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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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