Transfer Pricing REPORT Volume 11 Number 17 Page 786 Wednesday, January 8, 2003 ssN1521-7760 A nalysIS GERMANY German Transfer Pricing Rules Compatibility with EC Law Court,'s Rulings Indicate Need for Germany to Make Reforms By Heinz-Klaus Kroppen and Lars rehfeld Dr. Heinz-Klaus Kroppen, LL. M, is an international partner and Lars rehfeld is a consultant with Deloitte Touche GmbH's European Transfer Pricing Group in Dusseldo For the past several years German tax literature has questioned the compatibility of German transfer pricing rules with European Community law. Even the German Federal Fiscal Court in a June 21 2001, judgment expressed reservations concerning the compatibility of Section 1 of Germany's Foreign Tax Relations Act(AStG)with the requirements of the European Community Treaty Those reservations further escalated when the European Court of Justice's advocate general said in September 2002 that Germany's thin capitalization rule discriminates against companies that borrow from related foreign parties, and recommended the court strike it down as violating the EC Treaty a The European Court of Justice then issued on Dec 12, 2002, a decision that struck down Germany's thin capitalization requirements because they conflicted with the European Community Treaty, although not necessarily for the same reasons presented by the advocate general. that decision has raised the debate even further over whether Germany' s transfer pricing laws also should be struck down. However, before the ruling in Lankhorst-Hohorst was issued, another ECJ decision on a Swedish case--issued on Nov. 21--presents an even stronger case for concluding that German transfer pricing rules are not compatible with the ec treaty and should be revised. a The Riksskatteverk decision makes it clear that German tax officials and German legislators need to change German tax law with cross-border references and bring them under the guidelines of the eC Treaty--especially the treaty' s basic freedoms Legal Background The November 2002 ECJ judgment stems from attempts by two Swedish residents, X and Y, who wanted to transfer their shares in the X-A. B, a Swedish company, to another Swedish company, the Z-A.B, at their acquisition costs. The Z-A.B. is a wholly owned subsidiary of the Y-S.A, which is domiciled in Belgium. 6= Swedish state income tax law(SIL) provides different legal consequences depending on whether the company receiving the assets is Swedish or is a foreign company and whether the company has Swedish or foreign shareholders. While a transfer of shares to a Swedish company having Swedish
Volume 11 Number 17 Wednesday, January 8, 2003 Page 786 ISSN 1521-7760 Analysis GERMANY German Transfer Pricing Rules' Compatibility with EC Law: Court's Rulings Indicate Need for Germany to Make Reforms By Heinz-Klaus Kroppen and Lars Rehfeld* *Dr. Heinz-Klaus Kroppen, LL.M., is an international partner and Lars Rehfeld is a consultant with Deloitte & Touche GmbH's European Transfer Pricing Group in Düsseldorf. For the past several years German tax literature has questioned the compatibility of German transfer pricing rules with European Community law. 1 Even the German Federal Fiscal Court in a June 21, 2001, judgment expressed reservations concerning the compatibility of Section 1 of Germany's Foreign Tax Relations Act (AStG) with the requirements of the European Community Treaty. 2 Those reservations further escalated when the European Court of Justice's advocate general said in September 2002 that Germany's thin capitalization rule discriminates against companies that borrow from related foreign parties, and recommended the court strike it down as violating the EC Treaty. 3 The European Court of Justice then issued on Dec. 12, 2002, a decision that struck down Germany's thin capitalization requirements because they conflicted with the European Community Treaty, although not necessarily for the same reasons presented by the advocate general. 4 That decision has raised the debate even further over whether Germany's transfer pricing laws also should be struck down. However, before the ruling in Lankhorst-Hohorst was issued, another ECJ decision on a Swedish case--issued on Nov. 21--presents an even stronger case for concluding that German transfer pricing rules are not compatible with the EC Treaty and should be revised. 5 The Riksskatteverk decision makes it clear that German tax officials and German legislators need to change German tax law with cross-border references and bring them under the guidelines of the EC Treaty--especially the treaty's basic freedoms. Legal Background The November 2002 ECJ judgment stems from attempts by two Swedish residents, X and Y, who wanted to transfer their shares in the X-A.B., a Swedish company, to another Swedish company, the Z-A.B., at their acquisition costs. The Z-A.B. is a wholly owned subsidiary of the Y-S.A., which is domiciled in Belgium. 6 Swedish state income tax law (SIL) provides different legal consequences depending on whether the company receiving the assets is Swedish or is a foreign company and whether the company has Swedish or foreign shareholders. While a transfer of shares to a Swedish company having Swedish
shareholders results in a transfer of assets on a book-value basis the transfer to a foreign person or a Swedish company with foreign shareholders has to be performed on a market-value basis taxed at the shareholder s personal income tax rate, even if there is no realized income on costs are The legal consequence is that the difference between the market value and the acquisiti X and Y applied for a preliminary decision on tax matters by the revenue law commission on the application of Article 3, Paragraph 1 of the SIL on the present case. From their point of view, the taxation of a gain equivalent to the difference between the market value and the acquisition cost of the assets would represent a breach of the basic freedoms guaranteed by the Ec Treaty. They argued that the Swedish taxation rules are not compatible with the freedom of establishment under Article of the EC Treaty, the freedom of capital movement provision under Article 56 of the treaty, and the double taxation convention between Belgium and Sweden. 7E The Swedish revenue law commission insisted on the realization of the hidden reserves on a market value basis. The commission s view was that Article 43 of the EC Treaty did not apply to the present case. Further, the commission said that even if Section 3, Paragraph 1 of the SiL did apply and was discriminatory on the basis of the basic freedoms guaranteed by the EC Treaty, the discrimination would be justified by overriding public interest requirements recognized by the Swedish Tax System as necessary to ensure effective fiscal supervision and the cohesion of the Swedish tax system.aIn addition, the authorities alleged that it could be determined that there are strong tax avoidance reasons for the transaction X and Y appealed the decision to the Swedish Supreme Administrative Court claiming that the transfer should be taxed on the basis of the book value. Both X and Y pointed out that the different treatment of Swedish companies and foreign companies or Swedish companies with foreign shareholders leads to an obstacle to the basic freedoms under article 43 and 56 of the ec treaty which could not be justified by overriding public interest requirements Taking the view that the solution of the dispute leads to an interpretation of EC law, the Swedish Supreme Administrative Court decided to refer the question of compatibility with the EC Treaty to the ECJ for a preliminary ruling under Article 234 of the treaty The European courts judgment The ECJ declared in its decision that Article 3, Paragraph 1 of the SIL was incompatible with the freedom of establishment under the EC Treatys Article 43. Referring to former decisions, the court held that Article 43 precludes a national provision that excludes the transferor of shares in companies from the benefit of deferral of a tax due on capital gains made on those shares where the transfer is to a foreign person, in which the transferor directly or indirectly has a holding, giving him definite influence over the decisions of that person, or to a Swedish limited company that is a branch or subsidiary of the foreign person a In cases of the transferor directly or indirectly holding shares, which do not give him a substantial influence on the direction of the receiving company, the ECJ conceded an unjustified restriction of the freedom of capital movement under Article 56 of the EC Treaty 00
787 shareholders results in a transfer of assets on a book-value basis, the transfer to a foreign person or a Swedish company with foreign shareholders has to be performed on a market-value basis. The legal consequence is that the difference between the market value and the acquisition costs are taxed at the shareholder's personal income tax rate, even if there is no realized income. X and Y applied for a preliminary decision on tax matters by the revenue law commission on the application of Article 3, Paragraph 1 of the SIL on the present case. From their point of view, the taxation of a gain equivalent to the difference between the market value and the acquisition cost of the assets would represent a breach of the basic freedoms guaranteed by the EC Treaty. They argued that the Swedish taxation rules are not compatible with the freedom of establishment under Article 43 of the EC Treaty, the freedom of capital movement provision under Article 56 of the treaty, and the double taxation convention between Belgium and Sweden. 7 The Swedish revenue law commission insisted on the realization of the hidden reserves on a market value basis. The commission's view was that Article 43 of the EC Treaty did not apply to the present case. Further, the commission said that even if Section 3, Paragraph 1 of the SIL did apply and was discriminatory on the basis of the basic freedoms guaranteed by the EC Treaty, the discrimination would be justified by overriding public interest requirements recognized by the Swedish Tax System as necessary to ensure effective fiscal supervision and the cohesion of the Swedish tax system. 8 In addition, the authorities alleged that it could be determined that there are strong tax avoidance reasons for the transaction. X and Y appealed the decision to the Swedish Supreme Administrative Court claiming that the transfer should be taxed on the basis of the book value. Both X and Y pointed out that the different treatment of Swedish companies and foreign companies or Swedish companies with foreign shareholders leads to an obstacle to the basic freedoms under Article 43 and 56 of the EC Treaty, which could not be justified by overriding public interest requirements. Taking the view that the solution of the dispute leads to an interpretation of EC law, the Swedish Supreme Administrative Court decided to refer the question of compatibility with the EC Treaty to the ECJ for a preliminary ruling under Article 234 of the treaty. The European Court's Judgment The ECJ declared in its decision that Article 3, Paragraph 1 of the SIL was incompatible with the freedom of establishment under the EC Treaty's Article 43. Referring to former decisions, the court held that Article 43 precludes a national provision that excludes the transferor of shares in companies from the benefit of deferral of a tax due on capital gains made on those shares where the transfer is to a foreign person, in which the transferor directly or indirectly has a holding, giving him definite influence over the decisions of that person, or to a Swedish limited company that is a branch or subsidiary of the foreign person. 9 In cases of the transferor directly or indirectly holding shares, which do not give him a substantial influence on the direction of the receiving company, the ECJ conceded an unjustified restriction of the freedom of capital movement under Article 56 of the EC Treaty. 10
Reasons for the decision The ECJ stated that although direct taxation falls within the competence of EC member states, they must exercise that competence in a manner consistent with ec law that avoids discrimination on grounds of nationality Furthermore, the freedom of establishment under Article 43 was relevant in the present case, the ECJ Referring to the judgment in Case C-112/91 Werner, the Swedish tax authorities denied the pertinence of Article 43, saying the fundamental freedoms conferred by the treaty have no bearing on the case The authorities asserted that the freedoms were not applicable because the case involved an EC member's internal affairs2- The European Court rejected the Swedish authorities argument, saying the relevant Swedish tax regulations require a cross-border transaction of shares or a cross-border reference to foreign companies or foreign shareholders of Swedish companies and therefore the matter is not purely internal Sweden s Article 3, Paragraph 1 distinguishes three types of asset transfers having a crossborder reference transfers to a foreign legal person in which the transferor directly or indirectly has a transfers to a Swedish limited company in which a foreign legal person either directly or indirectly has a holding transfers to a Swedish limited company different from those described in the previous indent and in which the transferor directly or indirectly has a holding Article 43 guarantees the foundation and direction of companies by citizens of different EC-member countries. As a consequence the freedom of establishment is relevant if a citizen of one EC member representing an economically structured entrepreneurship. 499 its seat in another EC member state, oreover, the ECj stated that the application of Article 3, Paragraph 1 in the present case constitutes obstacle to the exercise of freedom of establishment under article 43. In the case of a transfer of shares to a foreign person, denying a carryover on a book value basis could have a deterrent effect on the exercise of the taxpayers right to pursue economical activities in another member state through an intermediary company protected by Article 43. Therefore, refusing to provide the tax advantage is an unjustified discrimination of cross-border transactions leading to a restraint of the freedom of establishment. The second case dealing with a transfer of shares to a Swedish company having foreign shareholders or being a subsidiary of a foreign company is judged in a similar way. Apart from the first case, the ECJs evaluation of the EC Treaty is even more strict. The court stated that accepting the proposition that a relevant member state may deny a benefit, i.e., deferring capital gains tax, because the parent company is situated in another member state, thereby depriving the transferor of a cash flow advantage, would deprive Article 43 of all meaning. 16
788 Reasons for the Decision The ECJ stated that although direct taxation falls within the competence of EC member states, they must exercise that competence in a manner consistent with EC law that avoids discrimination on grounds of nationality. 11 Furthermore, the freedom of establishment under Article 43 was relevant in the present case, the ECJ said. Referring to the judgment in Case C-112/91 Werner, the Swedish tax authorities denied the pertinence of Article 43, saying the fundamental freedoms conferred by the treaty have no bearing on the case. The authorities asserted that the freedoms were not applicable because the case involved an EC member's internal affairs. 12 The European Court rejected the Swedish authorities' argument, saying the relevant Swedish tax regulations require a cross-border transaction of shares or a cross-border reference to foreign companies or foreign shareholders of Swedish companies and therefore the matter is not purely internal. 13 Sweden's Article 3, Paragraph 1 distinguishes three types of asset transfers having a cross-border reference: - transfers to a foreign legal person in which the transferor directly or indirectly has a holding. transfers to a Swedish limited company in which a foreign legal person either directly or indirectly has a holding. transfers to a Swedish limited company different from those described in the previous indent and in which the transferor directly or indirectly has a holding. Article 43 guarantees the foundation and direction of companies by citizens of different EC-member countries. As a consequence the freedom of establishment is relevant if a citizen of one EC member state has a substantial shareholding in a foreign company having its seat in another EC member state, representing an economically structured entrepreneurship. 14 Moreover, the ECJ stated that the application of Article 3, Paragraph 1 in the present case constitutes an obstacle to the exercise of freedom of establishment under Article 43. In the case of a transfer of shares to a foreign person, denying a carryover on a book value basis could have a deterrent effect on the exercise of the taxpayer's right to pursue economical activities in another member state through an intermediary company protected by Article 43. Therefore, refusing to provide the tax advantage is an unjustified discrimination of cross-border transactions leading to a restraint of the freedom of establishment.15 The second case dealing with a transfer of shares to a Swedish company having foreign shareholders or being a subsidiary of a foreign company is judged in a similar way. Apart from the first case, the ECJ's evaluation of the EC Treaty is even more strict. The court stated that accepting the proposition that a relevant member state may deny a benefit, i.e., deferring capital gains tax, because the parent company is situated in another member state, thereby depriving the transferor of a cash flow advantage, would deprive Article 43 of all meaning. 16
Gaining a Tax Advantage Justifying the restriction of the freedom of establishment, the Swedish tax authorities pointed out that the only reason for the share transfer transaction proposed by the applicants in the main proceedings is to gain a tax advantage. Therefore, Sweden is entitled to take measures to prevent its nationals from misusing rights created by the treaty, circumventing their national legislation, or to prevent individuals from improperly or fraudulently taking advantage of the provisions of community law The ECj basically accepted this line of argument. However, the court also said this could not lead to a general restriction of the freedoms guaranteed by the treaty without detailed provisions of an individual case first being closely examined by a domestic court. E The Swedish tax authorities line of argument refers to the basic guarantees of Article 43, which could not be subject to a member states disposition. Especially the charge of fraudulent use of EC law could not justify a breach or restriction of guaranteed freedoms of the EC Treaty Tax System Coherence Further, the Swedish tax authorities refer to the argument that the different treatment is justified by overriding public interest requirements relating to the need to ensure the coherence of the Swedish tax system. This basic principle was stated at first by the ECJ in the Badman case. 18 =since that decision, the ECJ has never again accepted coherence of a national tax system as a reason that justified a member state's restricting of basic freedoms. In the present case, the ECj also did not accept the need to safeguard the cohesion of a tax system To have accepted the cohesion of a national tax system as a reason that justified restriction of a one side and the taxation of payments has to be given for the same taxpayer. se deductibility on the treaty-guaranteed fundamental freedom--in this situation, a direct link between the In the present case, any fiscal coherence between the deferral of a capital gains tax and the final taxation of the gain could not be found. =Moreover, the deferral and the taxation of capital gains are realized on different levels. The double taxation convention between Sweden and Belgium insofar takes priority over Article 3, Paragraph 1, which addresses allocating the right of taxation on the hidden reserves to the residence country of the shareholder only in cases of a disposal of the shares under Article 13, Paragraph 4 of the Sweden-Belgium double taxation convention. So there is not direct correlation between advantage and disadvantage on the national taxation level of the shareholde In addition, Article 13, Paragraph 4 of the Sweden-Belgium double taxation agreement allocates the right of taxation to the country of source under the provisions of the transfer of residence within the last five years before the realization of capital gains. As a legal consequence, the double taxation convention contains the attribution of the taxation right concerning the capital gains resulting from a disposal of shares on a legal entity, so the court concluded that there is no need to ensure the coherence of the Swedish tax system by the taxation of the hidden reserves in cases of share transfers to a foreign shareholder or a Swedish company with foreign shareholders.- Furthermore, the European court pointed out that the right of taxation on capital gains could be safeguarded by measures that are less restrictive to freedom of establishment and relate specifically to the risk of a definitive departure of the taxpayer, but not on the transfer of assets to a foreign company -The court argued that the tax evasion does not depend on a transfer of shares to a Swedish company, Swedish shareholders, or a foreign company, because anti-tax avoidance measures always have to concentrate on the transferor, but not the transferee. Moreover, Sweden loses its right to tax capital gains by the time a shareholder changes his country of residence irrespective of in which country the shareholder owns shares. Therefore tax evasion or tax fraud
789 Gaining a Tax Advantage Justifying the restriction of the freedom of establishment, the Swedish tax authorities pointed out that the only reason for the share transfer transaction proposed by the applicants in the main proceedings is to gain a tax advantage. Therefore, Sweden is entitled to take measures to prevent its nationals from misusing rights created by the treaty, circumventing their national legislation, or to prevent individuals from improperly or fraudulently taking advantage of the provisions of community law. The ECJ basically accepted this line of argument. However, the court also said this could not lead to a general restriction of the freedoms guaranteed by the treaty without detailed provisions of an individual case first being closely examined by a domestic court.17 The Swedish tax authorities' line of argument refers to the basic guarantees of Article 43, which could not be subject to a member state's disposition. Especially the charge of fraudulent use of EC law could not justify a breach or restriction of guaranteed freedoms of the EC Treaty. Tax System Coherence Further, the Swedish tax authorities refer to the argument that the different treatment is justified by overriding public interest requirements relating to the need to ensure the coherence of the Swedish tax system. This basic principle was stated at first by the ECJ in the Badman case. 18 Since that decision, the ECJ has never again accepted coherence of a national tax system as a reason that justified a member state's restricting of basic freedoms. 19 In the present case, the ECJ also did not accept the need to safeguard the cohesion of a tax system. To have accepted the cohesion of a national tax system as a reason that justified restriction of a treaty-guaranteed fundamental freedom--in this situation, a direct link between the deductibility on the one side and the taxation of payments has to be given for the same taxpayer. 20 In the present case, any fiscal coherence between the deferral of a capital gains tax and the final taxation of the gain could not be found. 21 Moreover, the deferral and the taxation of capital gains are realized on different levels. The double taxation convention between Sweden and Belgium insofar takes priority over Article 3, Paragraph 1, which addresses allocating the right of taxation on the hidden reserves to the residence country of the shareholder only in cases of a disposal of the shares under Article 13, Paragraph 4 of the Sweden-Belgium double taxation convention. So there is not direct correlation between advantage and disadvantage on the national taxation level of the shareholder. In addition, Article 13, Paragraph 4 of the Sweden-Belgium double taxation agreement allocates the right of taxation to the country of source under the provisions of the transfer of residence within the last five years before the realization of capital gains. As a legal consequence, the double taxation convention contains the attribution of the taxation right concerning the capital gains resulting from a disposal of shares on a legal entity, so the court concluded that there is no need to ensure the coherence of the Swedish tax system by the taxation of the hidden reserves in cases of share transfers to a foreign shareholder or a Swedish company with foreign shareholders. 22 Furthermore, the European court pointed out that the right of taxation on capital gains could be safeguarded by measures that are less restrictive to freedom of establishment and relate specifically to the risk of a definitive departure of the taxpayer, but not on the transfer of assets to a foreign company. 23 The court argued that the tax evasion does not depend on a transfer of shares to a Swedish company, Swedish shareholders, or a foreign company, because anti-tax avoidance measures always have to concentrate on the transferor, but not the transferee. Moreover, Sweden loses its right to tax capital gains by the time a shareholder changes his country of residence, irrespective of in which country the shareholder owns shares. Therefore, tax evasion or tax fraud
790 cannot be concluded generally from the fact that the transferee or its parent company is established in another member state, and therefore the fact cannot justify a fiscal measure that compromises the exercise of a fundamental freedom guaranteed by the treaty .2 4a With similar considerations, the court determined an unjustified obstacle to the freedom of capital movement under Article 56 of the EC Treaty in case of a non-substantial shareholding, which does not give any influence on the direction of the company. 25-0 Consequences on German Transfer Pricing The ECJ court has again emphasized that a different treatment of cases cannot be justified by the fact that one case is a domestic and the other is a cross border case. Cross-border transactions between related and unrelated companies or such companies and their shareholders cannot be treated differently from domestic transactions under the same or similar conditions Section 1, Paragraph 1 of the Foreign Tax Relations Act(AStG) is only applicable on transactions between related companies in different countries. The legal consequence of the provision is a profit German tax law does not provide for an adjustment possibility in such cases. -nout es between a adjustment according to the arm length principle. Contrary to that, the supply of services between a German parent company and its resident subsidiary could be performed without compensation Draft Legislation Germany's legislature is expected to take up in 2003 proposed legislation drafted by the German Finance Ministry that would establish the need for taxpayers to provide detailed documentation about the economical and legal basis for the setting of transfer prices between associated enterprises.7=all these obligations are not fulfilled, taxpayers face the possibility the auditor will estimate the taxpayers arm'sength profits, the burden of proof will shift to the taxpayer, and a surcharge will be imposed according to recent drafts. 28 -Despite the ECj's ruling, the legislation contains provisions that would provide for different treatment of foreign and resident companies concerning documentation requirements because it is only applicable on cross-border transactions. It can be predicted that the German tax authorities will respond to charges of discrimination by referring to the need to prevent tax evasion and the need to secure the coherence of the national tax system. As the judgment of the ECj in the present case shows, this general practice of the German tax authorities will probably not be successful In Case C-436/00, the European court already stated that the danger of tax evasion is not a specific reason to justify an obstacle to the basic freedoms. 9-The need to safeguard the cohesion of the German tax system also cannot justify a different treatment by the German tax provision. This basic principle requires a direct link between the systematic advantage and disadvantage in the taxation of one single person. The adjustment of transfer prices between two related companies does not fulfil this requirement because the advantage or disadvantage of high or respectively low transfer prices affects different taxpayers Lankhorst-Hohorst Similar to the decision in the present case, the ECJ on Dec. 12, 2002, declared the German thin capitalization provisions under Section 8, Paragraph 1 of the No. 2 German Corporate Taxation Act
790 cannot be concluded generally from the fact that the transferee or its parent company is established in another member state, and therefore the fact cannot justify a fiscal measure that compromises the exercise of a fundamental freedom guaranteed by the treaty. 24 With similar considerations, the court determined an unjustified obstacle to the freedom of capital movement under Article 56 of the EC Treaty in case of a non-substantial shareholding, which does not give any influence on the direction of the company. 25 Consequences on German Transfer Pricing The ECJ court has again emphasized that a different treatment of cases cannot be justified by the fact that one case is a domestic and the other is a cross border case. Cross-border transactions between related and unrelated companies or such companies and their shareholders cannot be treated differently from domestic transactions under the same or similar conditions. Section 1, Paragraph 1 of the Foreign Tax Relations Act (AStG) is only applicable on transactions between related companies in different countries. The legal consequence of the provision is a profit adjustment according to the arm'-slength principle. Contrary to that, the supply of services between a German parent company and its resident subsidiary could be performed without compensation. German tax law does not provide for an adjustment possibility in such cases. 26 Draft Legislation Germany's legislature is expected to take up in 2003 proposed legislation drafted by the German Finance Ministry that would establish the need for taxpayers to provide detailed documentation about the economical and legal basis for the setting of transfer prices between associated enterprises. 27 If these obligations are not fulfilled, taxpayers face the possibility the auditor will estimate the taxpayer's arm'-slength profits, the burden of proof will shift to the taxpayer, and a surcharge will be imposed, according to recent drafts. 28 Despite the ECJ's ruling, the legislation contains provisions that would provide for different treatment of foreign and resident companies concerning documentation requirements because it is only applicable on cross-border transactions. It can be predicted that the German tax authorities will respond to charges of discrimination by referring to the need to prevent tax evasion and the need to secure the coherence of the national tax system. As the judgment of the ECJ in the present case shows, this general practice of the German tax authorities will probably not be successful. In Case C-436/00, the European court already stated that the danger of tax evasion is not a specific reason to justify an obstacle to the basic freedoms. 29 The need to safeguard the cohesion of the German tax system also cannot justify a different treatment by the German tax provision. This basic principle requires a direct link between the systematic advantage and disadvantage in the taxation of one single person. The adjustment of transfer prices between two related companies does not fulfill this requirement because the advantage or disadvantage of high or respectively low transfer prices affects different taxpayers. Lankhorst-Hohorst Similar to the decision in the present case, the ECJ on Dec. 12, 2002, declared the German thin capitalization provisions under Section 8, Paragraph 1 of the No. 2 German Corporate Taxation Act
blishment under Article 43the La In another case, Bosal Holding B V, the Ec advocate general underlined the necessity for equal treatment of national and cross border transactions between affiliated companies _ This statement might lead to the assumption that any different treatment of cross-border transactions within the Ec in comparison to national transactions results in an unjustified breach of EC law. -only public interests of high importance can justify an interference in the basic guarantees of the treaty freedoms. But in the last few years the ECj did not accept any of the arguments brought up by the member states for ar obstacle to Ec law Conclusion Noting the ECJ advocate general s opinion in the lankhorst-Hohorst and Bosal Holding B.V. cases and the ecj decisions in the riksskatteverk and Lankhorst-Hohorst gmbh cases. the german tax authorities and the german tax legislature would be well advised to review section 1 of the german Foreign Tax Act and draft transfer pricing legislation Now is the time to check and change German tax laws with cross-border references, such as those for transfer pricing, and bring them into alignment with the guidelines of the EC Treaty. German tax law has to be systemized under the requirements of European provisions, especially the basic freedoms of the treaties. If this does not happen within the next years, German tax legislation and German tax authorities always will be at risk of practicing unlawful regulations in terms of the EC' s statutes including those for transfer pricing This warning applies to other EC member states as well. The increasing number of judgments declaring national tax law compatible with EC law should lead other EC members to realize that national tax systems within Europe have to be adjusted to the requirements of the Communitys requirements 1 cp. Eigelshoven, IWB, Case 3, Group 1, p. 1761; Bauschatz, IStR 2002, p.291,333 Koplin/Sedemund, IStR 2002, p. 120; Borstel/Brunninghaus, IStR 2001, p. 757; Brenner, KFR 2001 p 383: Menck, IWB, Case 2, p 715; Pfluger, PIStB 2001, p. 260 B141/00,BFHE195,p.398 3 Lankhorst-Hohorst GmbH, European Court of Justice, C-324/00, advocate generals opinion issued 9/26/02(11 Transfer Pricing Report 680, 11/27/02) 4 See the related article and text of the decision in this issue Case C-436/00. Riksskatteverk ECJ, Case C-436/00, Riksskatteverk, Para. 14. Section 3, Paragraph 1 ECJ Case C-436/00. Riksskatteverk Para 19 ff 8 ECj. case C-436/00. Riksskatteverk Para 24 9 ECJ Case C-436/00. Riksskatteverk. Para. 65.75 ECJ Case C-436/00. Riksskatteverk, Para. 74 ff
791 (KStG) as incompatible with the freedom of establishment under Article 43--the Lankhorst-Hohorst ruling. 30 In another case, Bosal Holding B.V., the EC advocate general underlined the necessity for equal treatment of national and cross border transactions between affiliated companies. 31 This statement might lead to the assumption that any different treatment of cross-border transactions within the EC in comparison to national transactions results in an unjustified breach of EC law. 32 Only public interests of high importance can justify an interference in the basic guarantees of the treaty freedoms. But in the last few years the ECJ did not accept any of the arguments brought up by the member states for an obstacle to EC law. 33 Conclusion Noting the ECJ advocate general's opinion in the Lankhorst-Hohorst and Bosal Holding B.V. cases and the ECJ decisions in the Riksskatteverk and Lankhorst-Hohorst GmbH cases, the German tax authorities and the German tax legislature would be well advised to review Section 1 of the German Foreign Tax Act and draft transfer pricing legislation. Now is the time to check and change German tax laws with cross-border references, such as those for transfer pricing, and bring them into alignment with the guidelines of the EC Treaty. German tax law has to be systemized under the requirements of European provisions, especially the basic freedoms of the treaties. If this does not happen within the next years, German tax legislation and German tax authorities always will be at risk of practicing unlawful regulations in terms of the EC's statute--s including those for transfer pricing. This warning applies to other EC member states as well. The increasing number of judgments declaring national tax law as incompatible with EC law should lead other EC members to realize that national tax systems within Europe have to be adjusted to the requirements of the Community's requirements. _____________________________________ 1 cp. Eigelshoven, IWB, Case 3, Group 1, p. 1761; Bauschatz, IStR 2002, p. 291, 333; Köplin/Sedemund, IStR 2002, p. 120; Borstell/Brünninghaus, IStR 2001, p. 757; Brenner, KFR 2001, p. 383; Menck, IWB, Case 2, p. 715; Pflüger, PIStB 2001, p. 260 2 I B 141/00, BFHE 195, p. 398 3 Lankhorst-Hohorst GmbH, European Court of Justice, C-324/00, advocate general's opinion issued 9/26/02 (11 Transfer Pricing Report 680, 11/27/02). 4 See the related article and text of the decision in this issue. 5 Case C-436/00, Riksskatteverk. 6 ECJ, Case C-436/00, Riksskatteverk, Para. 14. Section 3, Paragraph 1 7 ECJ, Case C-436/00, Riksskatteverk Para. 19 ff. 8 ECJ, Case C-436/00, Riksskatteverk Para. 24. 9 ECJ, Case C-436/00, Riksskatteverk, Para. 65, 75. 10 ECJ, Case C-436/00, Riksskatteverk, Para. 74 ff
792 11 ECJ. Case C-264/96. ICL. ECR 1998. 1-4695. Para. 19 Case C-55/00. Gottardo, ECR 2000. 1-413 Para. 32 ECJ Case C-436/00. Riksskatteverk No 33 ECJ Case C-436/00. Riksskatteverk No 34 ECJ Case C-251/98. Baars ECR 2000. 1-2787. Para. 22 ECJ Case C-436/00. Riksskatteverk. Para. 36: Case C-251/98. Baars ECR 2000. 1-2787 Para. 22 28: Case C-208/00, Uberseering, Para. 77. ECJ, Case C-436/00, Riksskatteverk, Para. 38: Cases C-397/98 and C-410/98, Metallgesellschaft ECR2001,|-1727,Para.42. 17 ECJ. Case C-436/00. Riksskatteverk. Para. 43. with reference to Case C-212/97. Centros. ECR 1999, Para. 25: cp. In this direction, the enumeration of judgments dealing with the fraudulent use of basic freedoms guaranteed by the Ec treaty in Case C-212/97, Centros, ECR 1999, 1-1459, Para. 24 ECJ, Case C-204/90, Badman, ECR 1992, 1-249; Case C-300/90, Commission/Belgium, ECR 1992 -305 cp. the current judgment of the ECJ, Case C-324/00, Lankhorst-Hohorst, Para. 39 ff, Thommes, DB 2002,p.2397 No D. ECJ, Case C-35/98: Verkooijen, ECR 2000, 1-4071, Para. 57 with reference to previous 2] ECJ Case C-436/00. Riksskatteverk. Para. 53 ff 22 ECJ Case C-436/00. Riksskatteverk Para55 23ECJ Case C-436/00. Riksskatteverk. Para. 59 ECJ Case C-436/00. Riksskatteverk, Para. 60 ff ECJ Case C-436/00. Riksskatteverk, Para. 66 ff 26BFH,BSB!.1988Ⅱ,p.348;1989l,p.633 Section 90, Paragraph 3 of the German Internal Revenue Code(AO), See Rasch, Stephan; Roeder, Achim, The German Move to Transfer Pricing Documentation, Penalties, (11 Transfer Pr 731,12/11/02) Proposed Section 162, Paragraph 2-4 of germany s Internal Revenue Code ECJ. Case C-264/96. ICl. ECR 1998. 1-4695. Para. 25: Cases C-397/98 and C-410/98 Metallgesellschaft, ECR 2001, 1-1727, Para. 59; Case C-307/97, Saint-Gobain, ECR 1999, 1-6161 Para. 50 ECJ Case C-324/00 Case C-168/01; cp. Thommes, DB 2002, p 2397 Thommes, DB 2002, p 2397 33cp. ECJ, Case C-436/00, Riksskatteverk, Para. 51 for an enumeration of accepted interventions
792 11 ECJ, Case C-264/96, ICI, ECR 1998, I-4695, Para. 19; Case C-55/00, Gottardo, ECR 2000, I-413, Para. 32. 12 ECJ, Case C-436/00, Riksskatteverk, No. 33. 13 ECJ, Case C-436/00, Riksskatteverk, No. 34. 14 ECJ, Case C-251/98, Baars, ECR 2000, I-2787, Para. 22. 15 ECJ, Case C-436/00, Riksskatteverk, Para. 36; Case C-251/98, Baars, ECR 2000, I-2787, Para. 22, 28; Case C-208/00, Überseering, Para. 77. 16 ECJ, Case C-436/00, Riksskatteverk, Para. 38; Cases C-397/98 and C-410/98, Metallgesellschaft, ECR 2001, I-1727, Para. 42. 17 ECJ, Case C-436/00, Riksskatteverk, Para. 43, with reference to Case C-212/97, Centros, ECR 1999, Para. 25; cp. In this direction, the enumeration of judgments dealing with the fraudulent use of basic freedoms guaranteed by the EC Treaty in Case C-212/97, Centros, ECR 1999, I-1459, Para. 24. 18 ECJ, Case C-204/90, Badman, ECR 1992, I-249; Case C-300/90, Commission/Belgium, ECR 1992, I-305 19 cp. the current judgment of the ECJ, Case C-324/00, Lankhorst-Hohorst, Para. 39 ff., Thömmes, DB 2002, p. 2397. 20 cp. ECJ, Case C-35/98; Verkooijen, ECR 2000, I-4071, Para. 57 with reference to previous judgments. 21 ECJ, Case C-436/00, Riksskatteverk, Para. 53 ff. 22 ECJ, Case C-436/00, Riksskatteverk, Para. 55. 23 ECJ, Case C-436/00, Riksskatteverk, Para. 59. 24 ECJ, Case C-436/00, Riksskatteverk, Para. 60 ff. 25 ECJ, Case C-436/00, Riksskatteverk, Para. 66 ff. 26 BFH, BStBl. 1988 II, p. 348; 1989 II, p. 633 27 Section 90, Paragraph 3 of the German Internal Revenue Code (AO), See Rasch, Stephan; Roeder, Achim, "The German Move to Transfer Pricing Documentation, Penalties," (11 Transfer Pricing Report 731, 12/11/02). 28 Proposed Section 162, Paragraph 2 - 4 of Germany's Internal Revenue Code. 29 ECJ, Case C-264/96, ICI, ECR 1998, I-4695, Para. 25; Cases C-397/98 and C-410/98, Metallgesellschaft, ECR 2001, I-1727, Para. 59; Case C-307/97, Saint-Gobain, ECR 1999, I-6161, Para. 50 30 ECJ, Case C-324/00, 31 Case C-168/01; cp. Thömmes, DB 2002, p. 2397 32 Thömmes, DB 2002, p. 2397. 33 cp. ECJ, Case C-436/00, Riksskatteverk, Para. 51 for an enumeration of accepted interventions
