Survey results of German transfer pricing audits.

At Tax Executives Institute's 1995 Midyear Conference, I was pleased to discuss transfer pricing developments in Germany and other European countries. In preparing for the conference session, I prepared a questionnaire that was circulated to members of TEI's International Tax Committee. The following article is a summary of the responses to two areas that were explored in the survey: awareness of German transfer pricing rules and audit experiences. The conference materials, including an article on German transfer pricing as well as an English translation of Germany's General Administrative Principles are available upon request.

Familiarity with German Legal Provisions

1. Awareness of German Transfer Pricing Rules

Of the total number of respondents (15), 11 stated that they are aware of the German rules regarding transfer pricing (generally referred to as the "General Administrative Principles" or "GAP"). Of these 11 respondents, 6 stated that their company's transfer pricing policies were developed on the basis of the U.S. regulations, as well as the regulations of other individual countries; only 4 stated that the GAP was consulted in developing the company's transfer pricing policies.

2. Awareness of the Availability of Binding Rulings

Of the 15 respondents, 11 stated that they are aware of the possibility of obtaining binding rulings from the German tax authorities; only 2 companies have attempted to obtain such rulings.

3. Awareness of German Rules Regarding Provision of Information and Duty

to Cooperate

Of the 15 respondents, 8 stated that they are aware of the German rules regarding the provision of information and the duty to cooperate, but only 2 of the companies responded that such rules are consulted on a regular basis (or at all).

4. Summary and Conclusions

From the limited number of responses, it is difficult to draw any correlations between a company's awareness of the various German legal provisions regarding transfer pricing and its experiences with German audits. While some companies that are unaware of the GAP and the other German legal provisions have not been subject to an audit investigation in which transfer pricing was an issue, other respondents who noted that the GAP were consulted in developing the company's transfer policy have been subject to such audits.

It is possible to conclude, however, that, while most companies are aware of the GAP and the German legal provisions regarding the provision of information and the duty to cooperate, little attention seems to be given to these provisions in the planning and carrying out of the respondents' German operations. Furthermore, while almost all the respondents are aware of the possibility of obtaining binding rulings from the German tax authorities, such rulings play a very small role in their German tax-planning activities.

Experience with German Tax Audits

1. Number of Respondents Subject to German Tax Audits

Of the 15 respondents, 11 stated that their companies have been subject to one or more German tax audits. The frequency of such audits ranged from once in the last 10 years to annually. Of these 11 companies, 4 indicated that transfer pricing was an issue raised by the auditors and a fifth respondent, while stating that transfer pricing was not an issue, answered the subsequent questions in such a manner that it must be assumed that the company's transfer pricing policies were challenged. In the following paragraphs, only these 5 respondents are discussed.

2. Reason for the Transfer Pricing Challenge

Three of the respondents reported that the transfer pricing challenge was based on the auditors' claim that the company had experienced losses over an excessive number of years. The other two challenges were based on claims that there were excessive market penetration expenses and that a different transfer pricing method would have produced higher profits.

3. Basis for Additional Tax Assessment

Three of the respondents said that the auditors assessed additional tax amounts on the basis of hidden profit distributions alone. In one case, additional tax was assessed both on the basis of a hidden profit distribution and on an adjustment to the company's income. The remaining respondent provided no information as to the method of additional tax assessment.

4. Books and Records Examined by the Auditors

Four of the respondents indicated that the auditors examined the company's published financial statements (balance sheet, profit and loss statement, etc.) within the course of their analysis. Three of these respondents also noted that the auditors examined records regarding specific transactions or groups of transactions in which the German affiliate was involved. Only one of these respondents noted that the auditors reviewed information obtained from the company's affiliates in other countries. The fifth respondent provided no information in regard to this question. None of the respondents indicated that the auditors requested information regarding transactions conducted by non-affiliated companies in the same industry or branch of industry.

5. Additional Information Requested by the Auditors

Four of the respondents reported that the auditors required the company to provide written transfer pricing policies or cost sharing agreements to justify its transfer pricing practices. Two of these respondents also noted that the auditors requested information regarding the financial results of other affiliates arising from their transactions with the German affiliate; one of these respondents stated that the auditors required information regarding the financial results of affiliates arising from their transactions with other group members.

Additionally, four of the respondents noted that, to their knowledge, the auditors did not attempt to obtain information from foreign tax authorities under exchange of information provisions. The fifth respondent provided no information in regard to these questions. None of the respondents indicated that the auditors requested information regarding the financial results of affiliated companies in other regions where different transfer pricing policies apply.

6. Results of the Audit Challenge

Of the five companies subject to transfer pricing challenges, one indicated that no adjustment was made; two noted that, on the basis of a negotiated settlement, an additional tax amount was paid that was lower than the adjustment originally claimed by the tax auditors; one company stated that an additional amount of tax was paid, but the adjustment is being challenged; and the final respondent indicated that the audit outcome is pending.

7. Summary and Conclusions

In most of the cases in which the respondents' transfer pricing policies were challenged under German tax audits, the auditors limited their investigations to information that was likely readily available to the German company or its U.S. parent. They did not require information regarding non-affiliated companies in the same business branch or industry and did not attempt to obtain information from foreign countries under exchange of information provisions set forth in tax treaties or provided under domestic law.