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Nexia Ebner Stolz

Why tax authorities are focusing on cross-border intragroup transactions

A large num­ber of medium-sized Ger­man com­pa­nies are inter­na­tio­nally ori­en­ted and ope­ra­ting in many dif­fe­rent coun­tries around the world. Their for­eign invol­ve­ment ran­ges from basic rep­re­sen­ta­tive offices to com­p­lete pro­duc­tion units with their own res­pon­si­bi­lity for a parti­cu­lar mar­ket.

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That being the case, it comes as no sur­prise that the tax aut­ho­ri­ties are paying more atten­tion to cross-bor­der tran­sac­ti­ons, inc­rea­sin­gly making them a focal point of their field audits. Fis­cal aut­ho­ri­ties have boos­ted capa­city sig­ni­fi­cantly at both the state and federal levels by expan­ding their use of tax exa­mi­ners with exper­tise in inter­na­tio­nal tax issues.

Expe­ri­ence shows that cer­tain hot-but­ton issues come up time and again during rou­tine field audits:

Trans­fer pri­ces

When goods and ser­vices are tra­ded glo­bally among the various com­pa­nies making up a cor­po­rate group, the pri­ces char­ged for those goods and ser­vices must be appro­priate. In order for the tax aut­ho­ri­ties to accept the trans­fer pri­ces in the coun­tries and ter­ri­to­ries con­cer­ned, the par­ties invol­ved in a tran­sac­tion must ensure and main­tain docu­men­ted proof that their trans­fer pri­ces com­ply with the arm’s length stan­dard. If, wit­hin a group of com­pa­nies, for example, mana­ge­ment-rela­ted tasks such as IT, finan­cial and pay­roll acco­un­ting, con­trol­ling or staff deve­lop­ment are hand­led cen­trally by one group com­pany, the other group com­pa­nies have to pay a recur­ring mana­ge­ment fee for this. In order for the tax aut­ho­ri­ties to recog­nize the amo­unt of this fee as valid, it must be equi­va­lent to what inde­pen­dent, i.e. unre­la­ted, par­ties would typi­cally agree upon in simi­lar cir­cum­stan­ces.

For instance, if a Ger­man com­pany sim­ply pas­ses on the costs it incurs to pro­vide such goods and ser­vices, the Ger­man tax aut­ho­ri­ties will add an appro­priate pro­fit mar­gin to the amo­unt, which inc­rea­ses the parent com­pany’s taxable ear­nings. Con­ver­sely, if the mark-up on the amo­unt a Ger­man sub­si­diary is char­ged is more than the parent com­pany would be able to charge a third party, the tax aut­ho­ri­ties will reduce the busi­ness expense deduc­tion accor­din­gly and treat the dif­fe­rence as an undis­c­lo­sed pro­fit dis­tri­bu­tion. The same prin­ciple app­lies when the cost basis to which the mark-up is app­lied is unrea­son­ably high.

There is no auto­matic gua­ran­tee that a trans­fer price adjust­ment made in one coun­try or ter­ritory will be accom­pa­nied by a com­pa­ra­ble adjust­ment in the other coun­try or ter­ritory con­cer­ned. For instance, alt­hough the one juris­dic­tion’s tax aut­ho­ri­ties may reduce the busi­ness expense deduc­tion for the mana­ge­ment fee, those in the other may treat the full fee as taxable income, the overall result being dou­ble taxa­tion of the por­tion dee­med to be in excess of the accepta­ble amo­unt. In many cases, the only way, if any, to eli­mi­nate this dou­ble taxa­tion is through a very lengthy mutual agree­ment pro­ce­dure con­duc­ted bet­ween the two juris­dic­ti­ons.

With­hol­ding Taxes

Allo­wing an affi­lia­ted com­pany the use of int­an­gi­ble assets pres­ents ano­ther inte­res­ting situa­tion. Apart from com­p­li­ance with the arm’s length stan­dard when deter­mi­ning the amo­unt to charge for this, com­pa­nies also must be mind­ful of with­hol­ding taxes. This is because it is rou­tine practice in the source coun­try for taxes to be with­held from the amo­unt paid inso­far as an exemp­tion from the with­hol­ding can­not be clai­med, parti­cu­larly on acco­unt of EU laws and regu­la­ti­ons. If the amo­unt of tax with­held is adjus­ted during a field audit, then the com­pany paying to use the assets could be on the hook for any taxes it fai­led to with­hold. Ulti­ma­tely, it will be lia­ble for these taxes if it can­not seek recourse against the com­pany to which it paid the fees.

Per­ma­nent estab­lish­ments

Ano­ther issue recei­ving grea­ter atten­tion during field audits is per­ma­nent estab­lish­ments. The exis­tence of a per­ma­nent estab­lish­ment is regu­larly the deci­ding fac­tor in deter­mi­ning whe­ther a coun­try has the right to tax the pro­fit a for­eign busi­ness gene­ra­tes in its ter­ritory. Howe­ver, the issue of per­ma­nent estab­lish­ments is also very important, because since 2013, the busi­ness a com­pany’s head­quar­ters tran­sacts with its per­ma­nent estab­lish­ments, like that which it tran­sacts with its for­eign sub­si­dia­ries, must com­ply with arm’s length requi­re­ments. Con­f­licts bet­ween Ger­man and for­eign tax law regar­ding what con­sti­tu­tes a per­ma­nent estab­lish­ment are not uncom­mon in this regard. For example, Ger­man tax law does not recog­nize ser­vices-rela­ted per­ma­nent estab­lish­ments, while the tax aut­ho­ri­ties in the BRICS coun­tries (Bra­zil, Rus­sia, India, China and South Africa) do. In those juris­dic­ti­ons a com­pany can be dee­med to have for­med a per­ma­nent estab­lish­ment merely by ren­de­ring ser­vices there for a cer­tain period of time.

Not inf­re­qu­ently this prompts dis­cus­si­ons during field audits about whe­ther and, if so, how to allo­cate the com­pany’s pro­fit to the respec­tive coun­tries for tax pur­po­ses.

The illu­s­t­ra­tive exam­p­les pro­vi­ded here demon­s­t­rate the oppor­tunity that cross-bor­der intra­group tran­sac­ti­ons pre­sent for field audi­tors, in gene­ral, and tax exa­mi­ners with exper­tise in inter­na­tio­nal tax issues, in parti­cu­lar, to inc­rease tax reve­nues. Glo­bally active com­pa­nies need to be proac­tive when it comes to struc­tu­ring their intra­group tran­sac­ti­ons by see­king the com­pre­hen­sive advice of experts and exer­ci­sing the grea­test of care.

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