Transfer Pricing of a contract manufacturer

Markus Volkmann

Federal Central Tax Office Germany, Bonn

Federal Audit Department

OECD Transfer Pricing Case Studies WorkshopSan Jose, 31 March – 4 April 2014

• Germany, a federation with16 federal states

• Consent tax law,but federal states are responsiblefor their own tax matters

• 16 views of one problem may exist.

German Tax Administration

Federation16

Federal States

Federal Ministryof Finance (Berlin)

Federal Central Tax Office (Bonn)

11 RegionalRevenue Offices

640Local Tax Offices

16 Ministriesof the States

42,100 employees

144,700 employees

Federal Central Tax Office• International

responsibilities for:– tax refund– information exchange– Mutual Agreement

Procedures– Advance Pricing

Agreements

• Federal Audit Department– audit of LTP

Federal Audit Department

• 230 auditors– cooperation with the local tax offices– joint audit teams

• Audit of large taxpayers(turnover > 100 million Euro)

• Industry specialists

• Priority: transfer pricing

• Working on APA and MAP

Audit of TP in Germany

• 640 Local Tax Offices– 13.200 auditors (2012)– 19 bn Euro additional taxes (2012)

• Specialists for international tax issues– Seminars at the Federal Finance Academy– Basics / Transfer Pricing / Business

Restructuring / Permanent Establishments– International tax law / Use of databases

„Large Enterprise“• Classification every three years

last 01.01.2013

ExamplesParameter Large

Enterprise

Commercial TurnoverProfit

7,300 k€

280 k€

Production Turnover

Profit

4,300 k€

2250 k€

Other TurnoverProfit

5,600 k€

330 k€

„Large Enterprise“

Classification 2012

Enterprises 8,571,212

Large enterprises 191,335

Large enterprises (examined 2012) 41,365

Audit period (average) 3 years

Cycle of audit 4.6 years

Regulations

• General Tax Audits– Audit procedure: Notification / tax audit report /

adjusted tax base– Taxpayer: Obligation to co-operate– Penalties for late submission of information and

documents

• Audit (Transfer Pricing)– More taxpayer obligations, if international tax issues

(Sec. 90 (2) General Tax Code)– TP documentation requirements since 2003– Penalties

Documentation requirements

• Since 2003: Sec. 90 (3) General Tax Code– Taxpayers with foreign connections

• Shareholder / participation: 25 %

– Exceptions: Small and medium sized enterprises

• Content of documentation– Facts and details of the transaction– ALP – Compliance

Documentation requirements

• Taxadministration: request to document– No obligation to do it in advance

• Exception: business restructuring / permanent contracts*

– Time limit: 60 days (*30 days)– Language: German (upon taxpayers request,

any other living languages - english)

• Burden of proof– depends on the documentation

Penalties

• Non-Compliance with documentation requirements– Late submission of documentation– Failure to provide

• Applied rarely, only in cases of refusal– Crucial, effort to cooperate with the

taxadministration

Other Regulations

• Foreign Tax Law (AStG)– Sec.1 AStG: arm‘s length principle

• Administration Guidelines– Transfer Pricing (1983)– Permanent establishments (1999)– Documentations (2005)– Business restructurings (2010)

• Double Taxation Agreements

Transfer Pricing Workshop

• Case: Contract manufacturer

• Parent company: P• Subsidiary: P1• Foundation: 2003• P1 produces for P• No important

tangibles or intangibles

P

P1

100%

Product 1

• Tanks for machines since 2003– main work in Germany

• Material– free of charge from P to P1

• P1– assembles the parts

• P– leak testing, completing, delivering to the

customer

Product 2

• Tubes for machines since 2005

• Material– supply of material to P1 not free of charge– production scrap remains

• P– procurement and logistic services

Transfer Pricing System

• Price per unit

• Cost plus method

• Expected production costs + 8% profit margin

• Material for product 2:– material costs + 2% overhead + profit margin

• No Price adjustments

Financial performance

k€ 2004 2005 2006 2007

Net Sales 1,115 1,616 1,862 3,769

Operating Profit

174 388 -582 -393

Net Profit 177 398 -884 -221

Problem / Question

• Permanent losses - arm‘s length?

• P anticipates corrections of the foreign TA.

• What changes in the transfer pricing system are necessary?