Transfer Pricing REPORT Volume 11 Number 17 Page 786 Wednesday, January 8, 2003 ssN1521-7760 A nalysIS GERMANY German Transfer Pricing Rules Compatibility with EC Law Court,'s Rulings Indicate Need for Germany to Make Reforms By Heinz-Klaus Kroppen and Lars rehfeld Dr. Heinz-Klaus Kroppen, LL. M, is an international partner and Lars rehfeld is a consultant with Deloitte Touche GmbH's European Transfer Pricing Group in Dusseldo For the past several years German tax literature has questioned the compatibility of German transfer pricing rules with European Community law. Even the German Federal Fiscal Court in a June 21 2001, judgment expressed reservations concerning the compatibility of Section 1 of Germany's Foreign Tax Relations Act(AStG)with the requirements of the European Community Treaty Those reservations further escalated when the European Court of Justice's advocate general said in September 2002 that Germany's thin capitalization rule discriminates against companies that borrow from related foreign parties, and recommended the court strike it down as violating the EC Treaty a The European Court of Justice then issued on Dec 12, 2002, a decision that struck down Germany's thin capitalization requirements because they conflicted with the European Community Treaty, although not necessarily for the same reasons presented by the advocate general. that decision has raised the debate even further over whether Germany' s transfer pricing laws also should be struck down. However, before the ruling in Lankhorst-Hohorst was issued, another ECJ decision on a Swedish case--issued on Nov. 21--presents an even stronger case for concluding that German transfer pricing rules are not compatible with the ec treaty and should be revised. a The Riksskatteverk decision makes it clear that German tax officials and German legislators need to change German tax law with cross-border references and bring them under the guidelines of the eC Treaty--especially the treaty' s basic freedoms Legal Background The November 2002 ECJ judgment stems from attempts by two Swedish residents, X and Y, who wanted to transfer their shares in the X-A. B, a Swedish company, to another Swedish company, the Z-A.B, at their acquisition costs. The Z-A.B. is a wholly owned subsidiary of the Y-S.A, which is domiciled in Belgium. 6= Swedish state income tax law(SIL) provides different legal consequences depending on whether the company receiving the assets is Swedish or is a foreign company and whether the company has Swedish or foreign shareholders. While a transfer of shares to a Swedish company having SwedishVolume 11 Number 17 Wednesday, January 8, 2003 Page 786 ISSN 1521-7760 Analysis GERMANY German Transfer Pricing Rules' Compatibility with EC Law: Court's Rulings Indicate Need for Germany to Make Reforms By Heinz-Klaus Kroppen and Lars Rehfeld* *Dr. Heinz-Klaus Kroppen, LL.M., is an international partner and Lars Rehfeld is a consultant with Deloitte & Touche GmbH's European Transfer Pricing Group in Düsseldorf. For the past several years German tax literature has questioned the compatibility of German transfer pricing rules with European Community law. 1 Even the German Federal Fiscal Court in a June 21, 2001, judgment expressed reservations concerning the compatibility of Section 1 of Germany's Foreign Tax Relations Act (AStG) with the requirements of the European Community Treaty. 2 Those reservations further escalated when the European Court of Justice's advocate general said in September 2002 that Germany's thin capitalization rule discriminates against companies that borrow from related foreign parties, and recommended the court strike it down as violating the EC Treaty. 3 The European Court of Justice then issued on Dec. 12, 2002, a decision that struck down Germany's thin capitalization requirements because they conflicted with the European Community Treaty, although not necessarily for the same reasons presented by the advocate general. 4 That decision has raised the debate even further over whether Germany's transfer pricing laws also should be struck down. However, before the ruling in Lankhorst-Hohorst was issued, another ECJ decision on a Swedish case--issued on Nov. 21--presents an even stronger case for concluding that German transfer pricing rules are not compatible with the EC Treaty and should be revised. 5 The Riksskatteverk decision makes it clear that German tax officials and German legislators need to change German tax law with cross-border references and bring them under the guidelines of the EC Treaty--especially the treaty's basic freedoms. Legal Background The November 2002 ECJ judgment stems from attempts by two Swedish residents, X and Y, who wanted to transfer their shares in the X-A.B., a Swedish company, to another Swedish company, the Z-A.B., at their acquisition costs. The Z-A.B. is a wholly owned subsidiary of the Y-S.A., which is domiciled in Belgium. 6 Swedish state income tax law (SIL) provides different legal consequences depending on whether the company receiving the assets is Swedish or is a foreign company and whether the company has Swedish or foreign shareholders. While a transfer of shares to a Swedish company having Swedish