Transfer Pricing of a contract manufacturer Markus Volkmann Federal Central Tax Office Germany, Bonn Federal Audit Department OECD Transfer Pricing Case Studies Workshop San Jose, 31 March – 4 April 2014

Germany, a federation with 16 federal states Consent tax law, but federal states are responsible for their own tax matters 16 views of one problem may exist.

German Tax Administration Federation 16 Federal States Federal Ministry of Finance (Berlin) Federal Central Tax Office (Bonn) 11 Regional Revenue Offices 640 Local Tax Offices 16 Ministries of 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 – 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 Examples ParameterLarge Enterprise CommercialTurnover Profit 7,300 k€ 280 k€ ProductionTurnover Profit 4,300 k€ 2250 k€ OtherTurnover Profit 5,600 k€ 330 k€

„Large Enterprise“ Classification2012 Enterprises8,571,212 Large enterprises191,335 Large enterprises (examined 2012)41,365 Audit period (average)3 years Cycle of audit4.6 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€ Net Sales1,1151,6161,8623,769 Operating Profit Net Profit

Problem / Question Permanent losses - arm‘s length? P anticipates corrections of the foreign TA. What changes in the transfer pricing system are necessary?