German transfer pricing amendments shift burden of proof, reveal climate of distrust  

By Oliver Treidler, CEO, TP&C GmbH, Berlin

The German Federal Ministry of Finance, on 3 December, updated its administrative guidance on transfer pricing. While German transfer pricing rules remain unchanged, taxpayer compliance burdens are increased and greater powers are granted to the tax authority.

Moreover, the fine print-type modifications seem geared to allow tax auditors to rely much more heavily on pressure to maximize transparency and force the application of alternative transfer pricing methods.

German transfer pricing rules remain unchanged

The new administrative principles partially replace a BMF Circular from 12 April 2005. The updated and revised paragraphs specifically relate to two issues: enhanced obligations for taxpayers in respect to compliance in the context of tax audits [mostly relating to § 90 (3) German Fiscal Code (“Abgabenordnung”)] and enhanced powers for tax auditors to conduct tax assessments by way of estimates [mostly relating to § 162 German Fiscal Code].

While the new administrative principles discuss transfer pricing-related topics, such as functional and risk analysis, transfer pricing methods, benchmarking, the update explicitly states that German transfer pricing regulations remain unaltered (see par. 91 of the update).

Practitioners should nevertheless take notice, as the aspects amended by the update are highly relevant for tax audits.

The update does not constitute a drastic revision of the existing administrative procedures. Nonetheless, the cumulative effect clearly promises to place an increased compliance burden on the taxpayer.

Specifically, the scope of internal documents MNEs must disclose during audits, and the burden of proof has been modified in a way that seems designed to increase the opportunity for tax auditors to exert pressure.

Information provided to German tax authorities

The BMF Circular from 12 April 2005 already contained detailed provisions regarding the obligations of MNEs to cooperate with the authorities in tax audits.

The update is focused on specifying and extending these rules.

An example is new paragraphs 13 and 14, which stipulate the “evidence” MNEs are obliged to provide to auditors in addition to a full-scope transfer pricing documentation.

Section 13 states:

 The evidence also includes books, records, business papers, or other documents as well as data of foreign-related persons, without which a complete investigation of the facts is not possible. This also applies documents and data of related parties that, independent of the transfer pricing method used by the party concerned, allow tax authorities to test the appropriateness of prices or results of business transactions. The obligation to submit also applies to expert opinions and statements on transfer prices, insofar as these are deemed relevant for the determination of transfer prices or Income determination in connection with transfer prices as well as for e-mails, messenger service messages, or messages that are considered by means of other electronic communication media, insofar as these include business contents with a relevant tax context. (Own translation – emphasis added)

Section 14 discusses this enhanced obligation, noting that it extends to ensuring that data held by related parties can be collected by the taxpayer and shared with the tax authorities. Section 14 states: :

In the case of cross-border transactions, the taxpayer is required to take precautions to ensure that he can fulfill its enhanced obligation to cooperate. He can, therefore, not rely on pleading to be unable to obtain the relevant facts of the case or not being able to provide evidence. The taxpayer must, therefore, e.g., when executing a contract by appropriate contractual provisions, ensure that he will have access to evidence to present it to the tax authorities. (Own translation – emphasis added)

Again, the updated provisions are not “novel.” Still, they clearly reflect the German government’s intention to allow auditors to demand comprehensive information that will substantially exceed the scope of standard transfer pricing documentation.

While detailed assessments pertaining to the legal quality of the changes are beyond this article (tax lawyers will surely comment in due course shortly), the most likely implications for transfer pricing practitioners seem to be twofold.

First, tax auditors will feel entitled to request a lot of “colloquial” information, i.e., communication on transfer pricing issues, which, unlike transfer pricing documentation, is not compiled in systematic order.

 It is conceivable that some auditors will challenge the functional and risk analysis based on e-mails. Such an inclination already exists and will now come to full blossom.

 Due to the unsystematic nature of such information, discussions will likely not add clarity but spawn discord.

Second,  the enhanced obligation to adopt (formal) precautionary steps to make comprehensive information available will increase the burden of proof during audits. Also, tax auditor information requests will likely become more extensive, resulting in an increased compliance burden (which is already quite high).

Death of Paragraph 3.4.20

The “tricky” aspect of the update is that large sections of the BMF Circular from 12 April 2005 are unaltered, while single words are changed.

 Again, I leave it to the tax lawyers to present a legal assessment, but the following two examples relating to Paragraph 3.4.20 in BMF Circular from 12. April 2005 illustrate the nature of the changes:

Paragraph 3.4.20 states (within an extensive paragraph) that “usable (transfer pricing) documentation constitutes the basis (or starting point, depending on the translation) of a tax audit.”

Typically, this provision is interpreted as honoring the taxpayer’s effort to compile a transfer pricing documentation. Essentially, you could point to this paragraph and kindly ask the auditor to stay “on the topic;” in other words, to ask the tax auditor to read your transfer pricing documentation before issuing requests for supplementary information that had little or no bearing on the case.

However, the update integrates the word “merely” into the paragraph. As this is hardly a copy/paste mistake, the change debases the weight put on a transfer pricing documentation while simultaneously increasing the importance of the complementary “evidence” mentioned above (yes, including e-mails).

Another intriguing novelty is introduced in Paragraph 46 of the update, according to which the tax authority will select the “correct” transfer pricing method.

Based on the existing Paragraph 3.4.10.1., it is clear that the taxpayer is free to choose the transfer pricing method deemed most appropriate for the case at hand and has no obligation to verify or justify his results by adopting an alternative method.

According to the update, however, a taxpayer is now obliged to provide information to the authorities required to apply an alternative transfer pricing method deemed “correct” by the authorities.

While the taxpayer was already obliged to provide available planning data to the tax authorities for a general plausibility-check of the results, this obligation did not include providing information required for applying a specific alternative transfer pricing method.

Also, Paragraph 2.1. of the existing Administrative Procedures stipulates that there is no such thing as a single correct result in transfer pricing. The notion of a “correct” transfer pricing method would seem to be inconsistent with this stipulation.

Overall, the new wording means that any uncertainties regarding comparability (and when are these ever completely absent in transfer pricing?) allow the tax authorities to consider an alternative.

There may be a myriad of similar examples, but the two examples mentioned above are perhaps the most relevant for transfer pricing audits – and they are not pleasant.

Climate of distrust

One may (and I do) wonder what has motivated the BMF to update the Administrative Principles?

Yes, there are cross-references to the 2017 OECD guidelines. Still, they are mostly meaningless for transfer pricing practitioners as the ordinance already covers them on the documentation of profit allocations (reflecting the standard OECD-GL approach).  

Also, there is no visible benefit in ensuring clarity of terminology of processes. On the contrary, the parallel existence of the BMF Circular from 12 April 2005 and the BMF Circular from 3 December 2020 is confusing.

In my experience, the BMF Circular from 12 April 2005 functioned well in day-to-day practice. At least, I am not aware of any complaints or problems.

Also, the procedural rules did provide some balance of power for taxpayers vis-à-vis tax auditors. That balance of power has now been shifted in a worrisome fashion in favor of the auditors

While the principle of proportionality is mentioned in the update, it seems questionable that it can be effectively invoked in practice (it was already difficult before the update).

It is a mystery where this underlying mistrust originates. Especially post-BEPS, such a one-sided update seems out of proportion.

Instead of engaging in an open dialogue with taxpayers, especially during difficult times, the update reflects a climate of distrust.

If there was any dialogue, it was behind closed doors. That is sad and not what we need.