ITPJ 15 In our opinion, there is an exception to the above-mentioned (paragraph 7. 1. 2. of the Administrative Principles), includin rule where German commercial law exempts a German com- direct and indirect costs. If, under a direct charge method pany which has subsidiaries from the obligation to consoli- arms length prices are available, then costs are not relevant date the results of subordinated companies because the ulti onsolidated report(which includes the results of the sub- D. Determining the appropriate remuneration sidiaries subordinated to the Ge eman“ top subsidiary) Arguably, there is a service flow from the ultimate foreign As stated in C above, in a direct charge system, am's length parent company to the German top subsidiary which is in the prices should be used if they are available. In their absence latter's interest since it is relieved of the costs of consolidated the cost plus method should be used(by definition, it includes a profit element). Paragraph 7. 1.6. of the Adminis- trative Principles states, however, that a profit element will C Symmetrical treatment not be recognized for tax purposes in the absence of In cross-border situations, outward and inward charges are, in ever, in practice, the tax authorities sometimes allow a mark- entitled to ere is a tendency on the part of the German tax authorities up on costs to restrict inward charges and to force outward charges. This authorities in conducting audits of cross-border transactions. IV. TAX TREATY SOLUTIONS The handbook treats outward transactions differently from inward transactions. In addition, the tax authorities'attitude According to the prevailing opinion, the tax law provisions in owards the deductibility of inward charges often hinges. Germany's treaties are not self-executing(similar to Article 9 upon the amount and quality of the evidence produced by the of the OECD Model Convention). The treaties do not impose taxpayer. an obligation on the taxpayer to use a particular method for computing taxable income; rather they"allocate"taxable income, which is determined under the intemal laws of one or C. Method of allocation/apportionment the other state. The state which is entitled to impose the tax is The Administrative Principles in No. 6 and 7 distinguish The purpose of treaty provisions, such as Article 9 of the between the direct charge method and the cost allocation oECD Model Convention, is to ensure that incomeallocation method for charging out service costs to subsidiaries. The Administrative Principles clearly favour charging services tween internationally affiliated companies complies with directly to subsidiaries the arm's length principle. At least with regard to intemation- ally affiliated companies, it is generally acknowledged: that Cost allocation is permissible only if the consideration for the the German rules follow the arms length principle. The tax transfer of services can be assessed globally or where it is dif- authorities generally take the position that clauses such as ficult to ascertain the costs associated with individual ser- Article 9, do not overrule domestic restrictions on the also be determined based upon the prices charged by third OECD Repo ovisoiait. Geman tax treaties usually do not vices (paragraph 7. 1.1. of the Administrative Principles). deductibility of cos Under a direct charge regime, the arm's length price should include any provisions such as those suggested in the 1984 parties (e. g. hourly rates for consulting services). If it is not possible to establish arms length prices, the Administrative Principles require the use of the cost-plus method for direct V. TAX PLANNING CONSIDERATIONS On the other hand, under an indirect charging method, the Since the deduction of costs related to the holding of foreign recipients of administrative services in a group are charged participations has been treated rather generously by the tax the costs incurred for those services on the basis of an alloca- authorities in the past and Germany is a high-tax jurisdiction tion formula (ratio of sales, employees, capital employed, it is still common for German MNEs to hold foreign shares etc.). The formula is acceptable only if it truly reflects the directly. This is because financing costs are deductible proportion of the subsidiarys use or expected use of the unless a dividend is paid in the same year even though a administrative services (paragraphs 7. 4. of the potential dividend or sale of the foreign participation would Administrative Principles). be tax free in germany. For the cost-allocation method and the cost-plus method, the tax authorities require that they be applied on a full cost basis o 1997 International Bureau of Fiscal documentatio