By Francesca Amaddeo, Lecturer-Researcher, Tax Law Competence Centre (SUPSI), Manno, Switzerland
The European Court of Justice has been asked to review German transfer pricing documentation requirements and associated sanctions through a July 15 request for a preliminary ruling in the case C-431/21, X GmbH & Co. v Finanzamt Bremen.
The preliminary ruling request from Germany follows others in the field of direct taxation, including ones issued by the Italian Supreme Court (cases C-433 and 434/21). Once again the issue is the compatibility of national tax regulations and the freedom of establishment under article 49 of the treaty on the functioning of the EU (TFEU).
Facts and legal bases
The case concerns a German limited partnership (KG) – the applicant – which is part of a group of companies established in Germany and in the Netherlands. Its commercial purpose is the holding and management of participations, in particular of those undertakings resident in Germany, as well as the provision of services to affiliated companies and third parties.
Among others, the YN. V. company, a member of the group and established in the Netherlands, provides services to KG on a business management contract basis. The consequent remuneration is to be based on the costs and expenses actually incurred. In 2012, German tax authorities proceeded with an audit, especially focussing on the management fees paid by the applicant to YN. V. In particular, the taxpayer was asked to show documentary evidence of the transfer pricing policies and those documents related to cross-border elements.
Indeed, under German tax law, specifically, art. 90, para 3 of the Abgabenordnung (AO), those taxpayers who have transactions with foreign entities must keep records on the nature and content of their business relations with related parties. Such recordings must include the economic and legal bases for an arm’s length agreement on prices and other terms and conditions enforced.
This is an additional requirement for these taxpayers, and no such requirement applies to taxpayers who have only national businesses. The aim of the provision is clearly to fight tax avoidance and evasion.
But that’s not all. The cited art. 90, para 3 AO must be read together with art. 162, para 3 and 4 AO, which is a statement of sanctions. Specifically, it provides that monetary sanctions apply if a taxpayer does not respect these obligations by failing to submit records, submitting records that are unusable, or failing to submit records in a timely manner. Moreover, the tax administration shall presume that the taxpayer’s income subject to tax domestically is higher than the amount declared.
The rule adds that if the tax authority is required to estimate the income, and such income can be determined only within a certain range, especially on the basis of price bands, the upper value of that range may be taken as the basis to the detriment of the taxpayer.
After an intense exchange of documents, German tax authorities found the evidence supplied by the taxpayer to be insufficient to clarify the facts, especially concerning the transfer pricing policies of the group. Thus, since they were unusable, art. 90 para 3 and art. 162 para 4 AO were applied. This meant the application of a surcharge of at least 5% of the excess income per year, equaling a total of EUR 80,000.
After the taxpayer’s objection to the imposition of such a surcharge was dismissed as unfounded by the tax authorities, the taxpayer brought an action in front of the Finanzgericht Bremen, as the court of appeal.
Issues under the preliminary ruling
Given the above, national judges found that the framework made up of articles 90 para 3 and 162 para 4 AO aims to grant a right assessment.
Nonetheless, such provisions – the one imposing recording diligence obligations on these taxpayers and the other providing a surcharge as sanction – might lead to a violation of the freedom of establishment under art. 49 TFUE, or alternatively, of art. 56 TFUE, granting the freedom to provide services.
Indeed, only taxpayers who maintain business relations with related foreign parties are obliged to fulfill special record-keeping obligations. Moreover, if such taxpayers fail to comply with the requirement, a sanction, in the form of a surcharge, will apply. Similar dues and consequences do not apply to taxpayers who operate only within national borders.
The German court is aware of the relevance of proper provisions able to tackle tax avoidance and tax evasion. Granting a fair allocation of taxing rights is also a valid reason which can be assumed as a reasonable justification to limit the freedom of establishment.
Detailed documents recording cross-border elements allow the administration to verify the compliance with arm’s lengths principles and so the proper allocation of profits. The surcharge boosts the willingness of taxpayers to comply.
Despite this, in the German judges’ view, persons from other Member States might refrain from setting up subsidiaries in Germany or establishing business relations with them to avoid incurring expenses and costs for keeping additional records, under penalty of such a surcharge.
The question is if such measures are not only proper but also necessary to achieve their scope. Doubts arise especially concerning the sanction stated by art. 162 para 4 AO.
As the European Court of Justice said in the case of SGI (C-311/08), legislation is necessary for the attainment of the pursued objective only if it is limited to the correction of arrangements that are inconsistent with the arm’s length principle. Thus, the referring court wonders about the balance between the scope of the surcharge and the detriment for taxpayers. Art. 162 para 4 seems not to contribute in ensuring that tax assessment is as correct as possible and it does not consider the arm’s length principle.
It is worth noting that art. 162 para 3 also provides a further sanction to non-cooperative taxpayers: the above-mentioned presumption of higher income than the one declared.
Remarks
The preliminary ruling under exam represents another arrow in the European Union’s bow to address direct taxation issues.
Indeed, the deep meaning of such a request referred by a national court to the Court of Justice concerning the compatibility of a Member State’s domestic tax legal framework with EU freedoms (especially freedom of establishment) is the willingness of jurisdictions to clearly understand where the European boundaries really end.
The emphasis, in this case, is put on sanctions, which in taxation are often the subject of debate. But there is more. Reading between the lines, there is the recognition that discretionary powers of states will necessarily give way to a centralization also in direct taxation. The question is if Member States are contented to resign the crown.
Francesca Amaddeo
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