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Special Reports one requirement for a transfer Commission recommends incorporated in the new law and pricing adjustment (see discussion following a common EU approach regulations above) and only gives an initial on documentation requirements indication that the price is not at The purpose of the arm s-length Transfer Pricing Analysis arms length test is to put related parties on the The Tax Court made an adjust Nevertheless, an adjustment is same level playing field as ment by applying the resale price possible only if the agreed price is unrelated parties; unrelated method. It compared the gross outside the range of appropriate parties by the very nature of their margin that the taxpayer prices. The determination must be relationship do not have to prepare generated from the sale of made by the authorities, even in products parent the tax authorities through docu- to the gross margin earned from use a transfer pricing method at mentation rules force related sales of products purchased from all, used an unaccepted method, or taxpayers to spend millions of three unrelated manufacturers used a"wrong"method. The price dollars on documentation, related The purchases constituted used might still be at arm's length taxpayers will be at a disadvan- percent of the taxpayers total by sheer accident, even though the tage compared to independent sales. The Federal Tax Court found taxpayer did not determine it that the third-party purchases based on any economic or scientific were not comparable to the basis purchases made from the parent company because of their low It is not German tax authorities are oncerned about the documenta The court held that on the one tion and burden of proof aspects of It is not surprising that hand, a purchaser of high volumes the Federal tax Court's decision the german tax may be able to negotiate b They are currently discussing changes to the existing tax law. 8 authorities are percent of purchases may onl Although the final outcome of the concerned about the pplement the existing product discussion is uncertain a new law documentation and nge, and the wholesaler, having might cover several issues a special interest in the products burden of proof aspects willing to accept higher prices. 1 The new law will probabl of the Federal tax The findings of the Federal Tax ntroduce documentation require- ments into German Tax Law Courts decision. They Court are probably correct. They whereby taxpayers will be are currently discussing required to show how they set prices and why they believe changes to the existing those prices are at arm s length. If tax law the taxpayer does not prepare the documentation, the burden of proof For an analysis of the first draft might be shifted to the taxpayer if administrative principles see Kroppen/Roeder, Tax Management ere is uncertainty regardin Transfer Pricing Report, Vol 9(2000), no. whether a price is within the arm's-length range sEe Commission Staff Working Paper: It can only be hoped that the tax parties because the related Market. " SEC(2001)1681, dated 23 Oct. authorities will be reasonable taxpayers will have fewer 2001,pp.346f when they draft the new laws. to spend on their LThe EU Commission stressed this They shouldnt enact totally new tional needs, including research aspect, too. See Commission Staff Workin documentation concepts, but should instead require documents and development, and marketing. Market. "SEC(2001)1681. dated 23 Oct. similar to those that are alread Taxpayers will accept new required in other jurisdictions. It is documentation rules, including This argument of the Federal Tax Court is in line with its decision as of 4 try to reinvent the wheel, which studies, only if the new rules result 1981 part Il, pp. 492t ederal Tax Bulletin acceptable for each country to requirements for transfer burdens taxpayers with different in greater certainty for taxpayers n: Becker/Kr requirements that are time n their dealings with the tax eds )Handbuch Internationale authorities. The authorities should Verrechnungspreise(Koln: Dr.Otto Commission recently published a consider safe harbor rules limiting Schmidt verlag, 1999), W 22, Bar mhofi, report on EU company taxation the scope of an audit when the AuBensteuerrecht(Koln: Dr. Otto Schmidt addressing transfer pricing. The documentation satisfies standards Verlag, 1997, 2001), Sec. 1 AStG note 303 Tax Notes international 10 December2001·1113one requirement for a transfer pricing adjustment (see discussion above) and only gives an initial indication that the price is not at arm’s length. Nevertheless, an adjustment is possible only if the agreed price is outside the range of appropriate prices. The determination must be made by the authorities, even in cases where the taxpayer did not use a transfer pricing method at all, used an unaccepted method, or used a “wrong” method. The price used might still be at arm’s length by sheer accident, even though the taxpayer did not determine it based on any economic or scientific basis. It is not surprising that the German tax authorities are concerned about the documenta￾tion and burden of proof aspects of the Federal Tax Court’s decision. They are currently discussing changes to the existing tax law. 8 Although the final outcome of the discussion is uncertain, a new law might cover several issues. The new law will probably introduce documentation require￾ments into German Tax Law whereby taxpayers will be required to show how they set their prices and why they believe those prices are at arm’s length. If the taxpayer does not prepare the documentation, the burden of proof might be shifted to the taxpayer if there is uncertainty regarding whether a price is within the arm’s-length range. It can only be hoped that the tax authorities will be reasonable when they draft the new laws. They shouldn’t enact totally new documentation concepts, but should instead require documents similar to those that are already required in other jurisdictions. It is unacceptable for each country to try to reinvent the wheel, which burdens taxpayers with different requirements that are time￾consuming and costly. The EU Commission recently published a report on EU company taxation addressing transfer pricing. The Commission recommends following a common EU approach on documentation requirements. 9 The purpose of the arm’s-length test is to put related parties on the same level playing field as unrelated parties; unrelated parties by the very nature of their relationship do not have to prepare transfer pricing documentation. If the tax authorities, through docu￾mentation rules, force related taxpayers to spend millions of dollars on documentation, related taxpayers will be at a disadvan￾tage compared to independent parties because the related taxpayers will have fewer resources to spend on their opera￾tional needs, including research and development, and marketing. 10 Taxpayers will accept new documentation rules, including requirements for transfer pricing studies, only if the new rules result in greater certainty for taxpayers in their dealings with the tax authorities. The authorities should consider safe harbor rules limiting the scope of an audit when the documentation satisfies standards incorporated in the new law and regulations. Transfer Pricing Analysis The Tax Court made an adjust￾ment by applying the resale price method. It compared the gross margin that the taxpayer generated from the sale of products from its parent company to the gross margin earned from sales of products purchased from three unrelated manufacturers. The purchases constituted 5 percent of the taxpayer’s total sales. The Federal Tax Court found that the third-party purchases were not comparable to the purchases made from the parent company because of their low volume. The court held that on the one hand, a purchaser of high volumes may be able to negotiate better discounts. On the other hand, the 5 percent of purchases may only supplement the existing product range, and the wholesaler, having a special interest in the products, is willing to accept higher prices. 11 The findings of the Federal Tax Court are probably correct. They Tax Notes International 10 December 2001 • 1113 Special Reports 8For an analysis of the first draft administrative principles see Kroppen/Roeder, Tax Management Transfer Pricing Report, Vol. 9 (2000), no. 4 pp. 122. 9See Commission Staff Working Paper: “Company Taxation in the Internal Market,” SEC(2001) 1681, dated 23 Oct. 2001, pp. 346 ff. 10The EU Commission stressed this aspect, too. See Commission Staff Working Paper: “Company Taxation in the Internal Market,” SEC(2001) 1681, dated 23 Oct. 2001, p. 258. 11This argument of the Federal Tax Court is in line with its decision as of 4 April 1980, I R 75/78, Federal Tax Bulletin 1981 part II, pp. 492 ff. 12See Kroppen, in: Becker/Kroppen (eds.) Handbuch Internationale Verrechnungspreise (Köln: Dr. Otto Schmidt Verlag, 1999), W 22; Baumhoff, in: Flick/Wassermeyer/Baumhoff (eds.), Außensteuerrecht (Köln: Dr. Otto Schmidt Verlag, 1997, 2001), Sec. 1 AStG note 303. It is not surprising that the German tax authorities are concerned about the documentation and burden of proof aspects of the Federal Tax Court’s decision. They are currently discussing changes to the existing tax law
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