Transfer Pricing. Transfer Pricing in Germany. Abdulkerim Keser, Manager Deloitte Munich/Germany. December 19, 2006 Ritz Carlton Hotel - Istanbul

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1 Transfer Pricing. Transfer Pricing in Germany Abdulkerim Keser, Manager Deloitte Munich/Germany December 19, 2006 Ritz Carlton Hotel - Istanbul

2 Transfer Pricing in Germany Agenda Transfer Pricing Regulations in Germany Transfer Pricing Documentation Approach Top Ten Transfer Pricing Challenges

3 Transfer Pricing Regulations - Overview Legal provisions for transfer pricing documentation Sec. 90 para. 3 GTC: Definition of documentation and compliance obligation for cross-border transactions Sec. 162 para. 3 GTC: Estimation of transfer price, burden of proof Sec. 162 para. 4 GTC: Penalties Determination of documentation and compliance obligation: Decree Law on the Manner, Content and Extent of Documentation in the Sense of Section 90 Paragraph 3 of the GTC dated 10/28/2003 Administrative Principles - Procedures (APP) dated 04/12/2005

4 Transfer Pricing Regulations Documentation Requirements 4 GAufzV: Factual Background Organisation Legal structure (incl. branches) Functional organisation Shareholding relationships Overview of business activities Business transactions Intercompany transactions Intercompany contracts Intellectual property owned and/or used Functional- and risk analysis Functions/risks Important assets Business Strategies Market information Competition Value chain 4 GAufzV: rd Party Data Description of method Arm s length test Application of transfer pricing method Reasons for Application Calculation Comparable data 5 GAufzV: xtraordinary Transactions Modification of business strategies Special circumstances like measures of setoffs Cost allocations Transfer pricing arrangements with foreign tax authorities Transfer pricing adjustments on side of taxpayer Causes of losses in three consecutive years

5 Transfer Pricing in Germany Agenda Transfer Pricing Regulations in Germany Transfer Pricing Documentation Approach Top Ten Transfer Pricing Challenges

6 Transfer Pricing Documentation Approach Documentation Legal structure Obtain documentation of the legal structure Transaction flows/volumes Identify types of transactions (e.g. delivery of goods for distribution, semifinished products, services, secondments, loans, etc.) Business and industry description Industry description: competitors, main value drivers, development of the industry Business description: of each business/entity Value chain: overview of the value chain Functional and risk analysis Functions and risks must be described Checklist vs. extensive explanation of functions and risks Deloitte: find a realistic compromise between two extremes Economic analysis/ transfer pricing method Transfer pricing method Determination of the most reliable method for each country/activity Approach Provide a centralized description of the legal structure Evaluate whether transaction flows can be provided centrally Business and industry description allows the tax authorities to understand the role of the local legal entity function Development of a template for functional and risk analysis Adjustment of each template to reflect local facts

7 Transfer Pricing Documentation Approach Masterfile Concept of the EU JTPF Masterfile Standardized information for all group members Standardized country specific documentation per function performed Country A Standardized country specific documentation per function performed Country B Ensuring a global and consistent documentation within the group Maintaining TP documentation standardized and coordinated for all entities Utilization of existing TP documentation Synergies by coordinated preparation of TP documentation Establishing uniform and cost efficient processes Standardized country specific documentation per function performed Country XX Preparing appropriate TP documentation reports providing penalty protection in each country

8 Transfer Pricing in Germany Agenda Transfer Pricing Regulations in Germany Transfer Pricing Documentation Approach Top Ten Transfer Pricing Challenges

9 Top Ten Transfer Pricing Challenges (1) Identification of Arm s Length Evidence Databases for external data Company databases License databases Loan databases Amadeus OneSource Thomson Research Markus etc. RoyaltyStat RoyaltySource Deloitte. Royalty Database TechAgree etc. Bloomberg Terminal (Standard&Poors) Thomson One Banker etc.

10 Top Ten Transfer Pricing Challenges (2) Year-end adjustments Arguments of tax auditors: Abuse of transfer pricing system to shift profits Third party would never agree to a profit limitation agreement through a year-end adjustment Year end adjustment must be clear defined in advance Under which circumstance Which adjustment How calculated Proper documentation

11 Top Ten Transfer Pricing Challenges (3) Distributors with low profits or losses Claim that the losses were incurred because of non-arm s length transfer prices Distributors in a start-up period should not incur losses for more than three years (Federal Tax Court 02/1993) Established distributors should have a shorter loss period (Federal Tax Court 10/2001) Documentation of the reasons for low profits/ losses Development of business story Support of transfer prices through 3rd party data CUP and RPM are often used to defend losses

12 Top Ten Transfer Pricing Challenges (4) Restructuring/Transfer of Functions low Importance of fiscal implications high Transfer of Risks Transfer of Tangible Property Transfer of Intangible Property Transfer of Goodwill No Exit Taxation Higher risks reflected in higher margin of foreign plant Taxation of hidden assets Increased amortization for foreign plant Evaluation and Taxation of Intangible Property In general higher returns for foreign plant Additional Taxation according to Foreign Tax Code to be clarified Evaluation and Taxation of Goodwill In general higher returns for foreign plant

13 Top Ten Transfer Pricing Challenges (5) Inconsistencies of the transfer pricing over time If prices of the past are more prefereable for tax authority prices of the past are considered to be at arm s length and new prices are challenged If current prices are more prefereable for tax authority current prices are considered to be at arm s length and prices of the past are challenged Documentation with economic justification for changes in the transfer pricing system

14 Top Ten Transfer Pricing Challenges (6) Provision of Services Mark-up can be challenged Benefit analysis Allocation key Problem of retroactive documentation Obtaining and Documenting Cost Allocation Interdependence Determination of Allocable Costs

15 Top Ten Transfer Pricing Challenges (6) Provision of Services - Different Concepts Service Agreements Cost Allocation Agreement Services are provided as third parties would render the service activity Compensation: Market Price if not available, use of Cost plus method Services have to be: distinct and valuable provided in the interest of the recipient actually provided and received Chapter VII OECD Transfer Pricing Guidelines Centralization of services ( Pool-Concept ) Activities that would have to be performed by each company itself, are centralized All companies involved have to benefit from this centralization Example: Improved conditions through centralized purchasing activities Service Provider itself has to benefit from centralization of services, i.e. is a pool member Cost allocation at full costs Chapter VIII OECD Transfer Pricing Guidelines Allocation with profit mark-up Allocation without profit mark-up

16 Top Ten Transfer Pricing Challenges (6) Provision of Services - Allocable Costs Would group members pay for the service if they were independent companies? Not Allocable via Internal Cost Allocation Examples Shareholder Costs: Consolidation of Balance Sheet & Income Statement Investor Relations no Shareholder Meetings Controlling of Subsidiaries Development of general guidelines for recruitment and salary yes Allocable via Internal Cost Allocation Examples Controlling/Finance IT Central Purchasing Central Quality Control Central Marketing/Sales etc.

17 Top Ten Transfer Pricing Challenges (6) Provision of Services - Shareholder Costs Problem: Obtaining and Documenting Solution: Developing a Shareholder- Questionnaire to split the costs incurred Does not contain clear indication whether the costs are allocable or not, in order to avoid strategic answers

18 Top Ten Transfer Pricing Challenges (6) Provision of Services - Benefit Analysis Requirement: Documentation of the benefit of the services Approach: Description of services Obtaining necessary information in 2 steps services performed beneficiaries

19 Top Ten Transfer Pricing Challenges (6) Provision of Services - Interdependence Operating Profit Transfer Price Allocationkey Allocation Operating Costs TP method: TNMM Cost allocation influences the operating profit and vice versa Time Gap Solution: Efficient Controlling Testing during the year

20 Top Ten Transfer Pricing Challenges (7) License agreements Challenge of appropriate arm s length license fee Comparison with either the costs for development or with other royalty rates contained in the database for license agreements at the Federal Tax Office License agreements at the Federal Tax Office are not accessible for the taxpayer Legal certainty? Database search provides more legal certainty!

21 Top Ten Transfer Pricing Challenges (8) Challenge of single expense items Costs where the other party of the transaction should at least bear some part of the expenses incurred, e.g.: advertising/marketing warranty cost of currency fluctuation etc. Preparation of economic analysis

22 Top Ten Transfer Pricing Challenges (9) Lack of formality in their transfer pricing agreements Provision of contracts for all transactions with related parties required Challenge of deviations from contractual provisions Possible rejection of cost deduction

23 Top Ten Transfer Pricing Challenges (10) Secondments Scrutiny of employment costs for each secondee Disregard of any payments which are above the local salary level Documentation of the benefit

24 Abdulkerim Keser Manager Transfer Pricing Phone: +49 (89) Fax: +49 (89) akeser@deloitte.de

25 Deloitte Turkey Member of Deloitte Touche Tohmatsu