NOVEMBER/DECEMBER 2005 arbitrariness in the taxpayer's documentation and transfer The use of the general capital adequacy rule for PEs also leads to a stronger emphasis of risk for tax purposes. As the standard regulatory rules take into account different However, it will likely be useful to also take into account risk classes for assets that lead to different capital require oles-Procedure in light of the selection of transfer t' of a risk weightings based on a wider use of individual credit taxpayer. The regulations identify three types of com panies for the application of the transfer pricing method Is els. In the wake of this development, the standards that are applied to the allocation of banking assets for global trad The first group of companies performs only routine func- ing, but also including other banking business, are increas- low-risk routine functions. The tax authorities assume that mine an arm's length allocation of such assef? ' cs to dete. manufacturers. Pure service providers (e.g. in the back tigating or implementing internal transfer prio office)are also likely to be classified as performing such guidelines using balanced scorecard approache this type of company will derive a rather steady profit from its activities. For this group of companies, the trans actional net margin method (TNMM) is fully applicable if 4. APPLICATION OF TRANSFER PRICING o CUP, cost-plus or resale price method can be used. A METHODS proper benchmarking for those functions is essential to determine the arms length remuneration Historically, standard transactional transfer pricing The second group of companies consists of so-called methods have been favoured by the tax authorities. As dis- entrepreneurs or strategy leaders. These companies own cussed above, developments in recent years have to a cer substantial non-routine intangibles and their profits are tain extent reversed this tendency in favour of profit-based determined by these specific intangibles. Therefore, no methods. The new transfer pricing regulations on proce- reliably comparable companies are available for the appli dures refer to net margin approaches in a number of cation of the TNMM or the traditional, transaction-based prominent instances. For example methods. The entrepreneur typically receives the residual the use of the TNMM is explicitly allowed to Income from the transaction. If more than routine functions under certain conditions 17 and nice one entrepreneur is involved and no CUPs are available, the example on the putation of inter-quartile profit split could apply ranges uses database search results for a net operating The third group of companies is the so-called middle com panies, It seems that in other industries, a fully fledged The strong preference for standard methods in the past in distributor or a manufacturer licensing its intellectual some cases let to situations in which, for example, a CUP property will fall into this category. The TNMM is not method was applied and accepted by the tax authorities applicable to such companies, according to the tax author- even though under a strict application of OECD Standards ities, because allegedly no comparable data are available. the CUP data may not have been regarded as comparable If no other method could be used. the arm's length price a bank seeks to revise its approach and changes to another must be determined based on the companys budget da Otherwise, the taxpayer might be exposed to transter transfer pricing method, discussions with the German authorities in tax audits are to be anticipated cing sanctions Another aspect that must be taken into account is the allo- Compared to other industries, the financial services indus- cation of equity to the banking PE involved in the global try perhaps offers the widest range of comparable data for trading business. Here at least the basic principles of the the application of the CUP method. This is not only OECD Working Hypothesis (WH) seem to appear most because of the widespread existence of quantitative mar- clearly in German transfer pricing regulations for PEs. In ket data and the existence of a body of detailed, relevant September 2004, the tax authorities released regulations economic theory, but also because in recent years the on the allocation of equity to banking PEs, 16 From a regu- Tinancial sector has also experienced an increasing trend latory perspective, German branches of international of cooperation among unrelated parties(thereby leading to the existence of third-party service fees or commission equity depending on the location of the bank's head office. rates). Hc r, the current trend appears to be directed However, as there are rules regarding the minimum capital towards a more regular use of profit-based methods(also requirement for operations in Germany, the Septembe including the TNMM). Thus, Germany is continuously 2004 regulations basically stipulate that to determine an moving towards international standards in the application adequate (i.e. arm's length) equity capital dotation of a of transfer pricing methods, and this should also be banking PE, the non-tax regulatory rules that apply to legal entities conducting banking business should be applied to the branch for tax purposes, as well. Hence, the (iSn Seecaisle s ige Recipe for double taxation am Tar Notes international (22 tax authorities are primarily treating a PE like a separate August 2005), at 725. for a detailed discussion and distinct enterprise, claiming that for tax purposes the 16. Principles on the Allocation of Dotation Capital of Internationally Active capital adequacy requirements should be applied in the Banks (29 same manner to PEs as to separate legal entities 17. TZ. 3.4.10.3 b) Administrative Principles -Procedure 18. Tz. 3.4. 12.5 d) Administrative Principles-Procedure G 2005 IBFD