Today, about 30 countries have requirements on the legal documentation of transfer pricing, which have, in some countries, existed for many years. Germany first adopted legal provisions in 2003. The new legal provisions were necessitated by a decision made by the German supreme tax court in 2001. Due to the lack of legal provisions, the German supreme tax court ruled that the tax office was not entitled to estimate the profit derived from inter-company transactions to the detriment of the taxpayer only because the taxpayer did not provide sufficient transfer pricing documentation. The tax office still has to prove the transfer price was not in accordance with the dealing at arm’s length principle. Hence the tax administration amended the general tax code with new laws, which established documentation requirements and a change of the burden of proof if the documentation requirements are not met by the taxpayer.
Affected by the new law are German companies that own, directly or indirectly, at least 25 percent of a non-German company, have controlling influence on an overseas’ company. The law also applies to non-German companies that own, directly or indirectly, at least 25 percent of a German company or have controlling influence on a German company (related entity/person). The same applies if a third party owns at least 25 percent of the taxpayer ("taxpayer" represents any form of company, partnership or individual) or has a controlling influence on the taxpayer and the third party owns at least 25 percent of a foreign entity or has a controlling influence on the foreign entity. The new laws are also applicable to overseas companies with German permanent establishments or partnerships and vice versa.
The documentation requirements are described in detail in the so called "profit allocation documentation regulations," which became effective on June 30, 2003. The documentation generally required is divided into four sections. Section 1 covers general information on participations, business and organizational structure; section 2, business relationships with respect to related entities/persons; section 3, the analysis of functions and risks; and section 4, the analysis of transfer pricing. In extraordinary cases additional documentation has to be provided to the tax office that addresses the change of business strategies, cost sharing agreements, transfer pricing confirmations or agreements with foreign tax offices, price adjustments for the taxpayer and the reasons for losses
The documentation has to be made in German, although exemptions are possible upon prior request of the taxpayer. It can generally only be requested by the tax office for the purpose of field audits and has to be provided to the tax office within 60 days of the tax offices’ request. Documentation of extraordinary business transactions has to generally be made within six months of the extraordinary business transaction. These are, for instance, transfers in the course of restructurings and changes of functions and risks in the company.
If the taxpayer is not able to provide the required documentation on the tax offices’ request, it is not usable or the documentation has not been made within the relevant period of time (six months), the tax office is entitled to presume that the income of the taxpayer is higher than declared. The taxpayer then carries the burden of proof that the income declared is correct. If the taxpayer fails to prove the correctness of the transfer price chosen, the tax office is entitled to estimate the taxpayer’s profit. It can estimate the profit at the highest level of a transfer price range, if such a range exists for the relevant transfer price.
The tax office is entitled to impose a penalty of Euro 5,000. The penalty is at least 5 percent and at most 10 percent of the increased earnings and will be incurred as calculated even if this exceeds Euro 5,000. If the disclosure of correct documentation is delayed, a penalty of Euro 100 for each day of delay to a maximum of Euro 1,000,000 will be imposed.
The documentation requirements put an additional administrative burden on entrepreneurs with overseas relationships. The problem becomes more serious as advanced pricing agreements are not available in Germany.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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