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. Click here for English translation Click here for other translation GER Y-300-Z-BECKRS-B-2023-N-21789 ...

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 FG Nürnberg Urteil vom 27-09-2022 - 1 K 1595-20 ORG ...

This chapter only covers transactions between associated enterprises in the context of Article 9 of the OECD Model Tax Convention and does not address the attribution of profits within a single enterprise on the basis of Article 7 of the OECD Model Tax Convention, as this is the subject of the Report on the Attribution of Profits to Permanent Establishments ...

The case concerned a complex financing structure within the General Electric Group. The taxpayer, GE Financial Investments Ltd (GEFI Ltd), a UK resident company was the limited partner in a Delaware limited partnership, of which, GE Financial Investments Inc (GEFI Inc) a Delaware corporation was the general partner. GEFI Ltd filed UK company tax returns for FY 2003-2008 in which the company claimed a foreign tax credit for US federal income tax. In total, US federal income taxes amounted to $ 303 millions and exceeded the amount of tax due in the UK. The tax authorities opened an enquiry into each of GEFI’s company tax returns for the relevant period, and subsequently issued an assessment where the claims for foreign tax credits was denied in their entirety. Judgement of the Tax Tribunal The tribunal dismissed the appeal of GEFI Ltd and ruled that the UK company did not carry on business in the US. Hence GEFI Ltd was not entitled to a foreign tax credit. Excerpt “By contrast the construction of Article 4 advanced by HMRC requires both worldwide taxation and a connection or attachment to the contracting state concerned. In my judgment, this is the correct approach as it takes into account the common feature or similarity of domicile, residence, citizenship etc, in the context of the Convention, ie that they are all criteria providing, in addition to the imposition of a worldwide liability to tax, a “connection” or “attachment” of a person to the contracting state concerned. Such an interpretation is consistent with Widrig (see paragraphs 44 – 46, above) and Vogel (see paragraph 47, above) and Crown Forest which, as Ms McCarthy submits, when properly understood in context is authority for the proposition that full or worldwide taxation is a necessary feature of the connecting criterion but is not sufficient of itself. … Although her further submission, that, other than the imposition of a worldwide liability to US tax, share stapling has no US law consequences at federal or state level (eg it does not carry with it US filing or reporting obligations or make a stapled overseas company’s constitutional documents subject to or dependent on US law), was not supported by evidence, I agree that, given the differences that do exist for tax purposes (see paragraph 29, above) the connection or attachment is between the stapled entities rather than to the country concerned. 66. Therefore, in the absence of the necessary connection or attachment by GEFI to the US, and despite Mr Baker’s persuasive submissions to the contrary, I do not consider that GEFI was a resident of the US for the purposes of Article 4 of the Convention by reason of the share staple between it and GEFI Inc. As such it is necessary to consider Issue 2, the Permanent Establishment Issue. … However, Ms McCarthy confirmed that, should I conclude that the activities of the LP are sufficient to amount to the carrying on of a business, there is no separate dispute as to whether that business is carried on in Stamford, Connecticut, or some other location. 71. As such, it is therefore necessary to consider what is in effect the only issue between the parties under issue 2(a), namely whether, as it contends, GEFI by its participation in the LP carried on a business in the US or, as HMRC argue, it did not.” … I agree with Ms McCarthy who submits that there is nothing to suggest that personnel or agents acting on behalf of the LP made or conducted continuous and regular commercial activities in the US. All that appears to have happened was that monies were directed straight to GELCO without negotiating terms or the consideration at a director level as would have been expected from a company carrying on commercial activities on sound business principles. … Therefore, notwithstanding its objects, and having regard to the degree of activity as a whole, particularly the lack of participation in the strategic direction of the LP by the directors of GEFI Inc, I have come to the conclusion that GEFI was not carrying on a business in the US through its participation in the LP. … Having concluded for the reasons above that GEFI did not carry on business in the US it is not necessary to address Issue 2(b), ie whether, if GEFI had carried out business in the US, US tax was payable under US law and if so whether the UK is required under Article 24(4)(a) to give relief against this US tax. … Therefore, for the reasons above the appeal is dismissed.” ”G UKFTT 210 (TC) TC08160″] ...

This chapter only covers transactions between associated enterprises in the context of Article 9 of the OECD Model Tax Convention and does not address the attribution of profits within a single enterprise on the basis of Article 7 of the OECD Model Tax Convention, as this is the subject of the Report on the Attribution of Profits to Permanent Establishments ...

A & W AG, a company based in Germany, had maintained a permanent establishment in Austria which provided “distribution and support of software” services. No profits had been attributed to the Austrian permanent establishment. An assessment was issued where profits for FY 1998 to 2002 had been determined by the tax authorities using the cost plus method with a mark up of 9.5% to 7.5% for the years 1998 to 2002. A & W AG appealed against the tax assessments and argued that a mark up of 2% would be more appropriate. The Administrative Court of Appeal remanded the case to the Unabhängiger Finanzsenat (UFS). Judgement of the UFS The UFS decided predominantly in favour of A & W AG. The tax office explained that, based on empirical values ​​and relevant literature, mark up rates of between 5% and 15% should be regarded as customary. The mere reference to these empirical values ​​did not convince the UFS, since the facts to be assessed were not specifically addressed. The UFS explained that the disclosure of anonymous comparative values ​​would not provide any indication of the respective taxpayer and would not violate the duty of confidentiality. The UFS came to the conclusion that mark up of 2% requested by A & W AG was appropriate. Click here for English translation Click here for other translation Austria vs A & W AG April 2010 ...

A & W AG, a company based in Germany, had maintained a permanent establishment in Austria which provided “distribution and support of software” services. No profits had been attributed to the Austrian permanent establishment. An assessment was issued where profits for FY 1998 to 2002 had been determined by the tax authorities using the cost plus method with a mark up of 9.5% to 7.5% for the years 1998 to 2002. A & W AG appealed against the tax assessments and argued that a mark up of 2% would be more appropriate. Judgement of the Court The Administrative Court of Appeal found the mark up determined by the tax authorities to be incomprehensible. The tax authority would have had to justify the mark-ups, for example by submitting specific empirical values ​​from comparable companies. The case was remanded to the court of first instance, where in a decision of April 28, 2010 ( RV/3837-W/09 ), a cost mark-up of 2% was found to be appropriate. Click here for English translation Click here for other translation VwGH 20102009, 2006-13-0116 ...