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.