By Konstantin Sakuth, Linklaters LLP, Munich
On 3 December, Germany’s Federal Ministry of Finance published new transfer pricing guidance (Verwaltungsgrundsätze 2020), which complements and partially replaces its previous guidance.
The new transfer pricing publication addresses a multinational group taxpayer’s obligation to cooperate with the tax authorities concerning income allocation. It further elaborates on the legal provision according to which the German tax office can estimate the relevant tax base if the taxpayer fails to comply with this collaboration duty.
It is fair to say that updated guidance was overdue since the corresponding provisions in the German transfer pricing legislation and the supplementing regulations were amended a few years ago.
General cooperation principles
The new transfer pricing guidance states that the tax authorities must investigate the facts and circumstances of a tax-relevant case. However, in parallel to this investigation duty, the taxpayer must cooperate to the extent reasonable.
This obligation becomes imperative in cross-border cases where the tax authorities are limited in their capacity to investigate outside of national borders.
Cross-border transaction documentation
The guidance states that the taxpayer’s cooperation obligation includes a duty to examine the facts and gather relevant evidence.
This obligation extends to documents and data possessed by a related party with which the taxpayer engages in transactions if such transactions are relevant to the German taxpayer’s tax liability.
Hence, the taxpayer must ensure that it has a right to receive relevant information in its intercompany agreements.
Hence, the taxpayer must ensure that it has a right to receive relevant information in its intercompany agreements.
The German Federal Ministry of Finance considers it reasonable to assume that a prudent business person would contractually insist on sufficient documentation from his related counter-party.
This documentation would include, among others, evidence of resale prices if the resale-minus method is applied, documented cost calculations if the cost-plus method is applied, and evidence of revenues generated from intangibles if licensing payments depend on the corresponding sales figures.
The new guidance stresses that transfer pricing documentation, such as, for example, the local file, is intended to provide the tax authorities with the information necessary for risk assessment and examination of whether the taxpayer has complied with the arm’s length principle.
As a part of this, the taxpayer must provide documentation that evidences why his chosen transfer pricing method is the most appropriate one for the case at hand.
It is in the tax authorities’ discretion, though, to choose the “right,” i.e. the most appropriate, method. To do so, the taxpayer must submit relevant information.
Considering what is expected from a prudent businessman, one might question why a taxpayer would have documents available for a transfer pricing method that it eventually does not apply. The tax authorities might argue, though, that such documentation is required to compare different methods to assess which one is the most appropriate.
Timing for determining the arm’s length price
When determining transfer prices, one could apply an ex-ante perspective (price-setting approach) or an ex-post perspective (outcome testing approach).
In this regard, the new German transfer pricing guidance states that the conclusion of the related party agreement is the relevant date for assessing the arm’s length price; i.e., a price-setting approach applies.
The taxpayer may still refer to information that became available later if it reflects the conditions at the time of the arrangement. Likewise, according to the guidance, the tax authorities can test the applied transfer prices based on data that becomes known at a later stage. The question of which circumstances and data should be considered – potentially in hindsight – is likely to give rise to discussions between taxpayer and tax authorities.
Consequence of non-compliance
If the tax authorities conclude that the taxpayer’s documentation is insufficient, they must inform the taxpayer accordingly and allow him to improve the data.
If a taxpayer still fails to comply with its obligation to cooperate and if the tax authorities have no further options to obtain information and examine the facts and circumstances, German law gives the tax authorities the option to estimate the relevant tax base.
When estimating, the outcome must reflect the true nature of the facts and circumstances as best as possible.
Thus, the estimate must be “coherent, economically possible and reasonable,” the guidance states.
Uncertainties will most likely remain to some extent; however, this risk must be borne by the taxpayer if its non-compliance caused it, the guidance states.
Concluding remarks
Proper documentation is key when it comes to defending one’s tax position in a tax audit. The recently published guidance helps taxpayers understand what is expected.
What is reasonable in this regard will depend on the individual situation, including the individual tax auditor in charge.
Discussion of this controversial topic will undoubtedly continue for many years.
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