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Germany adopts Chapter VIII of OECD TP Guidelines 2017 for Cost Contribution Agreements

Article by Christian Zimmermann and Tobias Schupp for Nexia International Transfer Pricing Newsletter, January 2019

With their cir­cu­lar da­ted 5 July 2018 Ger­man tax aut­ho­ri­ties start a new chap­ter re­gar­ding the tre­at­ment of Cost Contri­bu­tion Ar­ran­ge­ments (CCA). Ef­fec­tive 1 Ja­nu­ary 2019 (for CCAs im­ple­men­ted be­fore the publis­hing date of this cir­cu­lar ef­fec­tive 1 Ja­nu­ary 2020) Ger­man tax aut­ho­ri­ties will ap­ply Chap­ter VIII of the OECD TP Gui­de­lines 2017 for as­ses­sing CCAs. This me­ans a si­gni­fi­cant pa­ra­digm change since the prin­ci­ple of mu­tual be­ne­fit, which un­der­lies every CCA, is im­ple­men­ted dif­fer­ently in the con­cept ap­plied by the Ger­man tax aut­ho­ri­ties so far and the new OECD con­cept.

Comparison of the CCA concepts

The Ger­man tax aut­ho­ri­ties´ CCA con­cept is ba­sed on the prin­ci­ple of cost poo­ling. The par­ti­ci­pants of a CCA form an (un­dis­clo­sed) part­nership with the pur­pose to jointly be­ne­fit from ac­tivi­ties un­der­ly­ing the costs poo­led in the CCA. This part­nership car­ries out func­tions and be­ars risks con­nec­ted with the poo­led ac­tivi­ties. Con­se­quently, the contri­bu­ti­ons of the par­ti­ci­pants are va­lued with their re­spec­tive costs. Those costs are al­lo­ca­ted to the par­ti­ci­pants pro rata to their ex­pec­ted be­ne­fits from the CCA wi­thout mark-ups and form the ba­sis for ba­lan­cing pay­ments bet­ween the par­ti­ci­pants. This con­cept ap­plies ir­re­spec­tive of the type of ac­tivi­ties poo­led in the CCA (pro­vi­ded the pre­con­di­ti­ons to par­ti­ci­pate in such a pool are met).

In con­trast, the OECD in Chap­ter VIII of its TP Gui­de­lines 2017 un­der­stands a CCA as a per­for­mance contri­bu­tion agree­ment bet­ween mem­bers of a pool, which of­fers sim­pli­fi­ca­tion for ca­ses of mul­ti­ple tran­sac­tions in which each pool par­ti­ci­pant per­forms func­tions while sha­ring the re­spec­tive risks with the other par­ti­ci­pants. Con­se­quently, the contri­bu­ti­ons of the par­ti­ci­pants to the CCA are eva­lua­ted with their eco­no­mic va­lue de­ter­mi­ned un­der the arm´s length prin­ci­ple. The contri­bu­ted va­lue, in turn, is al­lo­ca­ted to the par­ti­ci­pants pro rata to their ex­pec­ted be­ne­fits and forms the ba­sis for ba­lan­cing pay­ments.

Re­gar­ding the va­lua­tion of the contri­bu­ti­ons, the OECD dis­tin­gu­is­hes bet­ween low-va­lue-ad­ding ac­tivity CCAs and other CCAs. In case the ac­tivi­ties poo­led in a CCA are of low va­lue ad­ding na­ture (de­fi­ni­tion no. 7.44 of the OECD TP Gui­de­lines 2017) the OECD for prac­tical re­asons sta­tes that the contri­bu­ti­ons may be va­lued at cost since in such ca­ses the arm’s length va­lue of the ser­vices are close to the re­spec­tive costs. The­re­fore, a mere low va­lue ad­ding ac­tivity CCA such as an ad­mi­nis­tra­tive ac­tivity CCA is prac­tically trea­ted equally un­der the OECD con­cept and un­der the (old) Ger­man tax aut­ho­ri­ties´ con­cept.

For other CCAs - in par­ti­cu­lar, CCAs con­cerning R&D ac­tivi­ties - the contri­bu­ti­ons to the CCA can­not be de­ter­mi­ned on a pure cost base but re­qui­res each contri­bu­tion to be va­lued in ac­cor­dance with the arm´s length prin­ci­ple. Even though this ap­proach might be clear in theory, this lea­ves the tax­payer with a cer­tain amount of in­se­cu­rity par­ti­cu­larly re­gar­ding CCAs, which in­volve func­tions, tan­gi­bles or in­tan­gi­bles which might be hard to va­lue. Thus, we ex­pect a high risk that each tax aut­ho­rity in­vol­ved in a CCA will as­sume high va­lue contri­bu­ti­ons by CCA par­ti­ci­pants tax re­si­dent in their re­spec­tive coun­try, as those contri­bu­ti­ons - to­ge­ther with the par­ti­ci­pants´ be­ne­fits - are de­cisive for de­ter­mi­ning the arm´s length com­pen­sa­tion to be re­cei­ved from other par­ti­ci­pants un­der a CCA.

Transfer pricing documentation and recommendations

In prin­ci­ple, in case an in­ter­na­tio­nal group with group mem­bers in Ger­many has a CCA in place spe­ci­fic do­cu­men­ta­tion needs to be in­clu­ded in the Lo­cal and Mas­ter File. As the ap­plica­ble CCA con­cept will change with ef­fect from 1 Ja­nu­ary 2019 (for CCAs im­ple­men­ted be­fore the publis­hing date of the cir­cu­lar with ef­fect from 1 Ja­nu­ary 2020), it is re­com­men­ded to re­view exis­ting CCAs. Fo­cus should be di­rec­ted to the cha­rac­te­ristics of the ac­tivi­ties poo­led in the CCA.

In case a CCA ex­clu­si­vely in­clu­des low va­lue ad­ding ser­vices, the ap­pli­ca­tion of OECD prin­ci­ples will most li­kely not have a prac­tical im­pact, as contri­bu­ti­ons and ba­lan­cing pay­ments should be va­lued at cost base. Still, it is ad­visa­ble to pre­pare do­cu­men­ta­tion re­gar­ding the cha­rac­te­ristics of the ac­tivi­ties poo­led in the CCA to be able to de­mons­trate towards the Ger­man (and other in­vol­ved) tax aut­ho­ri­ties that they are of low va­lue na­ture only.

If other ac­tivi­ties are in­clu­ded in the CCA - par­ti­cu­larly R&D ac­tivi­ties - it is stron­gly re­com­men­ded to re­view whe­ther a pre­cise de­ter­mi­na­tion of the va­lue of the contri­bu­ti­ons pro­vi­ded by each par­ti­ci­pant is pos­si­ble. In case pos­si­ble, care­ful do­cu­men­ta­tion is ad­vi­sed for de­mons­tra­tion pur­po­ses. Should a pre­cise va­lua­tion not be pos­si­ble, we see si­gni­fi­cant risks that the ba­lan­cing pay­ments made un­der a CCA re­sults in ex­ten­sive ar­gu­men­ta­ti­ons with the Ger­man and in­ter­na­tio­nal tax aut­ho­ri­ties. Con­se­quently, in such ca­ses it might be re­com­men­da­ble to eva­luate al­ter­na­tive struc­tu­ring for the ac­tivi­ties per­for­med un­der the CCA.

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