker "Verwaltungsgrundsatze zur Einkunftsabgrenzung"IM in turn also introduce know-how to the pool that is valued Helmut Becker and Heinz-KJaus Kroppen(eds ) Handbuch internationl Vih at approximately the same amount as the existing know echnungspreise(KoLn: Dr. Orto Schmidt Verlag, 1999). note 1.4.1 29. New Cost Shaning Guidelines, Para. 4.1 how of the pool, a buy- in payment will not be necessary. 30. See Helmut Becker, "Cost Sharing". Internationale Wirtschafs-Brrfei (1998), Fach 10, Gruppe 2, at 1328 et seq 2000 international Bureau of Fiscal ocumenta
AUGUST 2000 EUROPEAN TAXATION allocation of the rights developed under an R&D CONCLUSION agreement As can be seen from the discussion above, the new princi- Although the content of the documentation reg deseed ples for cost-sharing agreements change the existing rules and illustrated in much more detail. Documentation in some significant areas, including membership. There- appendices thereof, as well as the documentation of the ng agreements. Companies that are presently engaged in benefit for the service recipient and evidence that the cost- sharing agreements in Germany should review any agreed services have actually been rendered by the existing arrangements carefully and make whatever modi provider. The actual computation of the allocated costs for 2000.1 If the necessary changes are not made, the conse- quences could be severe. If there are major shortcomings However, the new guidelines prescribe the necessary in the arrangement, the deductibility of charges stemming information in much more detail. The annual settlement of from a cost-sharing scheme could be denied in Germany list of the total expenses in respect of cost centres and their decreased by the tax authorities based on an estimation.To direct and indirect costs according to cost types such as that cannot participate in the same pool under the ne labour costs, travel expenses and office rent On the level rules, such agreements might need to be terminated. of the service recipient, the documentation may take a lumber of forms, including the form of monthly, quarterly, or annual reports on services or projects, relevant corres- pondence, research reports, lists of patent applications and 31. New Cost Sharing Guidelines, Para. 8
