International tax law
Choice of legal form for international expansion
Expansions into global markets pose special challenges in terms of tax compliance. As a rule, market entry into foreign markets begins with the optimal choice of legal form, adapted to the needs of the target market and its legal system.
Observing the duty of disclosure to the tax authorities
Many companies and taxpayers are often unaware of the tax consequences that their step into the wider world can trigger. If, for example, the domestic tax return fails to report the foreign engagement that has been initiated, the penalties and fines office of the domestic tax office may already initiate unnecessary proceedings against the company's governing bodies. Some tax consequences of international tax law that decision-makers need to weigh up are presented in this article.
Critical problem cases of international tax law
- If transactions are carried out between related companies based in different countries, this is only tax-neutral if transfer prices are charged for the exchange of goods or services that are at arm's length.
- In addition, detailed documentation must be prepared on the determination of the transfer prices applied. In the event of violations of the legal requirements and documentation obligations relating to transfer prices, there is a risk of additional tax assessments and high additional tax payments in the course of an external audit by the tax authorities.
- If a foreign company refrains from establishing a subsidiary in Germany and instead merely maintains a German permanent establishment, it must be remembered that the profits attributable to this permanent establishment are also subject to German taxation and a determination of profits for the permanent establishment is required.
- If the registered office or management of a foreign company is located in the Federal Republic of Germany, this generally leads to unlimited tax liability of the company in Germany and thus possibly to double taxation both in Germany and abroad.
- If the foreign parent company makes payments to employees of the German subsidiary for work performed by them here, these payments are regularly subject to wage tax. The obligation to pay wage tax applies to the domestic subsidiary to which the employees are assigned by the tax authorities.
- If a German company relocates functions abroad, for example, it realizes profits from this change alone that are subject to full taxation in Germany.
- If a person with unlimited tax liability in Germany who owns a significant volume of shares in a company moves his or her residence abroad, he or she becomes subject to the so-called exit taxation. The tax office assumes a fictitious case of disposal for the GmbH shares or stocks held, even if they continue to belong to them. The same applies to gratuitous transfers to non-residents for tax purposes.
We advise our clients from Germany and abroad on the legal tax consequences of their cross-border activities. In addition, we plan how dividend, license and interest payments in group structures have tax implications on a global stage. If foreign tax law is involved, we work with foreign cooperation partners to optimize the tax implications of your plans.
OECD Base Erosion and Profit Shifting
Through the OECD's BEPS project, measures have been taken internationally up to 2015 to safeguard tax revenues. The focus is on profit reduction and profit shifting by multinational group companies. The BEPS project comprises 15 action points that are being implemented in all OECD countries, which are intended to bring about a uniform global distribution of tax assets. From a compliance perspective, the following BEPS measures are of particular interest:
- BEPS Action Item 12: Access by individual country tax administrations to timely and complete information in cases of aggressive or abusive tax planning schemes and tax avoidance strategies.
- BEPS action item 13: three-part structured transfer pricing documentation approach.
TP Transfer Pricing Documentation
Transfer pricing documentation, factual documentation and appropriateness documentation
The exchange of services between globally operating related parties is the focus of tax administrations worldwide. Transfer prices are to be recognized if they are based on prices that independent third parties would have agreed with each other.
What independent third parties would have agreed can only be determined by arm's length comparison. For this purpose, we prepare a study using data from Bureau van Dijk, a Moody's® company. Based on the transfer pricing study prepared for your industry, we create an individual adequacy documentation for your company.
Often the problem arises that for world market leaders and market niche experts transfer prices can only be determined under difficult conditions. In our firm, tax advisors and auditors work closely together to create appropriate and usable transfer pricing documentation that can be used in the context of an external audit to protect your company from surcharges and additional assessments by the tax authorities. In doing so, the adequacy documentation must not be discarded as unusable in order to preserve protection from penalties.
Master File, Local File, CbC (Country-by country) Reporting
Since the topic of transfer pricing and transfer pricing documentation was addressed in BEPS Action Item 13, the same transfer pricing rules apply in all OECD countries. As a rule, a TP report consists of three elements:
- Master File
- Local File
- Country-by-country reporting (CbC reporting)
Small companies with a pure exchange of services (not trade in goods) of less than 600,000 euros net per year are exempt from the extensive documentation requirements.
All foreign business transactions and global business relationships with related parties (usually parent and sister companies of the global group of companies) must be documented. The determination of profits is not arbitrarily manipulated only if the prices chosen for such business transactions are also customary among unrelated parties. As part of a mandate to prepare transfer pricing documentation, we prepare records of intra-company data that enable a plausibility check by the tax audit of the transfer prices agreed by our clients, such as forecast calculations and data on sales, profit and cost planning.
If prices have been determined between the companies involved on the basis of functions assumed, risks assumed or material assets, the weighting of these factors must be consistent; according to the Profit Recording Ordinance, in such cases, documentation of the functions performed, the extent of the risks actually assumed and the amount of the material assets actually employed must be presented in a quantitatively comprehensible manner in a TP report for each party involved in the transaction.
Pricing for Intercompany Dealings and Administrative Principles Transfer Pricing (VGr VP)
Pricing for all intercompany dealings must conform to recognized methods and be within the range of arm's length. The recognized methods include:
- Price comparison method with external and internal price comparison
- Resale price method (resale price method, retrograde method, margin recalculation or industry standard profit rates).
- Cost plus method (cost plus method)
- business transaction-related net margin method (net profit indicators) and
- transaction-based profit split method taking into account the working paper on the application of the profit split in the EU "The application of the profit split method within the EU, DOC: JTPF/002/2019/EN of the JTPF".
The administration has issued extensive principles that are hardly manageable for taxpayers without the help of a tax advisor, including the administrative principles on transfer pricing, which must be observed in addition to the Foreign Tax Act.
No ranking of transfer pricing methods
There is no rule on the order of precedence of transfer pricing methods (see paragraph 3.10 Transfer Pricing Principles). Thus, the choice of the transfer pricing method is of particular importance and there is a discretionary choice regarding the standard method for which a transfer price is determined. Depending on the type of service to be valued, different approaches are more suitable, so the tax advisor must work expediently to use the appropriate transfer pricing method. The benchmark is the proper and conscientious manager. The price comparison method has priority when comparative prices are ascertainable. The use of more than one or all of the standard methods is not mandatory. According to the requirements of the individual case, preferences for the method selected in each case may be concretized, mixed or supplemented in an elementary manner (method mix).
When the auditor comes... Take TP documentation obligations seriously!
SMEs often neglect their documentation obligations, even though the topic is the focus of tax auditors during external audits, so transfer pricing should enjoy the undivided attention of management. In cases with a foreign connection, there is a risk of severe sanctions if a usable profit record is not submitted. If a taxpayer fails to submit records of a transaction or if the records submitted of a transaction are essentially unusable, a surcharge of 5,000 euros is to be assessed. The surcharge shall amount to at least 5% and at most 10% of the profit adjusted for reasonable transfer prices by the tax audit.
Penalty for delayed submission of transfer pricing documentation and surcharge for unusable documentation
Usable transfer pricing documentation must be submitted in full within a period of 60 days when requested by the tax audit. In the event of late submission of usable records, the surcharge shall be up to EUR 1,000,000, with a minimum of EUR 100 for each full day that the deadline is exceeded.
NEW The current draft of a new law on DAC6 regulations provides that the submission of usable TP documentation to the tax office must occur within only 30 days with major changes in the rights of auditors to request TP documentation ahead of a tax audit!
This means that only those companies that properly fulfill their documentation obligations and comply with all legal aspects of the profit recording requirements will be rewarded. If transfer prices are not determined carefully and in compliance with the legal requirements, in particular also the above-mentioned deadline, the tax may be estimated.
Avoid lengthy and costly disputes with the tax office!
Precaution is better than cure when dealing with transfer pricing, otherwise there is almost certainly a risk of a lengthy and costly dispute with the tax authorities. It should not be overlooked that transfer pricing is also examined by the foreign tax authority abroad and must also be convincing there.
Advance Pricing Agreements (e.g. USA)
Different assessment standards in Germany and abroad carry the risk of double taxation. In some tax jurisdictions it is possible to conclude Advance Pricing Agreements (e.g. USA). We will be happy to advise you on all details relating to the topic of transfer pricing and its structuring options.
Double taxation agreements (DTAs) in international tax law
International tax law is barrier law. Bilaterally, Germany has concluded numerous international treaties based on the German negotiating basis and the OECD Model Convention with other countries worldwide. These treaties, known as double taxation agreements (DTAs), regulate the taxation rights between Germany and the contracting state. They are often supplemented by protocols that regulate details and are overlooked by taxpayers. As a rule, the contracting states agree on which state may tax the income and assets of an individual or legal entity under which conditions. Scarcely it concerns the distribution of the tax asset between two or more states. In order to be eligible for a treaty, tax residency in one of the participating states is generally a prerequisite.
Tax residency in Germany vs. United States
While becoming a tax resident of Germany only requires mandatory registration with the Einwohnermeldeamt or habitual residence, citizenship is irrelevant. However, U.S. citizens living in Germany, for example, are still required to file their annual returns stateside. In United States versus Richards (1983) the eighth circuit of the U.S. Tax Court upheld that the voluntary filing of a tax return is an imaginative argument and totally without merit. The word “voluntary,” as used in Flora and in IRS publications, refers to the U.S. system of allowing taxpayers initially to determine the correct amount of tax and complete the appropriate returns, rather than have the U.S. government determine tax for them from the outset. The requirement to file an income tax return is not voluntary and is clearly set forth in sections 6011(a), 6012(a), et seq., and 6072(a) of the Internal Revenue Code. See also Treas. Reg. § 1.6011-1(a). Any taxpayer who has received more than a statutorily determined amount of gross income in a given tax year is obligated to file a return for that tax year. Failure to file a tax return could subject the non-compliant individual to civil and/or criminal penalties, including fines and imprisonment.
DTAs and their limits (Treaty Override)
DTAs are to be observed on an equal footing with national tax laws and do not enjoy any special privilege over national provisions. National tax regulations even have the effect of overriding treaties, with the legal consequence that Germany taxes even though this was not originally provided for by the agreements under international law. This is the case, for example, if the contracting state does not exercise its right of taxation or other conditions are met. Individual advice from a tax advisor is therefore essential in tax cases involving two or more states in order to be aware of and specifically avoid multiple taxation of one and the same income or assets.
DTA for inheritance tax
Germany has concluded agreements with some countries in the area of inheritance tax, but these are scarce and typically don't apply to gift taxation.
Claim agreement benefits!
If a tax treaty intervenes in your specific case, you can be sure that we will base our planning on it.
Typical consulting services in international tax law
- Optimal tax structuring of foreign engagements: tax advice to foreign companies on investments and M&A transactions in Germany as well as tax advice to German companies on investments and M&A transactions abroad
- Optimization of payment flows within the group, taking into account German and international tax law and the relevant double taxation agreements (e.g. reduction / avoidance of withholding tax burdens)
- Ongoing tax advisory services for German subsidiaries or permanent establishments of foreign parents; on request, regular reporting to the foreign parent (e.g. also on the basis of US-GAAP)
- Advice in connection with transfer pricing: Research of correct transfer prices, documentation requirements, preparation of intercompany agreements, ongoing advice on transfer pricing.
- Tax optimization of international asset and business successions, in particular taking into account income tax, gift tax and inheritance tax aspects
- Advising clients who are liable to pay tax both abroad and in Germany and who fall within the scope of a double taxation treaty
- Inheritance tax and gift tax advice in cross-border situations