Eucotax Wintercourse 2008 Corvinus University (Budapest) Tax Competition

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1 Dipartimento di Scienze giuridiche CERADI Centro di ricerca per il diritto d impresa Eucotax Wintercourse 2008 Corvinus University (Budapest) Tax Competition Contributi di sintesi aprile 2008 Luiss Guido Carli. La riproduzione è autorizzata con indicazione della fonte o come altrimenti specificato. Qualora sia richiesta un autorizzazione preliminare per la riproduzione o l impiego di informazioni testuali e multimediali, tale autorizzazione annulla e sostituisce quella generale di cui sopra, indicando esplicitamente ogni altra restrizione 1

2 Il presente lavoro nasce dallo Eucotax Wintercourse, al quale l Università Luiss Guido Carli partecipa sin dal Ha formato oggetto dell ultima edizione del Wintercourse tenutosi presso l Università di Budapest dal 3 al 10 aprile 2008 il tema della Concorrenza fiscale tra ordinamenti Si presentano nel seguente documento i paper finali redatti nel corso dei lavori presso l Università di Budapest cui hanno contribuito i docenti e studenti rappresentanti della Luiss secondo il seguente schema: Gruppo Chairman Co-chairman Studenti Transfer pricing: standards Prof. Tulio Rosembuj Michael Rutemöller Paola Prof. Charles Gustafson Rinaldi Tax procedures, compliance (inter alia, opinions, advance pricing agreements, advance tax rulings, dispute settlement) Prof. Dániel Deák Prof. Eugenio Ruggiero Bori Kolozs Francesco Seccia Holding companies and preferentially taxed entities Prof. Giuseppe Melis Prof. Daniel Gutmann Federico Rasi Federica Pitrone (Group) tax facilities (other than holding companies and preferentially taxed entities Prof. Michael Lang Marie Ann Mamut Florian Brugger Ermanno Giuliani Intangibles (e.g., research and development facilities, exploitation of intangibles) Prof. Heike Jochum Jan Bjuvberg Vitalij Mierau Margherita Saccà Expatriates Prof. Bertil Wiman Prof. Luc De Broe Aagje Bellens Ulrika Gustafsson Myslinksi Alessio Persiani Livia Ventura 2

3 ELENCO DEI CONTRIBUTI TRANSFER PRICING STANDARDS INTRODUCTION...13 SOURCES: TRANSFER PRICING REGULATION...14 TARGET: THE CONCEPT OF THE RELATED GROUP...14 MECHANISM: THE TRANSFER PRICING METHODS...18 TANGIBLE ASSETS...19 INTANGIBLE ASSETS...20 DEFINITIONS...20 OWNERSHIP OF INTANGIBLES...21 CCAS...22 COST SHARING AGREEMENTS IN THE U.S...22 COMPARISON OF CCA TO CSA...24 AUSTRIA...27 FRANCE...27 GERMANY...28 HUNGARY...28 ITALY...29 THE NETHERLANDS...29 SPAIN...30 SWEDEN...30 U.S BACKGROUND...34 CCCTB MECHANISM...34 ADVANTAGES...35 DISADVANTAGES...35 CONCLUSION

4 TAX PROCEDURES INTRODUCTION TAX RETURN ADDITIONAL TAX RETURNS CONSEQUENCES IN CASE OF NON-COMPLIANCE TAX RETURNS AND TAX COMPETITION CALCULATION OF THE TAX LIABILITY IN GENERAL: POSSIBILITIES TO CALCULATE TAX LIABILITY SELF ASSESSMENT...49 ASSESSMENT NOTICE FROM THE TAX ADMINISTRATION...50 FINAL REMARK...51 AMENDMENT OF THE ASSESSMENT NOTICE (POST-CLEARANCE RECOVERY)...51 ASSESSMENT NOTICE EX OFFICIO...51 TAX ASSESSMENT WHAT IS AN AUDIT? STATUTE OF LIMITATION TAX ADMINISTRATION S POWERS OF INVESTIGATION? TOWARDS THE TAXPAYER...52 TOWARDS THIRD PARTIES...53 PRESUMPTIONS TAXPAYER S RIGHT TO BE INFORMED DETERMINATION OF TAX LIABILITY JUDICIAL PROCEDURES RULINGS IN EUROPE AND THE US INTRODUCTION DEFINITION AND AIM OF RULINGS POSSIBILITY OF RULINGS TYPES OF RULINGS...59 RULING ON PLANNED TRANSACTIONS...60 RULING AS A GENERAL INTERPRETATION OF LAW...60 CONDITIONS OF TAX RULINGS REPEAL OF RULING

5 FEES DUTY OF TAX AUTHORITIES TO ANSWER RULING PRE-FILING MEETINGS PUBLICATION OF RULINGS AUSTRIA TAX COMPETITION

6 HOLDING COMPANIES AND PREFERENTIALLY TAXED ENTITIES NOTION OF HOLDING COMPANIES DEFINITION OF HOLDING COMPANIES...66 TREATMENT OF HOLDING COMPANIES...67 RESIDENCE FOR HOLDING COMPANIES SIGNIFICANCE OF RESIDENCE...68 RESIDENCE CRITERIA...68 ANTI-ABUSE MECHANISMS FOR HOLDING COMPANIES...71 ITALIAN REBUTTABLE PRESUMPTION...71 CFC LEGISLATION...72 U.S. PFIC PROVISION...74 TAX COMPETITION BY WAY OF PARTICIPATION EXEMPTIONS TAXATION OF INTER-COMPANY DIVIDENDS INBOUND SITUATIONS...75 OUTBOUND SITUATIONS...77 TAXATION OF CAPITAL GAINS ON SHARES DISPOSAL OF A RESIDENT OR FOREIGN SUBSIDIARY BY A RESIDENT HOLDING...78 DISPOSAL OF A RESIDENT SUBSIDIARY BY A FOREIGN HOLDING...79 EXPENSES RELATING TO PARTICIPATIONS ACQUISITION COSTS...80 INTEREST COSTS AND THIN-CAPITALIZATION RULES...80 CAPITAL LOSSES ON PARTICIPATIONS REALIZED CAPITAL LOSSES...80 UNREALIZED CAPITAL LOSSES...81 INTERNATIONAL ASPECTS RELEVANT PROVISIONS IN TREATIES DISTRIBUTIVE PROVISIONS...82 State of residence (art. 4 MTC)...82 Taxation on dividends (art. 10 MTC)...82 Art. 13 MTC taxation on capital gains...83 ANTI-ABUSE PROVISIONS...83 Notion of beneficial ownership...83 Fraus conventionis

7 Limitation-on-benefits-clauses...85 Other specific anti-abuse rules...85 EC LAW ASPECTS...ERRORE. IL SEGNALIBRO NON È DEFINITO. EC FUNDAMENTAL FREEDOMS...86 General...86 National tax treatment of holding companies in the light of the EC fundamental freedoms...88 EC PARENT-SUBSIDIARY DIRECTIVE...90 EC COMMUNICATION REQUEST TO TERMINATE DISCRIMINATORY TAXATION OF OUTBOUND DIVIDENDS...91 COMPLIANCE WITH PROJECTS ON HARMFUL TAX COMPETITION...91 APPENDIX 1: RESIDENT MATRIX APPENDIX 2: TAXABLE BASIS

8 TAXATION OF GROUPS OF COMPANIES

9 INTANGIBLES INTRODUCTION DEFINITION AND CAPITALIZATION OF INTANGIBLES DEFINITION OF INTANGIBLE CAPITALIZATION OF INTANGIBLES DEPRECIATION DEDUCTIONS...41 LICENSE AND SALE OF INTANGIBLE ASSETS...41 LICENSE...41 SALE TRANSFER PRICING APPLICABLE METHODS FOR DETERMINING ARM S LENGTH CONSIDERATION FOR TRANSFERS OF INTANGIBLE PROPERTY COST CONTRIBUTION ARRANGEMENTS IMPORTANCE OF CCAS IN INTERNATIONAL R&D ACTIVITIES REQUIREMENTS FOR PARTICIPATION IN A CCA COST ALLOCATION ALLOCABLE COSTS...49 EXPECTED BENEFITS AS THE BASIS OF THE COST ALLOCATION KEY ADJUSTMENT OF COST ALLOCATION THROUGH BALANCING PAYMENTS BUY-IN AND BUY-OUT PAYMENTS...53 DOCUMENTATION REQUIREMENTS IMPORTANCE OF CCAS IN THE CONTEXT OF TAX COMPETITION...54 DOUBLE TAX CONVENTIONS OVERVIEW DEFINITION OF ROYALTIES WITHHOLDING TAX RATE TAX INCENTIVES CONCLUSION

10 EXPATRIATES INTRODUCTION I.THE PRINCIPLE OF NON-DISCRIMINATION...70 A.THE PRINCIPLE OF NON-DISCRIMINATION UNDER NATIONAL LAW THE CONCEPT OF RESIDENCY THE PRINCIPLE OF EQUALITY FICTION OF RESIDENCY AND NON RESIDENCY EXPATRIATION COSTS REDUCTION OF THE TAX RATE FULL EXEMPTION OF INCOME EARNED ABROAD...77 B.THE PRINCIPLE OF NON-DISCRIMINATION UNDER EC LAW...78 C.THE PRINCIPLE OF NON-DISCRIMINATION UNDER OECD...79 II.THE EUROPEAN CODE OF CONDUCT...81 A.THE PRESENT SITUATION OF THE CODE OF CONDUCT...81 B.THE FUTURE OF THE CODE OF CONDUCT...82 C. APPLICATION OF THE CODE OF CONDUCT...85 III.THE STATE-AID PROVISIONS (ART. 87 EC TREATY)...86 A. ADVANTAGE FOR A FIRM...86 B. STATE-ORIGINATED RESOURCES...87 C. DISTORTION OF COMPETITION

11 D. SPECIFIC / SELECTIVE...89 E.CONCLUSION REGARDING THE APPLICATION OF THE STATE AID PROVISIONS...91 IV. OVERALL CONCLUSION AND RECOMMENDATIONS...91 LIST OF ABBREVIATIONS

12 EUCOTAX Wintercourse 2008 Budapest TRANSFER PRICING STANDARDS 12

13 Introduction The global interconnectedness of the social, economic, and financial relations of enterprises as well as the associated increase in inter-company transaction have led tax authorities to focus increasingly on the issue of transfer pricing. Transfer prices are the prices that are assigned to goods and services as they flow internally within a firm, or as they are moved between the affiliated entities that comprise a multi-national corporation (MNC). 1 Transfer pricing standards attempt to identify and minimize discrepancies between the prices set in intrafirm transactions and those that would be set in arm s length trade. MNCs may have tax incentives to perpetuate such price differentials. This is because transfer prices may enable MNCs to lower their overall tax burden by minimizing taxable income generated by domestic operations and maximizing lightly taxed income generated by foreign operations. Transfer pricing incentives are pronounced in territorial systems like those of the Member States of the European Union (EU) and also exist in a worldwide taxability system, like that of the United States (U.S). Transfer pricing regulation lies at the crux of the resulting tension between corporate taxpayers and taxing authorities. On the one hand, MNCs are interested in raising operational and structural efficiency to gain higher profits and the goal of higher profits may be reached in part by transferring taxable income to countries where tax legislation is more favorable. On the other hand, tax authorities must arrive at an estimate of how much income to attribute to a local subsidiary or a permanent establishment (or generally to the jurisdiction) as a basis for taxation, which can be hindered by corporate manipulation of profits. The tension between corporate taxpayers and tax authorities results in competition between countries when each attempts to protect its taxable base through regulation. This study is an overview of transfer pricing in nine countries: Austria, France, Germany, Italy, Hungary, the Netherlands, Spain, Sweden, and the U.S. Part II mentions the legal sources of transfer pricing regulation in each country. Part III considers the target of transfer pricing, or the related group, as it is defined in the respective countries. Part IV describes the methods of regulating transfer pricing. Part V summarizes the documentation and penalty regime applied by the various countries to enforce the transfer pricing rules. Part VI analyzes the formulary approach that has been proposed for the EU in the form of the Common Consolidated Corporate Tax Base (CCCTB) and adopted in some U.S. states as an alternative to separate accounting. That Part considers some of the obstacles that may have to be overcome by the CCCTB if it is to be implemented in the EU, namely its potential non-conformity with the OECD Model Tax Convention. Part VII concludes with a discussion of the link between transfer pricing regulation and harmful tax competition. 1 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Preface, (P-11), OECD,

14 Sources: Transfer Pricing Regulation The following table lists the sources of transfer pricing regulation in each of the countries included in this study. Source of Law Austria France Germany Hungary Italy Netherlands Spain Sweden U.S. 6 (6) Austrian Individual Income Tax Act 8 Austrian Corporate Income Tax Act Article 57 Tax Code 1 Foreign Tax Act 90, 162 General Fiscal Code 8 Corporate Tax Act 4 Corporate Tax Act Article 9 and article CITA Tax Administration Circular 32/80 Articles 8 CITA, 8b CITA Article 3.8 ITA Transfer Pricing Decree 2001 Transfer Pricing Decree 2004 Articles 15 and 16 of the Corporate Tax Act Chapter 14, Income Tax Act 482 I.R.C Target: The Concept of the Related Group The focus of transfer pricing regulation is the related group. The existence of a related group depends on a finding of control between taxpayers. In arriving at a definition of control, the countries analyzed in this study refer to Article 9 of the OECD Model Tax Convention. The majority of the countries do not designate a specific percentage of control as dispositive, but Germany and Austria require participation of at least 25% capital control. For those countries that do not specify a percentage, the mere possibility of influencing the decisions of an entity contractually or through dominant influence over shareholder action may constitute control. The following is a more detailed description of the concept of the related group in each country: A. Austria According to section 6 (6) a) of the Austrian Individual Income Tax Act, a related group may be found when: - a foreign business belongs to the same taxpayer, 14

15 - a taxpayer is a co-entrepreneur in the foreign business, - a taxpayer has a material interest in the foreign corporation (that is, the taxpayer holds more than 25% of the corporate shares), or - both businesses are managed by the same persons or the same persons can influence the management of the two businesses. B. France In France, the concept of related group is explained in Article 57 of the French Tax Code. The concept of the related group supposes the existence of dependence between the companies composing the group. Two companies are dependent and belong to a single group when one of them is involved directly or indirectly in the other s management control or capital, or when the two companies have been held or are under the influence of the same group. A situation of control is present when: - a French company is subordinate to a foreign company, i.e. the foreign company directly or indirectly owns its capital shares; - a company controls most of the voting rights necessary to vote during the shareholder s ordinary meeting; or - a foreign company can exercise decisional power in another company, including contractually. In practice, owning over 50% of the capital of another company constitutes control under French law. C. Germany Under German law, the concept of related group is only relevant under certain circumstances. 2 Where the concept of the related group is relevant, section 1 of the German Foreign Tax Act is applied. Pursuant to that section, a related group is present when: - An entity has direct or indirect capital participation of 25% or more; - An entity has direct or indirect dominant influence over another entity due to the business relationship between the parties; or - There is dominant influence on an entity due to reasons other than the business relationship between the parties. 2 That is, the concept does not apply when the hidden profit distribution or hidden capital contribution rules apply. A description of these rules is outside the scope of this study. 15

16 D. Hungary According to the Hungarian Act on Corporate and Dividends Taxation, an association can exist between two taxpayers, taxpayers and non-taxpayers, taxpayers and private persons, or taxpayers and local governments. 3 Under the Hungarian Corporate Tax Act, the concept of related parties is defined by reference to majority influence. Majority influence exists if a person: - owns more than 50% of the votes of a company, or - exerts dominant influence over a legal person 4 (i.e. by having the right to elect and dismiss members of the supervisory board, or by agreement directly providing more than 50% of the voting power). E. Italy In defining the relationship of control between resident enterprises and nonresident companies, as mentioned in Article 110 of the Consolidated Income Tax Act, The Italian Tax Administration circular 32/1980, refers exclusively to the limits set down in Article 2359 of the Civil Code. The concept of control includes every assumption of potential or current economic influence, inferable from the circumstances, including situations in which a company: - has the majority of votes applicable in the ordinary meeting of another company; - has enough votes to exercise a dominant influence in the ordinary meeting of another company; - exercises a strong influence over another company due by contractual agreement. Under circular 32/1980, situations that may determine mutual relations between enterprises arise: - pursuant to sale of products manufactured by other enterprises, - when an enterprise cannot function without the capital, products, and technical know-how of the other enterprises, - pursuant to the right to nominate members to the board of directors or managing bodies of a company. 5 3 Since January 1, 2008, non-profit and prominently non-profit business associations and those over which the Hungarian government exercises majority influence directly or indirectly no longer fall under the scope of the regulation. Adózóna : Tárasági adó, Feb. 15, Civil Code 685/B. 5 The broad notion of control delineated by the Tax Administration circular has been confirmed by the Seventh Directive of the European Community. 16

17 However, the regulation of transfer pricing is broader than the definition of control provided by article 2359, and applies whenever a company has an interest in another company. F. The Netherlands In the Netherlands, the concept of control is provided in Article 8b of the Corporate Income Tax Act (CITA). Under Article 8b, a relation of control exists when an entity directly or indirectly participates in the management, supervision, or capital of another entity. Prior to the implementation of Article 8b of the CITA, only a shareholder relationship could lead to affiliation. However, as of January 2002 participation in the management of a company may also lead to affiliation. 6 G. Sweden Sweden follows the concept of associated enterprise provided by article 9 of the OECD model. An associated enterprise may be an enterprise of a contracting state participating directly or indirectly in the management, control or capital of an enterprise of the other contracting state. It could also be the same persons participating directly or indirectly in the management, control or capital of an enterprise of a contracting state and in an enterprise of the other contracting state. Hence associated companies are based on either ownership or control of companies. The regulation encompasses sale of goods, provision of services, the sale or lease of intellectual property and all types of financial transaction. 7 H. Spain Article 42 of the Commercial Law Code of Spain states that a related group exists when a company holds or could hold, directly or indirectly, control over at least one other company. Article 16.3 of the Corporate Tax Act provides that a group is: 1) two entities that belong to the same group, 2) an entity and partners or shareholders of another entity, when both entities belong to the same group, 3) an entity and advisers or administrators of another entity, when both entities belong to the same group, or 4) an entity and spouses or relatives, in the direct line or in the collateral line, by blood or by marriage, up to the third degree, of the partners or shareholders of another entity when both entities belong to the same group. According to a regulation in the Royal Decree 415/2007 (the General Accounting Plan), control exists when a company has: 6 This was added because, in practice, it turned out that going concerns often made use of entities without capital divided into shares, like foundations or trusts. Without this addition of affiliation there would be no case of a shareholder relationship, and thus no case of associated entities. Using only the criterion of shareholder relationship without application of the arm s length principle would lead to undesired possibilities of control. 7 IFA-TP NR

18 - the majority of the voting rights during the shareholder s ordinary meeting, or - a dominant influence according to contractual provisions. I. U.S. Section 482 of the Internal Revenue Code applies only when two or more organizations, trades or businesses are owned or controlled directly or indirectly by the same interests, and includes the taxpayer that owns or controls the other taxpayers. 8 There is no mechanical test for determining whether the requisite control exists. 9 Rather, the relevant inquiry is one of facts and circumstances and concerns the reality or presence of practical control, not theoretical or formal legal control. 10 Common control is determined at the time of negotiation of the transaction in question, and the determination concerns control that was actually used in the transaction. 11 For example, control includes that resulting from the actions of two or more taxpayers acting in concert or with a common goal or purpose. Also, control is presumed if income or deductions have been arbitrarily shifted. 12 Although common beneficial ownership or voting control of 50 percent or more may indicate control, it is not legally determinative. Courts have found common control in situations where a party owned a majority of the stock of a corporation, but a court has also held that common control was not present even though the parties owned majority interests in both corporations. 13 Mechanism: The Transfer Pricing Methods Countries differ with respect to honoring the validity of various transfer pricing methods that have been proposed by the OECD Guidelines for the transfer pricing of tangible assets, intangible assets, and the provision of services. 8 Treas. Reg (i) (5). 9 From a practical standpoint, the presence of the requisite control will not be a contested issue, particularly where the transactions in question involve parent corporations and their 100% owned subsidiary or brother-sister corporations that are both 100% owned by the same parent corporation. 10 Treas. Reg (i)(4). 11 DHL Corp. v. Commissioner, 258 F.3d 1210 (9th Cir. 2002). 12 Treas. Reg (i)(4). 13 See, e.g., W.L. Gore & Associates v. Commissioner, 96 T.C. 226 (1991); B. Forman Company, Inc. v. Commissioner, 54 T.C. 912 (1970), rev d. 453 F.2d 1144 (2d Cir. 1972). 18

19 Tangible Assets The traditional methods for setting a transfer price for transactions involving tangible assets are the 1) comparable uncontrolled price (CUP), 2) resale price method, and 3) cost plus method. The CUP method is the most direct and preferred method under the OECD Guidelines. 14 The OECD Guidelines state that the CUP method compares the price charged for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. 15 With regard to the resale price method, the OECD Guidelines provide as follows: The resale price method begins with the price at which a product that has been purchased form an associated enterprise is resold to an independent enterprise. This price (the resale price) is then reduced by an appropriate gross margin (the resale price margin) representing the amount from which the reseller would seek to cover its selling and other operating expenses and, in the light of functions performed (taking into account assets used and risks assumed), make an appropriate profit. 16 With regard to the cost-plus method, the OECD Guidelines provide as follows: The cost-plus method begins with the cost incurred by the supplier of property (or services) in a controlled transaction for property transferred or services provided to a related purchaser. An appropriate cost-plus mark up is added to this cost, to make an appropriate profit in light of the functions performed and the market conditions. 17 The availability of the traditional methods is subject to the feasibility of identifying comparable operations or products. Comparability is difficult to reach when products are specialized, or unique. If none of the traditional methods is available, additional methods that be used are: 1) the transactional net margin method (TNMM), and 2) the profit split method. The transactional net margin method (TNMM) examines the net profit margin relative to an appropriate base (including cost, sales, and assets) that a taxpayer realizes from a controlled transaction. 18 The profit split method seeks to determine the division of profit that independent enterprises would have expected to realize form engaging in a transaction. In practice, the profit split method first identifies the combined profits of an enterprise. This profit is divided between the associated enterprises, as it would have been in an arm s length transaction. Therefore the division is based on the relative value of the contributions of each enterprise. 19 All of the countries examined in this study express a preference for the traditional methods. Within the traditional methods, the CUP method is considered the best 14 Santaro, International Transfer Pricing Journal, May/June 2007, 147 (149). 15 OECD Guidelines for Multinational Enterprises and Tax Administration, para OECD Guidelines for Multinational Enterprises and Tax Administration, para OECD Guidelines for Multinational Enterprises and Tax Administration, para OECD Guidelines for Multinational Enterprises and Tax Administration, para Santaro, International Transfer Pricing Journal, May/June 2007, 147 (150). 19

20 method to represent market price. As mentioned, under the OECD Guidelines, only if the traditional methods are unavailable (if, for example, a comparable product or set of operations is non-existent) are the alternative methods to be applied. The U.S. transfer pricing rules also provide for use of the traditional methods (as well as an additional set of unspecified methods ) and do not establish priorities for the selection among these methods, nor between the unspecified methods. Instead, the U.S. transfer pricing regulations require the taxpayer to use the best method, or that which under the facts and circumstances provides the most reliable measure of an arm s length result. 20 Intangible Assets Definitions Intangible assets are nonphysical assets from which a company earns profits above those it would have earned by virtue of its physical assets alone. 21 Intangibles are difficult to value because they are usually not publicly traded, often bundled with tangible assets, and sometimes even difficult to detect. 22 Royalties, license fees, and dividends are proxies that assist with valuation of intangibles. The OECD defines intangibles as the right to use industrial assets such as patents, trademarks, corporate names and drawings or models. This definition includes property rights, copyrights, and intellectual property such as know-how and industrial or trade secrets. Because intangibles can take various forms, the OECD provides a detailed classification of manufacturing and commercial intangibles. Manufacturing intangibles include patents, inventions, concepts, techniques, drawings, models, and the know-how used in services or production activities. Commercial intangibles are the trademarks, brands, corporate names, customers, networks of distribution, and the descriptions or symbols of products. 23 France, Italy, Germany, Hungary, Sweden, and the Netherlands follow the OECD directives. For example, in the Netherlands, Decree 21 August, IFZ 2004\680 M states that the Netherlands follows the directives. Hungary follows the OECD s 20 Treas. Reg (c)(1); In practice, both the taxpayer and I.R.S. auditors often deviate from applying the best method analysis toward the easiest transfer pricing method, which is often the formulary CPM. 21 Monica Boos, International Transfer Pricing: The Valuation of Intangible Assets (Kluwer Law International: 2003) Id. 23 The OECD Guidelines provide an overview of intangible property in the introduction and treat the subject more extensively in Chapter VI. In Chapter VI, the OECD Guidelines point out that intangible property includes rights to use industrial assets such as patents, trademarks, trade names, designs or models as well as literary and artistic property rights and intellectual property such as know-how and trade secrets. The OECD Guidelines further concentrate on business rights, that is intangible property associated with commercial activities, including marketing activities. See MN 6.2 of the OECD Guidelines. 20

21 directives according to the Hungarian Corporate Tax Act paragraph 31.2 (stating that Hungary should apply all of the OECD directives). While Austria, Spain, and the U.S., do not follow the OECD directives directly, their respective definitions of intangibles do not contradict the OECD directives. In Austria, there is no precise definition of intangibles the commercial or tax law and the provisions only provide for non-exhaustive lists from which a thorough classification of intangible assets cannot be derived. Therefore, Austria may be said to follow the OECD directives despite having its own classifications because such classifications do not provide exact definitions nor state a clause against the application of the directives. In Spain, the definition of intangibles is provided in Section 5 of Part Two of the General Accounting Plan, Royal Decree 1415/2007, November. That section states that the initial recognition of an intangible takes place when the intangible meets the definition of an asset (as detailed in Part One), and when it complies with the identifiability requirement. The identifiability requirement is met when either one of two situations is present: 1) the asset is separable or capable of being separated from the company to be sold, transferred, rented or exchanged, or 2) the asset emerges from legal or contractual rights. Finally, in the U.S., Treas. Reg (b), classifies intangibles in six categories of items having substantial value independent of the services of any individuals: patents, copyrights, trademarks and trade names, licenses and methods, and other similar items that derive value from intellectual content or other intangible properties rather than their physical attributes. 24 In conclusion, intangibles are nonphysical assets from which a company earns profits above those earned solely by virtue of its physical assets. The OECD distinguishes between manufacturing and commercial intangibles. Most of the countries in this study follow these regulations directly or indirectly, with some (including Spain and Austria) requiring an intangible asset to meet further requirements. Ownership of Intangibles To determine the owners of an intangible asset, a distinction may be made in some systems between legal and economic ownership. In some instances, ownership of intangibles may also be determined with respect to contractual agreement or economic substance principles. In the OECD, while there is no precise definition of beneficial ownership, the general concept is provided by tax treaty law. 25 Under Article 12 of the OECD Model Convention, a taxpayer that receives a royalty is also the beneficial owner of the rights and assets for which the royalty is paid. An example of ownership by agreement is the Cost Contribution Agreement (CCA), as applied by the European countries that follow the OECD. 24 Marc M. Levey et al., Transfer Pricing Rules and Compliance Handbook (Kluwer: 2006) See Art. 12 (1) OECD MC. 21

22 CCAs A CCA is an agreement by which two or more enterprises agree to split the costs and risks for the development, production, and acquirement of assets or services. 26 The costs involved in the agreement include the direct and indirect expenses associated with the development of intangibles or services. Such expenses are covered by the contribution of each party, with the contribution defined by reference to the total benefit (or profit) that the participant expects to gain from the intangible right once it is exploited. The value of the contribution must be set according to the arm s length principle. This value must be equal to the value that would be paid by an independent company under similar conditions. In defining the CCA, the OECD guidelines provide four principal elements: 1) contractual agreement between related or independent companies; 2) division of costs and risks; 3) development, production or obtaining of assets, services or rights; and 4) determination of the nature and extension of the proportional part of every participant to future expected benefits. First, the contractual relationship serves to compensate for the absence of an unrelated party by replicating the kind of commitment that would have been expected in the presence of such an unrelated party. 27 Second, the contribution to the costs is not based directly on the project s novelty. Therefore, any resulting value derived from the exploitation of the intangible, whether in money or in kind, will be considered. Third, with respect to development of the intangible, the CCA is not dedicated exclusively to the joint development of intangibles but includes any activity that supposes reciprocal benefits for the parties, such as, centralized management services, advertising campaigns or combined funding. Cost Sharing Agreements in the U.S. 26 Par OECD Guidelines. 27 It can be argued that the arm s length principle is insufficient because there are non-economic elements in the contribution to the costs of the related group. The proportionality and reasonability of the CCA is a concept that is relevant within the contract, and may not be capable of being captured with reference to a relationship outside the context of the specific contractual relationship. 22

23 Under a Cost-Sharing Agreement (CSA) in the U.S., no charge has to be made between related parties for jointly developed intangible property. Adjustments are required only to the extent necessary to insure that each party bears its proportionate share of the costs invested. Once the intangible is developed, each party will be an owner of the intangible and no additional charge or royalty needs to be paid to exploit the property. 28 A qualified CSA under 482 must 1) include two or more participants, 2) provide a reliable method to calculate each participant s share of intangible development costs based on anticipated benefits, 3) provide for adjustments of cost shares to account for changes in circumstances, and 4) be recorded in a document contemporaneously with the formation of the arrangement. 29 The documentation must include: a list of participants and any other member of the controlled group that will benefit from the intangibles developed; the methods used for sharing costs and the circumstances requiring an adjustment to cost shares due to change in conditions; a description of the scope of the research and development project, including the intangible or class of intangibles intended to be developed; a description of each participant s interest in any covered intangible; duration of the arrangement; and conditions requiring and consequences of modifying the arrangement. The I.R.S. may apply the cost sharing rules to any arrangement that in substance constitutes a CSA, regardless of its compliance with these provisions. 30 The scope of the CSA under 482 covers any intangible property that is developed as a result of research and development undertaken under the arrangement, including development of intangible property not foreseen at the inception of the project. 31 Participants of a CSA can be controlled taxpayers or uncontrolled taxpayers. A controlled taxpayer must reasonably anticipate deriving benefits from the use of covered intangibles and substantially comply with accounting, documentation, and reporting requirements. 32 A qualified participant can derive benefits from exploiting the research and development results directly, or by licensing or transferring the intangible to others. Cost allocations under CSAs are based on the benefits each participant anticipates. These include operating expenses (except depreciation or amortization), charges for the use of any tangible property made available, and cost-sharing payments made to other participants. Anticipated benefits can take the form of additional income generated or costs saved by the use of the covered intangibles Treas. Reg (a)(2). 29 Treas. Reg (b). 30 Boos, supra at 141; Treas. Reg (a)(1). 31 Treas. Reg (b)(4)(iv). 32 Treas. Reg (c)(1). 33 Treas. Reg (e)(1). If, during the period of a CSA, one participant makes available to the other participant existing intangibles that it owns, the acquiring participant must pay appropriate consideration. This takes the form of a buy-in payment that must reflect an arm s length charge for the use of those intangibles. Additionally, when a change occurs in the interests of the controlled participants, including by reason of entry of a new participant or transfer of interests among existing participants, the controlled participant must make a buy-out payment to the transferor. An example of a situation requiring buy-out 23

24 Comparison of CCA to CSA The main difference between the CCA and the CSA is that the CSA abides exclusively to the development of one or more intangibles and aims at the development of the specific project while the CCA considers a relationship of development of products that is more broad in scope. J. Services The U.S. is the only country in this study to have implemented specific transfer pricing rules on services. In 2006, the I.R.S. issued final and temporary regulations regarding intercompany service transactions. 34 Under the pre-2006 rules, a charge for services undertaken for or on behalf of a related party is required if the probable benefits to the related members are not remote or indirect. 35 Where the services are not an integral part of the business activity of either the service provider or the service recipient, the arm s length charge for services rendered is determined based on the costs or deductions incurred with respect to such services by the service provider, unless the taxpayer establishes a more appropriate charge. 36 Where the services are an integral part of the business activity of either member, the arm s length charge is equal to the amount that would have been charged for the same or similar services if provided to an independent party. 37 A charge for the activities undertaken is to be consistent with the relative benefits intended from the services, based upon the facts known at the time the services were rendered. 38 Whether the anticipated benefits are realized is irrelevant. An adjustment may be required whether the services are performed for the joint benefit of all members of the group or for the exclusive benefit of one other member. Treasury regulation T contains new guidance for determining whether an activity constitutes the rendering of compensable services and new provisions relating to contingent payment contracts. II. Documentation Requirements and Penalties payments is when a participant relinquishes, transfers, or abandons its interests and withdraws from the CSA. 34 The 2006 regulations, issued principally under Treas. Reg T, replace previously issued guidance and are effective for taxable years beginning in 2007 (or by taxpayer election to any taxable years beginning after Sep. 10, 2003). 35 Services contemplated include marketing, managerial, administrative, or technical services for another member, either without charge or for compensation not equal to an arm s length charge. 36 Treas. Reg (b)(3). 37 Id.; An example of services that form an integral part of the business activity is where the service provider or recipient is engaged in the trade or business of rendering similar services to unrelated parties. See Treas. Reg (b)(7)(i). 38 Treas. Reg (b)(2)(i). 24

25 The differences in national tax systems in the field of transfer pricing have an impact on the competitiveness of countries and on the international tax planning decisions of. The areas within transfer pricing in which there is the greatest amount of variability between countries is that of documentation requirements, penalty provisions and Advance Pricing Agreements (APAs). The number of countries implementing specific documentation requirements and penalties has increased in recent years. 39 A. Documentation Requirements Documentation requirements are used primarily for proving the adequacy of a transfer price provided by the taxpayer to the tax authorities. 40 Since the OECD Guidelines do not create affirmative duties for the taxpayer, the documentation requirements presented therein can only be imposed on the taxpayer if the national law provides corresponding obligations. 41 That not all countries have implemented specific documentation requirements may create difficulties for taxpayers operating in different countries. 42 From the taxpayer s point of view, the documentation requirements are burdensome. The collection and preparation of data and material is considered to create compliance and administrative costs. Documentation is also used for proving the appropriateness of a transfer price. If the taxpayer is able to provide information and documentation that proves adherence to arm s length principles, the tax authorities may find it hard to disprove the taxpayer s position. 43 The existence of such documentation may provide for the resolution of tax disputes without the need for extensive legal proceedings. 44 However, the conduct of the taxpayer during a tax audit can significantly affect the outcome of the inquiry and the amount of any adjustment. If the taxpayer can take an objective approach and provide adequate documentary evidence, the taxpayer has a stronger position from which to defend transfer pricing against adjustments and penalties proposed by the tax authorities. 45 Therefore, the absence of specific documentation requirements is a disadvantage for the taxpayer. However, the tax authority s need for adequate information must be balanced with the need to protect corporate taxpayers from overly cumbersome documentation requirements Some argued that is questionable whether this development is in the interest of MNCs given the variability in the specific national provisions on documentation. See Macho/Reiner/Ruess, Verrechnungspreise kompakt, p See Schuch, in Tanzer (ed.) Die BAO im 21. Jahrhundert, p See Göschl, Die in den OECD-Verrechnungspreisrichtlinien angeführten Dokumentationspflichten und ihre rechtliche Bedeutung, in Schuch/Zehetner (eds.) Verrechnungspreisgestaltung im Internationalen Steuerrecht ( 2001) p See Macho/Reiner/Ruess, Verrechnungspreise kompakt, p See Göschl, in Schuch/Zehetner (eds.) Verrechnungspreisgestaltung, p See Göschl, in Schuch/Zehetner (eds.) Verrechnungspreisgestaltung, p See PricewaterhouseCoopers, International Transfer Pricing 2006, p. 228, MN See Chetcuti, The EU Tax Arbitration Convention. ( 25

26 A. Penalties Whereas some countries prove to be very aggressive in applying transfer pricing penalties, 47 other countries have not implemented no penalty provisions. 48 A large degree of discrepancy between the penalty regime of different countries increases the taxpayer s incentive to shift profits from countries with soft or no penalties to countries that have implemented severe penalties. 49 B. APAs APAs are binding agreements concluded between the taxpayer and the tax authorities as a predetermination of transfer prices that will be held to be permissible under specific circumstances. An APA can be concluded for future inter-company transactions and has binding character. The conclusion of an APA serves to reduce the uncertainty for the taxpayer by increasing the predictability of the behavior of relevant tax authorities. An environment of increased predictability may also serve to strengthen the competitiveness of a given country. 50 A related advantage is that subsequent disputes in mutual agreements procedures may be avoided. 51 Nevertheless, although taxpayers find it advantageous eliminate uncertainty to the greatest extent possible, such benefits do not necessarily outweigh the costs associated with APAs, including the expenses associated with long and costly procedures. For example, to complete an APA, tax authorities generally require at least the same or higher levels of documentation required under normal circumstances. 52 C. Survey 47 See Ernst & Young, Transfer Pricing 2005/2006 Global Survey, p See Ernst & Young, Global Transfer Pricing Reference Guide, p. 9; Macho/Reiner/Ruess, Verrechnungspreise kompakt, p See Kroppen, Hanbuch Verrechnungspreise, Volume 2, TZ 4.4. MN See Schön, IBFD, European Taxation 2002, p See Beudeker/Janssen, ITPJ 2006, pp. 235 et seq. 52 An APA can be unilateral, bilateral or multilateral, depending on the number of states granting an APA. Unilateral APAs may be in conflict with harmful tax competition, unless sufficient transparency and the exchange of information are guaranteed. Moreover, these forms of APA do not necessarily prevent double taxation. Formal APA programs have only been established by some Member States. Most member APAs are obtained through other general procedures, such as under the mutual agreement procedure of a double tax treatysee European Union, ITPJ 2003, pp. 23 et seq. 26

27 The following table demonstrates the implementation of specific transfer pricing provisions per country with respect to documentation requirements, penalty provisions and APAs, as discussed in more detail for each country in the text below: Specific Doc. Requirements Specific Penalty Provisions Advance Pricing Agreements AUSTRIA FRANCE GERMANY HUNGARY ITALY NETHERLANDS SPAIN SWEDEN U.S Country has implemented relevant provisions. - Country has not implemented relevant provisions. Austria Austria has implemented neither specific transfer pricing documentation requirements, nor penalty provisions. However, the Austrian Ministry of Finance may require documentation and data material from taxpayers in order to prove the adequacy of a transfer price used in an inter-company transaction. In this regard, general rules have been laid down in the Federal Fiscal Code (FFC). Under section 166 FFC, all matters relevant to a determination of facts may be presented as evidence. If the requirements of Section 131 FFC are met, such as the translation of foreign documents, the documentation is considered to be proper and is used for the determination of taxable income. Under Austrian law, it is not possible to obtain an APA because it is not possible to agree to a binding agreement with the tax authorities. However, it is possible to obtain an Express Answering Service (EAS) inquiry in international tax matters. This procedures offers the taxpayer the possibility to submit some important facts and circumstances of a case to the Austrian Ministry Finance in order to obtain some comments on its legal aspects. An EAS is not binding, but the answers of the Austrian Ministry of Finance are published regularly and often referred to in practice. France 27

28 In France, there are no formal specific documentation requirements for transfer pricing issues. However, in case of a tax audit, a company should be able to explain how the prices in its inter-company transactions have been established. The documentation must reflect the situation at the time the transactions occurred, even if not documented contemporaneously with the transaction. The documentation prepared should be in French (in practice, the French Tax Administration often accept transfer pricing documentation in English). The administration has access to all of the documentation enabling it to highlight the company's transfer pricing policy. The taxpayer has to give the necessary documents required to analyze the method and any accounting or extraaccounting document. The transfer pricing method chosen has to be justified. For this purpose, the taxpayer will have to collect relevant data about prices in transactions. With regard to penalties, the French have not implemented a special penalty regime for transfer pricing issues. Finally, French tax regulations provide for official procedures for concluding an APA. Currently, only forty APAs have been concluded by the French Administration and approximately 30 are in the process of being negotiated. Germany Germany has introduced a penalty regime on transfer pricing issues that distinguishes between ordinary and extraordinary transactions. In strict legal terms, a surcharge (no penalty for criminal misconduct) between 5 and 10% of a profit adjustment must be raised, with a minimum of 5,000 Euros. In case of late presentation of appropriate documentation, the maximum surcharge is 1 million Euros, with a minimum of 100 Euros for each day after the 60 days time limit is exceeded. Furthermore, Germany has implemented documentation requirements in the Germany Fiscal Code. The attitude of the Federal Ministry of Finance on APAs has recently changed toward favourable treatment of APAs. However, the Federal Ministry of Finance is typically not prepared to grant unilateral APAs in transfer pricing issues, since unilateral APAs have no binding effect on other countries concerned. Therefore, the German tax authorities are instructed to only grant APAs on a bilateral or multilateral basis. Hungary The Hungarian Finance Minister Decree regulates the documentation regarding transfer prices of associated enterprises. The aim of the documentation is to determine whether the tax base should be adjusted because the related parties did not apply fair market prices. The transfer pricing documentation has to be prepared by the time the company files the tax return. However, while such documentation must be kept by the 28

29 company, it does not have to be submitted to the tax authorities. According to the general rule, if a penalty is computed 50% of the unpaid tax is charged. If the transfer pricing documentation is unprepared or incomplete, the tax authority can impose a penalty of up to 2 million Ft (approximately 80,000 Euros). 53 The burden to prove the correctness of the applied transfer price is passed on to the taxpayer. The taxpayer is obliged to provide the information within five months of the end of the accounting period. Where adequate documentation is in place, the tax authorities must demonstrate that the method selected, the search criteria, and the uncontrolled comparables identified are not applicable. Finally, APAs may be concluded under the Hungarian Law. Italy In Italy, it is possible to request a formal opinion on any tax matter from the tax authorities and this may include a transfer pricing issue. The opinions can be concluded for an average duration of three to give years. The tax authorities are only bound by the opinion given in their response for the duration agreed upon. Italian tax authorities may require taxpayers to produce or send deeds and documents concerning the assessment to which they are subject. In this case, taxpayers are obliged to comply with tax authorities requests. If a taxpayer fails in submitting documentation within 15 days after the Tax Authorities request, the Tax Authority may make an income assessment based on its own evaluation. Administrative penalties may range from 100% to 240% of the amount of unpaid taxes. Finally, it is not possible to conclude an APA in Italy. The Netherlands The Netherlands follows the OECD Guidelines on requirements. Documentation requirements have been implemented in Article 8b sub 3 of the Corporate Income Tax Act. The definition in that Article is a relatively broad norm, which implies that transactions with limited risks can suffice with less information provided. The documentation must show how prices have been established and why they would have been agreed to by independent parties. In a transfer pricing audit, the tax authorities must first follow the method used by taxpayer. By the terms of the Article, it appears that documentation has to be provided contemporaneously with the transaction. However, the taxpayer must respond to the request for information by the authorities within four weeks with a maximum of three months for complex transactions. A taxpayer 53 Act XCII of 2003 on tax administration, para