A Hungarian company had a permanent establishment (PE) in Germany. The PE carried out meat cutting work on the basis of work contracts dated 23 February 2017 with the Hungarian company Z Kft. The PE had concluded a service agreement with A Kft. in which A Kft. undertook to provide administrative services in the area of support for employees posted to Germany and was to receive a fee calculated as a percentage of net sales in return. Following an audit of the PE the German tax authorities issued an assessment of additional taxabel income based on the German ordinance on allocation of profits to permanent establishments. Not satisfied with the assessment a complaint was filed by the PE with the Tax Court. In its complaint the PE argued that the tax authorities corrected all of the PE’s sales in Germany without a corresponding legal basis. Contrary to the opinion of the tax authorities, the BsGaV does not constitute a legal basis for a profit correction. In particular, the profit determinations contained in § 30 et seq. BsGaV are not covered by Section 1 of the AStG. Judgement of the Tax Court The Court decided in favour of the PE and set aside the tax assessment. Excerpt (English translation) “… 3. the aforementioned requirements for a permanent establishment-related income adjustment in accordance with § 1 para. 5 sentence 1 in conjunction with para. 1 sentence 1 AStG are not met in the case in dispute. para. 1 sentence 1 AStG are not present in the case in dispute. Business relationships between the domestic permanent establishment and the parent company, the conditions of which do not comply with the arm’s length principle and thereby reduce the domestic income of the plaintiff with limited tax liability, cannot be established. The Senate cannot recognise any relationships under the law of obligations to be assumed or business transactions with a certain degree of significance. It is true that the tax office can be agreed that the activities of the parent company, which essentially consisted of negotiating and signing contracts with the client (Z Kft.) and the contracted service company (M Partners Kft.) as well as the recruitment of the employees deployed in the permanent establishment, would have been regulated by contractual agreements if the permanent establishment and the parent company had been independent companies. However, no invoices were issued for these services. The tax audit also made no findings to the effect that transfer prices to the parent company were included in the tax calculation of the profit generated by the permanent establishment (see Flick/Wassermeyer, AStG § 1 para. 2850) and that the profit generated in Germany was reduced in this respect. However, according to supreme court rulings, the application of Section 1 (5) AStG is directly linked to its para. 1 and is therefore linked to a reduction in income that arises as a result of an agreement on conditions (transfer prices) that are not arm’s length (BFH, decision of 24 November 2021 I B 44/21 (AdV), BStBl II 2022, 431, para. 25 with further references). The tax office’s view that notional mark-up rates may have to be applied in relation to the service relationships between the parent company and the permanent establishment is not accepted. Such factual treatment cannot be inferred from the provisions of the AStG (see judgement of the Nuremberg tax court dated 27 September 2022 1 K 1595/20, IStR 2023, 211). The wording of Section 1 (5) AStG, and in particular the third sentence thereof, also does not indicate that, outside the scope of application of Section 1 AStG and in particular for the general determination of profits in accordance with Sections 4 et seq. Einkommensteuergesetz (EStG – German Income Tax Act), an assessment would have to be made (solely) on the basis of the people functions performed in the respective parts of the company. A corresponding “spill-over effect” cannot be read into Section 1 para. 5 AStG, also due to the systematic position of the provision in the AStG (see BFH, decision of 24 November 2021 I B 44/21 (AdV), BStBl II 2022, 431, para. 25 with further references). The Senate therefore does not share the opinion of the tax office that the activities performed by the commissioned companies Z Kft. and M Kft. can be attributed to the parent company as its own activities and thus as the exercise of essential people functions. The aforementioned companies are not the company’s own personnel (cf. section 1 para. 5 sentence 3 no. 1 AStG, section 2 para. 3 sentence 1 BsGaV). The companies also did not work for the company in accordance with § 2 Para. 4 BsGaV on the basis of a partnership agreement or employment contract with the company, but on the basis of a service or work contract. On the basis of the contracts submitted, the plaintiff proved that the “essential people functions” listed by the tax audit were not performed by the parent company, but by the service provider Z Kft. The latter contractually assumed the supervision of the posted employees, the provision of administrative work in the area of the supervision of employees posted to Germany, the preparation of payroll accounting, the registration and deregistration of employees with insurance companies and the organisation of transport and holiday trips home, as well as renting the office in A-Dorf to the plaintiff.” An appeal has later been filed by the tax authorities with the BFH (I R 49/23) where the case is now pending. 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“Z Pipeline” is a limited partnership which operates a network of pipelines. The network runs through Germany, Belgium and the Netherlands. During the year in question, “Z Pipeline”‘s administrative HQ was in Germany. Operational control of the pipeline was exercised by an ‘operations centre’ located in the Netherlands. It was not disputed that the pipeline constituted permanent establishments in Germany, Belgium and the Netherlands and that the profits should be allocated between the tree countries. The question was how the profits should be allocated. The tax authorities came to the conclusion that the profit should predominantly be allocated to the German permanent establishments. In accordance with the low functions and risks, only a low profit was to be allocated to the respective permanent establishments in Belgium an the Netherlands. The profit allocation was calculated using a cost-plus 30% due to industry and company-specific features. “Z Pipeline” disagreed with the method applied by the tax authorities and held that it was more appropriate to allocate the profits on the basis of the indirect method. Judgement of the Tax Court The Court decided in favour of “Z Pipeline”. Excerpt “66 VI.) Since the profit differentiation carried out by the defendant [tax authorities] cannot be used as a basis for taxation, the total profit achieved by the plaintiff [Z Pipeline] must be divided into domestic income within the meaning of § 15, para. 1, sentence 1, no. 2 of the Income Tax Act and into income that is tax-exempt according to double taxation agreements. In this respect, the Senate follows the apportionment made by the plaintiff, which results in domestic income from trade in the amount of €…. 67 The apportionment made by the plaintiff, which is essentially based on which part of the company’s assets (pipeline) generated which turnover, is consistent with Article 5, para. 2 DBA-NL 1959 / Article 7 DBA-Belgium. The defendant has not raised any comprehensible objections as to why the apportionment method, which the plaintiff also applied in a comparable form in the assessment periods up to and including 2009 and which withstood several external audits during this time, should be improper as of 2010. Insofar as he refers to the fact that the apportionment is already inappropriate because in Belgium, instead of the Belgian share of profits determined by the plaintiff, only a lump-sum taxation according to turnover has taken place, he fails to realise that the appropriateness of the profit apportionment has nothing to do with the subsequent taxation of the income and that, moreover, the lump-sum taxation according to turnover has taken place with the consent of the Belgian tax authorities. 68 In the opinion of the Senate, the apportionment chosen by the plaintiff also presents itself as a suitable and appropriate method for the apportionment of profits for the year in dispute 2011. In particular, the plaintiff applied an appropriate method for the apportionment of revenue by apportioning the fees from the transport of goods according to the extent to which the pipelines in Germany, Belgium or the Netherlands were actually used for the respective transport and by allocating the remuneration from the management of the foreign pipeline networks to Germany alone. The allocation of costs is also appropriate. Costs directly attributable to an operating facility (such as repair costs for a specific pipeline section) were allocated to the respective state of location, the costs for the Dutch operating centre responsible for monitoring the entire pipeline network were distributed among the three countries according to pipeline kilometres, and the remaining expenses were distributed according to various objective apportionment keys depending on the type of costs (including a country’s percentage share of the total investment costs or of the total revenue). As these apportionment keys had already been applied for many years and no specific objections had been raised by the tax authorities either in previous external audits or in the present legal action, the Senate had no reason to doubt the appropriateness of the apportionment keys. 69 This also applies to the plaintiff’s approach of allocating all administrative costs (personnel costs, etc.) to the German parent company and, in return, recognising fictitious service revenues for the administration of the foreign network share at the parent company (i.e. in the domestic income) determined according to arm’s length principles. Admittedly, neither this approach nor the calculation formula used by the plaintiff is without alternative. However, since no clearly more suitable yardsticks for the apportionment of administrative/personnel costs are apparent, the calculation can be followed. The fact that the apportionment method does not lead to an inappropriate result (from the perspective of the German tax authorities) is already shown by the fact that it results in higher domestic income in the year in dispute. The fictitious domestic service revenues (… €) are higher than the share of administrative costs that would be allocated to the foreign permanent establishments according to the general allocation formula (-… €) and is now taken into account as expenses in Germany. 70 The income from the supplementary balance sheets is also to be allocated to the individual countries – as undertaken by the plaintiff. The defendant’s allocation of the income from the supplementary balance sheets to Germany alone, which is not substantiated in detail, is not comprehensible. The income is directly related to the hidden reserves contained in the individual assets at the time of the acquisition of the shares in the company and is therefore attributable to the foreign permanent establishment, insofar as the respective asset – in particular the pipeline – belonged to its business assets. The plaintiff proved that a) the supplementary balance sheets were formed on the occasion of changes in shareholders in 2002 and 2005, b) both in the calculation of the capital gains for the departing shareholders and in the calculation of the top-up amounts entered in the supplementary balance sheets, a domestic share of 39,81% and a foreign share of 60.19% and c) the apportionments made by it were examined both in the external audit ...

A Hungarian company had a permanent establishment (PE) in Germany. The PE provided installation and assembly services to third parties in Germany. Following an audit of the German PE for FY 2017 the German tax authorities issued an assessment of additional taxabel income calculated based on the cost-plus method, cf. section 32 of the BsGaV (German ordinance on allocation of profits to permanent establishments). Not satisfied with the assessment a complaint was filed with the Tax Court. Judgement of the Tax Court The Court decided in favour of the PE and set aside the tax assessment. Excerpt (English translation) “Pursuant to Section 1 para. 1 sentence 1 AStG, the following applies: If a taxpayer’s income from a business relationship abroad with a related party is reduced by the fact that the taxpayer bases its income calculation on different conditions, in particular prices (transfer prices), than would have been agreed between independent third parties under the same or comparable circumstances (arm’s length principle), its income must be recognised as it would have been under the conditions agreed between independent third parties, irrespective of other provisions. This provision shall apply accordingly in accordance with Section 1 (5) AStG if the conditions, in particular the transfer prices, on which the allocation of income between a domestic company and its foreign permanent establishment or the determination of the income of the domestic permanent establishment of a foreign company is based for tax purposes for a business relationship within the meaning of paragraph 4 sentence 1 number 2 do not comply with the arm’s length principle and the domestic income of a limited taxpayer is reduced or the foreign income of an unlimited taxpayer is increased as a result. In order to apply the arm’s length principle, a permanent establishment must be treated as a separate and independent company, unless the affiliation of the permanent establishment to the company requires a different treatment. The criteria of Section 1 para. 5 sentence 1 in conjunction with Section 1 para. § Section 1 para. 1 sentence 1 AStG are not fulfilled in the case in dispute insofar as there are no transfer pricing issues in particular. There are no indications apparent to the court and no such indications were presented by the tax office that the service relationships between the Hungarian parent company and the domestic permanent establishment as the taxable entity were overcharged or would not stand up to a third-party comparison in any other way. Insofar as the domestic permanent establishment made payments to the parent company (e.g. payments to the Hungarian social security fund), these were merely cost reimbursements in the year in dispute, which were passed on to the branch without any mark-up. In particular, the court does not agree with the tax office’s view that fictitious mark-up rates should be applied in relation to the service relationships between the Hungarian parent company and the domestic permanent establishment. Such factual treatment cannot be inferred from the provisions of the AStG.” (An appeal has later been filed by the tax authorities with the BFH (I R 49/23). Click here for English translation Click here for other translation ...

If necessary to reflect an arm’s length result, a controlled taxpayer may report on a timely filed U.S. income tax return (including extensions) the results of its controlled transactions based upon prices different from those actually charged. Except as provided in this paragraph, section 482 grants no other right to a controlled taxpayer to apply the provisions of section 482 at will or to compel the district director to apply such provisions. Therefore, no untimely or amended returns will be permitted to decrease taxable income based on allocations or other adjustments with respect to controlled transactions. See § 1.6662-6T(a)(2) or successor regulations ...

The district director may make allocations between or among the members of a controlled group if a controlled taxpayer has not reported its true taxable income. In such case, the district director may allocate income, deductions, credits, allowances, basis, or any other item or element affecting taxable income (referred to as allocations). The appropriate allocation may take the form of an increase or decrease in any relevant amount ...

The purpose of section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. Section 482 places a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer. This section sets forth general principles and guidelines to be followed under section 482. Section 1.482-2 provides rules for the determination of the true taxable income of controlled taxpayers in specific situations, including controlled transactions involving loans or advances or the use of tangible property. Sections 1.482-3 through 1.482-6 provide rules for the determination of the true taxable income of controlled taxpayers in cases involving the transfer of property. Section 1.482-7T sets forth the cost sharing provisions applicable to taxable years beginning on or after January 5, 2009. Section 1.482-8 provides examples illustrating the application of the best method rule. Finally, § 1.482-9 provides rules for the determination of the true taxable income of controlled taxpayers in cases involving the performance of services ...

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UPS Asia is a company incorporated under the laws of Singapore and is engaged in the business of provision of supply chain management including the provision of freight forwarding and logistic services. In 2012 UPS Asia had entered into a Regional Transportation Services Agreement with UPS SCS (India) Pvt. Ltd. for the provisions of freight and logistics services. Under the Transportation Agreement, UPS Asia arranged to perform international freight transportation and provide overseas support services, while UPS India performed freight and logistics services in India to its India customers and to UPS Asia. Following an audit an assessment was issued according to which UPS Asia had a PE in India in the form of UPS India. Furthermore, profits of Rs.2,09,53,496 was considered attributable to operation in India. The tax authorities held that UPS India constitutes a PE of UPS Asia in India within the meaning of Article 5 of India–Singapore DTAA. Not satisfied with the assessment UPS Asia filed an appeal and submitted that UPS India was remunerated in accordance with the arm’s length principle (article 9) and, therefore, no further profit was required to be attributed (Article 7) to UPS India in the present case. Judgement of the Tax Appellate Tribunal The Tribunal allowed the appeal of UPS and set aside the assessment. Excerpt ” … 9. …. Thus, respectfully following the decision of the Co–ordinate Bench rendered in assessee’s own case cited supra, we hold that when the Indian A.E. is remunerated at arm’s length price no further profit attribution is required and the issue of existence of P.E. becomes wholly tax neutral. Accordingly, the addition made by the Assessing Officer is directed to be deleted. 10. In the result, appeal by the assessee is allowed in terms of our aforesaid findings. .. Click here for html-version ...

In 2011 a permanent establishment (PE) of a Danish company was established for income tax purposes in Germany in the form of an offshore wind farm. The PE had no employees of its own either in Germany or in Denmark. The technical and commercial management was carried out by two German service and management companies on the basis of management and service contracts. In 2013 the tax authorities issued an assessment related to taxation of assets which, according to allocation principles in the new AOA (significant people functions), would no longer be allocated to Germany. The tax authorities held that allocation of assets to the permanent establishment is determined on the basis of personnel functions exercised in the permanent establishment. If no personnel functions were carried out in the permanent establishment no assets were to be allocated to it. In the tax authorities view, this meant that the wind turbines previously allocated to the domestic permanent establishment as of 1 January 2013 would instead be allocated to the shareholder in Denmark. Due to this (new) allocation of the wind turbine, there was a transfer of assets. Consequently, withdrawal “for non-business purposes” within the meaning of § 4 para. 1 sentence 2 EStG was to be assumed, which was to be recognised at the fair market value of the withdrawn assets. An appeal was filed with the court. Judgement of the BFH The BFH clarified that Section 1 (5) AStG actually requires a reduction in income due to prices that are not at arm’s length in internal business relationships, so-called dealings, and that the allocation regulations of the income correction regulation in Section 1 (5) AStG have no spillover effect on the profit determination regulation of § 4 para. 1 sentence 3 EStG. “Insofar as the tax authorities assume in paragraph 2.2.4.1 of the BMF letter on the application of double taxation agreements to partnerships of 26 September 2014 (BStBl I 2014, 1258) that, with regard to the allocation of assets of a partnership, the principles of § 1 para. 5 AStG are “broadly consistent” with the case law of the BFH on the functional relationship, there are already doubts as to whether, within the framework of such an approach, the allocation of assets would have to be based solely on “personnel functions”. The previous case law of the Senate on this may be based on a function-based approach, but in any case it cannot be inferred that the personnel function alone would be regarded as the decisive allocation parameter” “Even if, with reference to § 1 (5) AStG, the decisive factor were to be the allocation of assets according to the “personnel function”, there are doubts as to whether, in the case in dispute, the wind turbines would have to be allocated to the management permanent establishment in Denmark because personnel functions are only exercised there. This is because it is questionable whether § 1 (5) sentence 3 AStG is to be interpreted to the effect that the relevant personnel function can only be exercised by personnel who are employed by the company as (its own) employees. In any case, the literature doubts that the personnel working in a function for the enterprise must be connected to the enterprise by an employment contract. The wording of the standard does not exclude personnel who work in this function by means of an employee leasing contract or a service contract (Andresen in Wassermeyer/Andresen/Ditz, loc.cit., margin no. 4.70). Thus, in the case in dispute, the personnel of the German service or management companies, who take over the technical and commercial management of the wind turbines on the basis of management and service contracts, would exercise a function in the domestic permanent establishment for the allocation of assets. Consequently, a personnel function would have to be assumed there” “Finally, the Senate has doubts as to whether the principles on the allocation of assets according to the personnel function are applicable at all for so-called permanent establishments without personnel under the validity of Section 1 (5) AStG. The literature points out that the principle of allocating assets according to the personnel function in such permanent establishments would result in the assets that establish the permanent establishment without personnel being allocated to the management permanent establishment……………. It is therefore considered necessary that in the case of permanent establishments without personnel — in deviation from the allocation according to the relevant personnel function — the assets that they establish and that ultimately serve the business function performed there must be attributed to them ” In any case, the tax authorities appear to support the case of a permanent establishment without a significant personnel function with reference to paragraph 75 of the OECD report on the attribution of profits to permanent establishments of 22 July 2010………, according to which, in the case of permanent establishments without a decisive personnel function, the use is to serve as the basis for the allocation of the economic ownership of tangible assets, a “different” allocation of assets is to be assumed ……. which, however, is again not beyond doubt in view of the ambiguous wording of the law (“belonging … to the enterprise”). 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Two Swiss companies, A GmbH und B GmbH, belonged to a multinational group under a Dutch parent. The group provided food and fuel to military troops and civilian in areas of crises and armed conflicts. A group company located in the United Arab Emirates provided services to the Swiss companies primarily in relation to activities in Afghanistan. A GmbH und B GmbH had a permanent establishment in Afghanistan. As there are no tax treaties between Switzerland and Afghanistan, for Swiss tax purposes the allocation of income between the two companies and the permanent establishment in Afghanistan was governed by Swiss domestic law. A tax assessment was issued by the authorities which was brought to the Swiss courts by the companies. In 2018 the case ended up in the Swiss Supreme Court. The Supreme Court ruled that according to Swiss law, the profit allocation has to start from the total global income of the companies. Hence, the assessment was partially incorrect, as taxable profit in Switzerland had been calculated without taking into account foreign profit or losses. The the case was remanded to the lower court for further consideration. Click here for English translation Click here for other translation ...

National Semiconductor appealed an IRS ruling pertaining the allocation of income from its Asian subsidiaries. In this decision, the United States Tax Court upheld the IRS ruling ...

In 1964, B KG had waived claims totalling … against B S.A. in France, in which it held an 88% interest. In the course of an audit of B KG’s profits for 1964, the tax authorities did not regard the waiver as a commercial transaction. Instead, they found that the amount waived was a contribution under company law, resulting in additional acquisition costs for the shareholding. A partial write-off of the investment itself was out of the question. B KG’s appeal to the Fiscal Court was dismissed the appeal. The Fiscal Court held that, under Article 5 of the DTC of 21 July 1959 between Germany and France, the reduction in profits resulting from the waiver of the claims could not be taken into account for tax purposes in Germany due to lack of business purpose. B KG appealed against that decision, alleging an infringement of substantive law. Judgment of the Federal Fiscal Court The Court referred the case back to the lower court for reconsideration. The Court held that Article 5 of the then French-German DBA (which is similar in content to Article 9 of the current Model Tax Convention), which allows for an adjustment of taxable profits in favour of one or other Contracting State in the case of a cross-border grouping of enterprises, does not directly create a tax liability. It merely authorises the legislature of each Contracting State to tax profits transferred to the other State under domestic law. With regard to formalities, the Court stated that a judgment of the tax court must contain a clear, complete and self-contained picture of the subject-matter of the dispute, even if it is brief, with emphasis on the submissions of the parties. Where reference is made to pleadings and other documents, they and the subject of the reference must be described with sufficient precision. General references to files and documents are not admissible. Click here for English translation Click here for other translation ...