JANUARY FEBRUARY 2004 ITPJ 1991 and 734 workdays in 1992. In the course of the field the contract was in fact not executed as stipulated in audit, it was concluded on the basis of travel expense state the contract. with regard to the services the contract ments, that the Italian employees of PPD were in Germany suggested that a cost allocation scheme was to be used for 311 days in 1991 and 41 days in 1992. Also in the However, in fact, the company took a fixed percentage course of the field audit, the total duration of stay in 1990 of sales as compensation for the services was determined to be 432 days Nevertheless, the tax office allowed a deduction for the expenses incurred for a certain amount of workdays for 2.2. Decision which the taxpayer provided evidence that Italian person nel were present in Germany. The Court concluded that The Lower Tax Court of Munich concluded that thethe estimate of the tax office of the expenses did not GmbH's complaint was unfounded. First, the Tax Court infringe the rights of the taxpayer analysed the relationship between the German rules on hidden profit distributions and Art. 9 of the Italy-Ger many income tax treaty(hereinafter: the Treaty). The 3. ANALYSIS Court held that Art. 9 of the Treaty is not self-executing but does limit domestic law. This view is also supported in The decision of the Lower Tax Court of Munich highlights German tax literature. The Court also held that German the importance of the use of written intra-group agree law is fully in line with the international interpretation of ments. However, having a written contract is only going the arms length principle halfway. The tax authorities emphasize that it is of vital importance to actually effect ones transactions in accord long-standing jurisprudence of the Federal Tax Court on ance with the relevant underlying agreement. If the tax- ment is justified if a prudent business manager would not written agreement, the tax authorities will often challenge have agreed to the terms of the contract). a hidden profit the clear and explicit wish of the contractual partners to be distribution arises where a company accepts terms in its bound under the intra-group agreement. transactions with related parties that differ from those In the present case, it seems-from the available informa- unrelated parties would have agreed upon under similar tion- that the taxpayer drafted a merely pro forma agree conditions. In addition, there is a requirement with regard ment without following the basic terms (e. g. instead of to transactions between a company and its majority share- paying the agreed 0.8% licence fee, a licence fee of 1.0%0 holder, that such transactions be based on contractual was paid). This obviously raised a red flag for the tax agreements that are entered into in advance, in clear and authorities. However, the tax authorities based their deci- unambiguous terms sion on the analysis of the Agreement; they did not con cts and sider whether the remuneration was arm's length. This cer- dent business manager would not have agreed to the con- tainly raises, the question of whether the arms length tract. The Court based its conclusion on the following rea- soning: compared to the internationally accepted principles under the contents of the contract must be clearly defined Art. 9 of the OECD Model Treaty. and both parties must clearly understand their rights only agree to pay a royalty of 0.8% i eger would 3. 1. Interpretation of the arm's length principle and obligations. A prudent business man clear, legally valid agreement in advance. Where this It is now the prevailing opinion in German tax literature is not the case, one can assume that the conditions that Art. 9 of OECD Model Treaty(hereinafter: Art. 9 have been "imposed"by the parent company does not have a self-executing effect; the provision merely if a contract is based on a percentage of turnover, a limits the application of domestic tax law. Thus, Art. 9 prudent business manager would insist that the obliga- would limit the application of domestic law if the applica- tract. It was contractually not ensured that the licensee However, the tax authorities expressed a different wcm.t. tions of the licensor be clearly described in the con- tion of an applicable treaty would lead to a higher tax could influence the deliverables such that the contract was more or less influenced by the parent company. In ght of these factors the Court reasoned that it was not 10. Sec. 8(3)Corporate Income Tax Act necessary to verify whether the licence fee is reason men, eds. Becker et al. (Herne- able Berlin: Verlag Neue Wirtschafts-Briefe, 1996). Art. 9 note 85: Rasch, Konger with regard to the technical assistance services re verrechnungspreise im nationalen, bilateralen und europischen Steuerrechr (Cologne: Verlag Dr, Otto Schmidt, 2001). at 187: Schaumburg. Ini not permissible if the services were for the administra- 12. See Eigelshoven, in Doppelbesteuerungsabkommen, eds. Vo tion, management, or control by the parent, or in the Lehner (Munich: Verlag C.H. Beck, 2003).Art. 9, note 18: Schaumbu case of consultancy or simiiar services. Because such Wassermeyer, in Doppeibesteuerung, eds. Debatin and Wassermeyer expenses were incurred in the interest of the share- Verlag C.H. Beck, 2002), Art. 9, note 4 and 103; Becker, in Doppel- holder (PPD), these expense are not deductible at the besteuerungsabkommen, eds. Becker et al(Herne-Berlin: Verlag Neue level of the subsidiary; and Wirtschafts-Briefe, 1996). Art. 9. note 66: Rasch, Konzen im nationalen, bilateralen und europischen Steuerrecht(Cologne Otto Schmidt, 2001), at 192. o 2004 International Bureau of Fiscal Documentation