Co-operation Obligation in German Transfer Pricing Audits Box A Finance Ministry Letter, February 26, 2004 Consequences from non-compliance with taxpayer's General Tax Code, the following general principles apply for duty to co-operate according to sec. 90 para. 2 of the testing the appropriateness of the pricing to its foreign parent General Tax Code in case of a transfer pricing audit of company is engaged in transactions with related parties abroad a) Due to the freedom of contract the subsidiary is under civil law- not obliged to set arm's length transfer (sec. 1 of the Foreign Tax Code)-application of the pnces with its parent company. In case the taxpayer federal tax court decision dated October 17, 2001(IR does not comply with the arm's length principle, the 103/01). Letter of the Ministry of Finance dated income tax base has to be adjusted accordingly in the February 26, 2004 taxpayers tax declarations (see sec. 1 of the Foreig Tax Code and sec. 8 para. 3 sentence 2 of the In its decision dated October 17, 2001( R 103/00)the Corporate Income Tax Code)as the taxpayer has to Federal Tax Court has ruled - inter alia- the following provide all necessary information to its best knowledge 1. f a taxpayer does not comply with his duty to sentence 1 of the general Tax Code, in case of cooperate in the sense of sec. 90 para. 2 of the non-compliance the rules on tax fraud according to General Tax Code, it must be differentiated if the eC.369 ff. of the General Tax Code may apply taxpayer 's duty refers to the legal requirement or to the ver, the subsidiary does not bear the burden of gal consequences of a tax provision. If the taxpayer's proof whether the transfer price agreed upon is in fact on-compliance refers to the legal requirement, the at arm's le evidence which must be provided for the relevant facts b) If the subsidiary, contrary to its duty, does not provide by the tax authorities is reduced. if the non-compliance relevant information about factors having refers to the legal consequences the tax authorities are pnces (fact pattern), e. g, type and quality of in general entitled to estimate the taxpayer's income purchased products, market and competitive situation 2. If a domestic subsidiary does not provide information and if therefore the tax authorities are not able to on how transfer prices with its foreign parent company determine arm's length prices, the tax authorities may were set, the tax authorities may solely conclude that estimate the taxpayers income according to sec. 162 the agreed transfer prices were caused by the para. 2 of the General Tax Code. Namely in case the shareholder relationship. However, the agreed transfer ity to cooperate refers to information and evidence pnces can still be at arm's length, The tax authorities which is only available to the taxpayer, negative have to provide evidence for the arms length transfer conclusions may be drawn from the taxpayer's pnces non-compliance In course of estimation according to 3. The determination of an arm's length transfer price for a sec. 162 para. 2 of the General Tax Code, the ta distrbution company cannot be based on the resale authonties duty to ascertain the facts which are ice method if the gross margin can only be derived increasing and decreasing the tax burden are from three independent manufacturers, if the decreased (limited degree of proof); a lack of evidence corresponding purchases do not refer to all years under the taxpayer accounts for, may not be to the advantage onsideration and if the purchases represent only five of the taxpayer( Federal Tax Court decision dated percent of the turnover of the distribution company ary 15, 1989, BStBl l 1989 p. 462 referring to With reference to the discussions with the supreme tax the: "hold back of evidence"). The tax assessment can authonties of the federal states the following applies be based on facts relying on a lower degree of certainty than required under regular circumstances(Federal Tax To 1: The increased duties to cooperate according to sec 90 para. 2 of the General Tax Code refer to the entire fact p 495). In case of a gross offence by the taxpayer pattern relevant to taxation if a hidden profit distribution of a domestic subsidiary to its foreign parent company is under which leads to significant adjustments compared to the facts given in the tax declaration the tax authorities are discussion. Such duties to cooperate shall enable the tax authonties to ascertain whether the legal requirements for generally not only allowed, but even obliged to assess the tax base according to the facts which are least hidden profit distribution are given favourable from the taxpayer's point of view, but which The Federal Tax Courts differentiation between duties to are factually still possible (Federal Tax Court decision cooperate with respect to the ascertainment of the legal dated March 9, 1967, BStBI Ill 1967 p 349). However. requirements of a hidden profit distribution and such duties estimates which have a penal character are not allowed with respect to the legal consequences is not reasonable and Federal Tax Court decision dated December 20, 2000 s not based on the law. the legal consequences are BStBI ll 2001 p, 381). The subsidiary may still disprove assessed by the tax authorities without the taxpayer's the facts the tax authorities based their estimate on nd which are disadvantageous from the taxpayer's point of view, or the subsidiary may attack the To 2. If a domestic subsidiary infringes upon its increased likelihood of the tax authorities' assumptions by duty to cooperate according to sec. 90 para. 2 of the specifying or submitting evidence n704C