epo The court further ruled that has turned that understanding different price. It's unsustainable when a distribution company has upside down. The court stated that that, under identical circumstances substantial losses for three years, even if the taxpayer's determina nd with the same pricing, an there is a presumption that the tion of the transfer prices was djustment would be possible just transfer prices are not at arms based on a standard method and because the results are different length. However, the taxpayer may the prices fall within a range of rebut that presumption by proving arms-length prices, the transfer Conclusion that the agreed transfer prices are prices may still have to be adjusted The Federal Tax Court has at arms length. For example, the if they do not lead to acceptable issued an important decision that taxpayer may be able to show will affect how transfer prices are mismanagement or that third party distributors also incurred The court's ruling permits the set in Germany. It will result in egislative measures because the long-lasting losses because of application of a profit-based difficult market conditions. If the determine a price. In fact, it uses a the impact of certain aspects of the taxpayer can rebut the presump- tion, losses will be accepted for a profit-based approach to supercede court's decision esults obtained by using a period longer than the three years. standard method and Because the Federal Tax Court es within has sent the case back to the Tax In defending audits, taxpayers the range Court. it remains to be seen how already try to analyze the reasons for their losses that are indepen A literal reading of the court's that court deals with some of the holding would allow an adjustment open issues. The most interesting dent from the transfer prices they. when a foreign manufacturer aspect will be the evidentiary used. The court has now recognized supplies products to several value the court gives to secret that practice as a valid audit unrelated and related distributors comparables. If the case is then in germany, under comparable appealed again, the Federal Tax The court also stated that if the circumstances for the same price if Court might get another opportu taxpayer is unsuccessful in proving the related distribution company nity to include this issue in its that the loss resulted from other makes losses. The court's position ruling reasons, the tax authorities cannot is unsupportable. If the situations be prevented from adjusting the are comparable, there is a strong prices, even in the first loss year, to presumption that the losses were achieve a total profit at the end of not caused by the pricing, but by the acceptable loss period. The other circumstances. Independent first year adjustment may not parties made profits with the same Min. See press release of the German nce dated 13 July 1995 d in IStR 1995, pp 384 result in a profit in the first year. price when the related party made punge istR 1995, pp 505 f and Tax losses at the same time Standard versus Profit Methods However the tax authorities 9(2001),no.18,pp.641f may still want to make an 2See number 3.54 OECD guidelines. The german tax authorities djustment under the facts. An Against this view Kroppen, in have always expressed strong adjustment is only acceptable if Becker/Kroppen(eds ) Handbuch reservations regarding profit they prove that the circumstances Dr. Otto Schmidt Verlag, 1999), w91 ff. based methods. Under the oeCd in both cases are not comparable guidelines, qualified profit-based An unrelated party under the Handbuch internationale methods are methods of last same circumstances as the related verrechnungspreise(Koln:Dr.Otto resort 21 The Federal Tax Court party would have negotiated a Schmidt verlag. 1999). W77 Tax Notes international 10 December2001·1115The court further ruled that when a distribution company has substantial losses for three years, there is a presumption that the transfer prices are not at arm’s length. However, the taxpayer may rebut that presumption by proving that the agreed transfer prices are at arm’s length. For example, the taxpayer may be able to show mismanagement or that thirdparty distributors also incurred long-lasting losses because of difficult market conditions. If the taxpayer can rebut the presumption, losses will be accepted for a period longer than the three years. In defending audits, taxpayers already try to analyze the reasons for their losses that are independent from the transfer prices they used. The court has now recognized that practice as a valid audit defense. The court also stated that if the taxpayer is unsuccessful in proving that the loss resulted from other reasons, the tax authorities cannot be prevented from adjusting the prices, even in the first loss year, to achieve a total profit at the end of the acceptable loss period. The first year adjustment may not result in a profit in the first year. Standard Versus Profit Methods The German tax authorities have always expressed strong reservations regarding profitbased methods. 20 Under the OECD guidelines, qualified profit-based methods are methods of last resort. 21 The Federal Tax Court has turned that understanding upside down. The court stated that even if the taxpayer’s determination of the transfer prices was based on a standard method and the prices fall within a range of arm’s-length prices, the transfer prices may still have to be adjusted if they do not lead to acceptable profits. 22 The court’s ruling permits the application of a profit-based analysis or profit-based method to determine a price. In fact, it uses a profit-based approach to supercede results obtained by using a standard method and prices within the range. A literal reading of the court’s holding would allow an adjustment when a foreign manufacturer supplies products to several unrelated and related distributors in Germany, under comparable circumstances for the same price, if the related distribution company makes losses. The court’s position is unsupportable. If the situations are comparable, there is a strong presumption that the losses were not caused by the pricing, but by other circumstances. Independent parties made profits with the same price when the related party made losses at the same time. 23 However, the tax authorities may still want to make an adjustment under the facts. An adjustment is only acceptable if they prove that the circumstances in both cases are not comparable. An unrelated party under the same circumstances as the related party would have negotiated a different price. It’s unsustainable that, under identical circumstances and with the same pricing, an adjustment would be possible just because the results are different. Conclusion The Federal Tax Court has issued an important decision that will affect how transfer prices are set in Germany. It will result in legislative measures because the tax authorities will seek to limit the impact of certain aspects of the court’s decision. Because the Federal Tax Court has sent the case back to the Tax Court, it remains to be seen how that court deals with some of the open issues. The most interesting aspect will be the evidentiary value the court gives to secret comparables. If the case is then appealed again, the Federal Tax Court might get another opportunity to include this issue in its ruling. ✦ Tax Notes International 10 December 2001 • 1115 Special Reports 20See press release of the German Ministry of Finance dated 13 July 1995, published in IStR 1995, pp. 384; cf. also Runge, IStR 1995, pp. 505 ff. and Tax Management Transfer Pricing Report, Vol. 9 (2001), no. 18, pp. 641 ff. 21See number 3.54 OECD guidelines. 22Against this view Kroppen, in: Becker/Kroppen (eds.) Handbuch Internationale Verrechnungspreise (Köln: Dr. Otto Schmidt Verlag, 1999), W 91 ff. 23Kroppen, in: Becker/Kroppen (eds.) Handbuch Internationale Verrechnungspreise (Köln: Dr. Otto Schmidt Verlag, 1999), W 77