Documentation requirements under German transfer-pricing rules.

German tax legislation, unlike in countries such as the U.S., the U.K. and Canada, does not provide any detailed transfer-pricing rules. The current German transfer-pricing provisions consist of administrative principles adopted almost 20 years ago. To overcome this lack of specific guidance, taxpayers have to follow existing general rules. For substantive rules, German transfer pricing is based on Section 8(3) of the Corporate Income Tax Act, Section 1(1) of the Foreign Tax Act and Article 9(1) of the Organization for Economic Cooperation and Development (OECD) Model Income Tax Treaty. The practical relevance of the Foreign Tax Act's Section 1(1) is rather limited, because it would apply only if Section 8(3) does not apply. The OECD Model Income Tax Treaty's Article 9(1) is not binding on German taxpayers. Consequently, a German taxpayer ends up basing transfer-pricing transactions on the Corporate Income Tax Act's Section 8(3) which, understandably, is sometimes not satisfactory for either the German tax authorities or the taxpayer.

The German legislative situation on procedural rules (especially documentation requirements) is no better. In 2000, the German tax authorities issued draft regulations on documentation requirements and advance pricing agreements (APAs), planning to issue final regulations during 2001. However, before this draft: could be finalized, it was invalidated by May and October 2001 German Federal Tax Court decisions.

Because a German taxpayer can be a German subsidiary of a U.S. parent, a U.S. entity might have to deal with the German transfer-pricing situation if there are transactions between the two companies.

Draft of German Transfer-Pricing Regulations

The draft circular mentioned focused on the procedural aspects of transfer-pricing compliance and audits, covering the following matters:

* Cooperation requirements;

* Contemporaneous documentation requirements; and

* APAs.

Under German law, a German taxpayer would have an extended obligation to cooperate with the tax authorities in an audit if the taxpayer has cross-border transactions with parties in foreign countries (Section 90(2) of the General Tax Act). The draft defined this obligation in-depth, specifying the documents that a taxpayer has to provide when audited and thus effectively spelling out the documents a taxpayer must prepare and retain. Further, the draft gave the German tax authorities authority to enter into APAs.

German Federal Tax Court Decisions

In a May 2001 decision, the German Federal Tax Court held that the lack of a transfer-pricing-document law precludes the government from penalizing taxpayers for failing to document their transfer-pricing method.

An October 2001 decision confirms the May decision by concluding that, under the German Corporate Tax Act, taxpayers do not have to provide special documentation as to how they developed their transfer prices in order to disprove allegations of hidden-profit distributions. Under existing law, the taxpayer is only required to keep accurate books and to provide all documents, records, business papers and other documentation that already exist and are available to the company.

Consequences of the Court's Decisions

The German Federal Tax Court's decisions invalidated the draft regulations. Therefore, they were never finalized.

Alternative

A viable approach for the German tax authorities is a legislative process that results in statutory law, rather than relying on regulations that tax courts can overrule. Reliable sources within the German tax authorities indicate that they are currently working on a proposal to introduce transfer-pricing-documentation requirements into German tax law. It is unlikely that such law will be enacted in 2002, as this is a German election year and such a law could potentially cause industry opposition.

Recommendation

As long as uncertainty for German taxpayers remains, U.S. companies with German transfer-pricing issues should create the required U.S. documentation in such a way that it could also be provided to German tax authorities. Put simply, transfer-pricing practices should be consistent. The German Federal Tax Court's decisions that dealt only with documentation requirements demonstrate that the absence of legislative guidance still does not prevent German tax authorities from adjusting transfer prices.

FROM BIRGIT FINDEIS, GERMAN ATTORNEY AT LAW, GERMAN CPA, CERTIFIED TAX ADVISER, NEW YORK, NY

Pamela Packard, CPA
Vice Chairman
Tax Services
BDO Seidman LLP
New York, NY