Facing the facts

With tax authorities worldwide ever more vigilant in closing tax loopholes, transfer pricing has become an ever more vexed and demanding activity.

As RP Richter’s Michael Heckel, one of Germany’s experts on the subject, explains: “Until the Eighties, transfer pricing was not very popular in Germany but as corporations and their tax advisors woke up to the possibilities, so the tax authorities also became focused on the issue and in 1983 general administrative principles regarding transfer pricing methods were laid down by the Federal Ministry of Finance.

“In the years since then, various more precise administrative principles have been defined for such issues as pooling and permanent establishments.”

In such a complex sphere, it is not surprising that conflicts of interpretation have often arisen, not just between commercial enterprises and their tax advisors on the one hand and the tax collectors on the other but between the revenue authorities and the courts: “In 2001, the Federal tax court ruled that, as the law stood at the time, the tax payer had limited obligation when it came to documentation,” explains Michael.

“Not surprisingly following this judgement, in 2003 the government put in place legislation that changed the playing field. So, from then on, tax-payers have been obliged to fully document their transfer prices, with severe penalties awaiting those who do not conform.

“With this highly effective new sword in its hands, the tax authority responded to the politicians’ demands that it begin a major clampdown.

“In 2008, this pressure culminated in a new paragraph in the Foreign Tax Act, dealing with transfer pricing. Besides general statements regarding what transfer pricing methods are now deemed valid and on the comparability of third-party data, the paragraph deals with the thorny issue of the transfer of functions between affiliated companies,

“In connection with the new Foreign Tax Act (AStG) an ordinance regarding the shift of functions was drafted. This lays down a sophisticated approach to be used in order to determine the appropriate transfer price of a function that is shifted from Germany abroad, or vice-versa.

“Any company that already plays in a global environment or that intends to expand beyond its own national borders is well advised to look into this regulation and take considered professional advice, in order to avoid unpleasant shocks in the future.

“The increasing tightening up of transfer pricing procedures is, of course, a global phenomena. There are several international organisations, including the OECD, PATA and the EU, that are making strenuous efforts to establish international standards regarding transfer pricing.

“One of the most important developments has been the publishing of the ‘OECD Transfer Pricing Guideline for Multinational Enterprises and Tax Administrations’ which should be required reading for anyone in the field.

“Within the EU, another result of this codifying effort is the EU Arbitration Convention, which seeks to avoid double taxation resulting from the way in which transfer pricing operates, and also the EU’s ‘Transfer Pricing Documentation Approach’ document, which provides a kind of master file approach, with pre-defined elements. In general, the transfer prices you set have to be determined at arm’s length. This means that the prices must be seen as being comparable with prices that would have been agreed between two independent parties for the transaction concerned.

“In Germany, inter-company transactions between affiliated companies have to be documented according to a pre-determined structure, which is laid down in paragraph 90 III of the General Tax Code (Abgabenordnung (AO)) and the connected ordinance.

“Today, it is essential for a company practising transfer pricing to have in place a properly constructed regime for such matters.

“A well-considered global value chain and the connected transfer prices can be a crucial factor for the optimisation of the group tax rate. Furthermore, a well-structured transfer pricing system will serve to reduce the administrative efforts and consequent costs incurred in the handling and the yearly documentation process.

“In some companies and their profit centres, transfer price regimes can be used as an incentive instrument to encourage management to optimise their activities.”

So what steps should companies take to put the right systems into place?

Explains Michael Heckel: “The transfer pricing issue should be treated as a carefully planned project, with carefully defined steps along the way,” he adds, “The typical project steps start with extensive and careful pre∞planning and the gathering of all the relevant information, which needs then to be sorted according to documentation requirements. This needs to be followed by a survey of comparable data for the documentation of the appropriateness of the transfer prices which are to be applied, if this is not already available from the determination of transfer prices. And then should follow the clear documentation that shows the appropriateness of the prices which have been applied to inter∞company transactions.”

So what opportunity does the taxpayer have to minimise his liabilities while at the same time avoiding falling foul of his legal obligations? Heckel advises: “Choose a carefully considered approach to the documentation. You can use a so∞called master file approach to generate the documentation for the group as a whole and for the individual companies within it. It is further to be recommended that defined processes be set in place for the yearly update of the documentation process.

“If you have reached a critical level of affiliated companies making inter-company transactions then the implementation of an IT supported documentation system will make the necessary generation and updating of documents a manageable matter.”

According to the current German documentation requirements, as laid down in paragraph 90 III of the AO, the following are listed among the general information items that must be provided for transfer pricing accounting: general information about the group and the relevant company concerned in the transaction (to include a description of the activity, strategy, the group structure and the legal chart); information about the inter-company transaction concerned (an overview of the type and value of the goods or services involved, plus the relevant legal documents), a description of the functions and risks of the affiliated companies involved; a description of the value added elements of the group companies within the value chain; information on the comparable data that has been used as the basis for determination of the inter-company transfer prices, and a full description of the calculation of the transfer prices applied and the underlying assumptions used in setting them.

Advises Michael: “It is key to ensure that the documentation you make is consistent, not only in itself but with the way in which you prepare other external documents, such as financial reports.

“This consistency needs to be applied to all the financial documentation employed, right across the group. In the course of drafting transfer pricing documentation for past periods, your future plans need to be fully considered because any change you make to the system once it has been set up needs to be justified and explained to the tax people.

“In order to ensure an efficient yearly process for updating the documentation, appropriate responsibilities and workflows must be defined among your accounting staff.

“It is absolutely essential to get the legal documentation complete and right, not only to avoid fiscal penalties for non-compliance but to help identify any sensitive transfer pricing issues and prepare for future tax audits.”

Companies that do not follow their duties in such matters are courting unfavourable situations. The financial penalties can be severe and some organisations have lost vast sums of money through tax deductions having been disallowed because of non-compliance with legal requirements. And in some cases criminal charges have been laid for tax evasion.

“Tax authorities around the world are becoming ever more active where transfer pricing is concerned and are now giving little leeway to those who do not get it right.

“Here in Germany, the tax auditors are now expressly required to follow up any indication of noticeable issues. This means that if you do not get your documentation in order you might at the very least involve yourself in a lot of time wasting investigation and explaining every transfer pricing topic in detail.”

About Michael Heckel

Born in 1974, Michael Heckel obtained an economics degree at the University of Hohenheim before starting his business career in 2001 as a member of the Global Transfer Pricing Services team at KPMG in Munich. From 2002 on he established together with a senior manager the Transfer Pricing Group of KPMG in Munich.

In 2009, Michael became Director International Transfer Pricing Services at RP Richter.

Just eight years after its foundation, the Richter organisation is listed by the German JUVE-Handbook 2008/9 edition as one of Germany’s leading tax and law firms and was nominated ‘Firm of the Year 2008 for Tax Law’.

Richter shares a rating of 17th among German tax firms, including the Big Four in International Tax Review, the comprehensive guide to the world’s leading tax firms. The firm’s founder, Wolfgang Richter, was previously for many years the managing partner responsible for tax and corporate law at the Munich office of Ernst & Young,

Among the firm’s professional services are the structuring and planning of international transfer prices and transfer pricing g systems; transfer pricing documentation and appropriate systems; benchmarking studies to demonstrate the arm’s length character of transfer prices; the supervision of transfer pricing issues within the course of tax audits; international MAP (Mutual Agreement Procedures); the preparation of inter-company agreements and professional opinions and advice on transfer pricing issues.

Richter, which today has a payroll of 203 (183 in Munich, 12 in Frankfurt am Main and eight in Stuttgart), has grown continually, thanks to its capacity to offer the services of tax advisors, attorneys-at-law and pubic accountants in a truly integrated manner.

Last year, Richter continued to strengthen its national team of lawyers and advisors by founding satellite offices in the financial centre of Frankfurt am Main and in Stuttgart. Thanks to its membership of the True Partners and JHI networks, RP Richter has representation in the most important countries of the world.

The firm’s core area of expertise is the provision of national and international advice on tax structuring, both inbound and outbound – including offshore structures – as well as tax minimisation, acquisition structures and financing. A particular strength is in dealing with complex structuring and implementation right up to successful completion of the tax audit.

RP Richter has an excellent team of corporate, M&A and real estate lawyers, particularly with regard to structuring issues, transactions and insolvency and re-organisation issues. Legal, tax and financial due diligence services are offered, as well as the negotiating and drafting of contracts, post-merger re-structuring, and re-cap measures.

Further information: www.rp-richter.com