NOVEMBER/DECEMBER 2001 authorities in many cases will not be allowed to estimate V. PROVIDING RECORDS OF A FOREIGN the taxpayer's income PARENT COMPANY example. One of the most difficult issues in international Within the scope of the extended duty to cooperate of Sec ansfer pricing is the determination of s jcense fee necessary foreign evidence. In doing so, the taxpayer must licence fees. In many cases the tax authorities required the must clearly show the foreign facts and must provide all was determined. In the past, the taxpayer has often not exhaust all legal and other possibilities for obtaining the foreign evidence. Therefore the taxpayer must even try to generated analysis to determine an arm's length royalty. obtain information from related parties. Through imposing The license fee was often determined from a pure busines perspective and little or no documentation was prepared this extended duty to cooperate, the legislature intended to ing, arguing that the taxpayer violated docu- the tax authorities to investigate outside german borders transfer pr requirements. Although the tax auditors often In the decision of the Federal Tax Court, the tax authorities mentation red presented significant adjustments, the justification for requested cost information of the foreign parent company these adjustments was often poor. In most cases the audit- in order to estimate the appropriate transfer prices. The ors did not use any reference to third-party information. taxpayer claimed that it had no means(legal or otherwise) For example the tax auditors might determine an"arms to obtain this information from its parent company. The length license fee"through reference to a lower license fee Tax Court of Dusseldorf accepted the arguments of the which was used by the taxpayer in the past, or to a lower taxpayer and agreed that, in general, the local taxpayer has license fee which is paid by a related party to the licensor no legal power-eg through its shareholder relationship (even if different geographic markets are concerned), or to demand information from a shareholder. The tax author which are collected in a database maintained at the Federal payer should have requested that it be granted the right to scence fees) ver. the Federal Tax Court referred in this matter to the It is also common to apply the so-called prudent business arm's length principle and argued that an obligation would only be acceptable if a third party would have requested manager test Under tax law, the prudent business manager the right to demand documents from the other party to the test is based on hypothetical assumptions which often seemingly allow the tax authorities to build up their own transaction theories on third-party dealings without any reference to Although not explicitly mentioned by the Federal Tax third-party transactions. This proceeding will now be Court, one must assume that the taxpayer will be obliged more difficult for the tax authorities. If the tax authorities to obtain documentation if a transfer pricing method is wish to adjust a taxpayer's transfer prices, they will now based on actual costs(e.g. when tual cost-plus be forced to determine an appropriate price and not just method is used or if the parties agreed on cost sharing and refer to a violation of documentation obligations and pre- shared the costs based on actual figures). However, the sent a rule of thumb to adjust the income Federal Tax Court emphasized that in a normal buy-sell Moreover, the taxpayer is well advised not to agree to an be able to demand cost accounting information from its amount. In the case at hand, the Federal Tax Court allowed supplier. Therefore, the Federal Tax Court concluded that the use of an estimation of the transfer prices only, because the taxpayer did not violate its obligation because the tax the taxpayer accepted that the transfer prices were not authorities were not able to prove that the taxpayer had the arm's length in principle and only disputed the amount. means (legal or otherwise)to demand the documentation Thus. it will now be much easier for the tax court to from its parent company adjust the income and to justify an income adjustment The Federal Tax Courts decision will also enhance the VI. CONSEQUENCES OF THE DECISION ossibility for a taxpayer to receive suspension of a tax assessment. The Federal Tax Court emphasized in former In practice, the tax authorities often request endless trans- decisions that suspension of tax assessment is to be fer pricing information from the taxpayer based on lengthy granted if serious reasons exist which at least hint that questionnaires provided at the beginning of an audit. 10In there are arguments for the taxpayer's. It is not a prerequi- the past the taxpayer often generated the information site that the arguments for an income adjustment domi- requested by the tax authorities in order to make sure that nate.As long as the facts have not been finally clarified the tax authorities could not claim that the company vio- and the taxpayer is accused of violating its duty to cooper- lated its right to cooperate. As mentioned above, the tax ate, there are always serious doubts as to whether the tax payer was often afraid that a violation would open the pos assessment is covered by law. Since there is always con- sibility for the tax authorities to estimate the tax base or troversy concerning certain factual elements when deter ng appropriate transfer prices, a suspension should ly be granted See Federal Tax Court decision of 20 May 1997, BFHNV 1997, at 432. 10. For a translation of the questionnaire, see Kroppen and Eigelshoven, in The Tax Treatment of Transfer Pricing( Germany chapter ), at 156 Q 2001 IBFD Publications BV