Z is the head of a globally operating group. At group level it was decided to discontinue production at subsidiary “X-BR GMBH” at location A and in future to carry out production as far as possible at location B by group company Y. The production facilities were sold by “X-BR GMBH” to sister companies. The closure costs incurred in the context of the cessation of production were borne by Y. No further payments were made as compensation for the discontinuation of production in A. The tax authorities found that “X-BR GMBH” had transferred functions and thus value to group company Y and issued an assessment of taxable profits. Judgement of the Court of Appeal The Court decided in favour of “X-BR GMBH” and set aside the assessment. According to the court there is no transfer of functions if neither economic assets nor other benefits or business opportunities are transferred nor is there a causal link between the transfer of benefits in the broadest sense and the transfer of the ability to perform a function.” Excerpt “…As a rule, the business opportunity is therefore an intangible asset, such as a customer or client base, a supply right or a specific export market, which can be transferred in return for payment. The advantage that accrues or could accrue to the opportunity can be a one-time advantage (e.g. entry into a contract), but it can also be an ongoing advantage that is reflected in several financial years. However, the advantage must always be so specific that it can be independently assessed by the parties involved. A certain marketability of the opportunity will be required as an essential criterion. If there is no marketability, it is regularly an “opportunity” that cannot be independently exploited. However, a business opportunity does not necessarily have to be a legally secured legal position (BFH judgement of 12 June 1997, I R 14/96). However, the business opportunity must be at least sufficiently concrete that it is amenable to valuation, especially since otherwise it would not be possible to determine an appropriate consideration for it (cf. Ditz DStR 2005, 1916?f.; Wassermeyer/Andresen/Ditz Betriebsstätten-Handbuch/Ditz Rz. 4.55; also Wassermeyer GmbHR 1993, 332). Whether this means that a business opportunity already qualifies as an intangible asset has largely been left open by the BFH (BFH judgement of 13 November 1996, I R 149/94, DStR 1997, 325 [BFH 27.03.1996 – I R 89/95]; BFH judgement of 6 December 1995, I R 40/95, BFHE 180, 38?f.). b) In the present case, there is no concrete business opportunity within the meaning of § 8 (3) KStG. The defendant’s assumption of a vGA is based on the consideration that the discontinuation of a profitable production by an external third party would not have occurred without compensation and that consequently a prevented increase in assets would have resulted from this. However, the defendant was not able to show what the concrete transfer of a chance of profit in the form of an asset position by X was supposed to have consisted of. Rather, in the opinion of the Senate, the transfer of an asset by X was lacking. The production was essentially based on the allocation of production quantities for group-affiliated sales companies by the group’s top management. There were no contractual commitments by the parent company to X that would have secured it a valuable legal position in the form of a supply right or a merely specific order allocation within the group. Own contracts under the law of obligations in the form of supply contracts with third parties existed only to a small extent at the time of the closure. Thus, in the years before the year in dispute, X’s sales outside the group in this area amounted to only between 1.46% and 3.43% of total sales. Accordingly, the profits resulted predominantly from the production and supply of the group’s own distribution companies on the basis of orders which were allocated to X by the parent company without any legal claim to the retention of the order volume. Within the framework of such a constellation, it would have been possible for Y without further ado to reduce the group-internal order allocation to X without compensation due to the reduced order situation in the group. However, if the production volume of X was already based on the order allocation by the parent company, which was “at the discretion of the group’s top management”, X had no independent business opportunity which it could leave to the parent company. In particular, it must be taken into account that X had no legally established position vis-à-vis the parent company with regard to a certain volume of orders. Valuable market positions in the form of contractual relationships with third parties and concluded supply contracts were essentially due to the parent company and not to X. In this respect, the existence of a business opportunity is ruled out. In this respect, the existence of a business opportunity for X, which it left to the parent company free of charge, is ruled out. Even insofar as the defendant believes that X is to be regarded as an independent company and that the group companies are to be treated as third parties in the context of the arm’s length principle, it was primarily Y that had access to the customer relationships with its subsidiaries. This is particularly supported by the fact that the Y allocated the order volume to the X and that the X had not concluded its own orders through contractual agreements with group companies. The Y was therefore itself in a position to control the customer relationships. The transfer of a business opportunity is therefore ruled out. Likewise, there is no granting of a business opportunity by transferring the customer relationships to external customers or a customer base for customers outside the group. Business relations with third parties outside the group and thus a customer base in the sense of external customers outside the group did not exist for X – as ...

“Agri B.V.” is a Dutch subsidiary in an international group processing agricultural products. Following a restructuring in 2009 “Agri B.V.” had declared a profit of € 35 million, including € 2 million in exit profits. In an assessment issued by the tax authorities this amount had been adjusted to more than € 350 million. Judgement of the Court of Appeal The Court of appeal decided predominantly in favour of the tax authorities. An expert was appointed to determine the value of what had been transferred, and based on the valuation report produced by the expert the court set the taxable profit for 2009/2010 to €117 million. Excerpt “The Functional Analysis of [company 9] submitted, the Asset Sale and Purchase Agreements, the Manufacturing Services Agreements and the Consulting services and assistance in conducting business activities agreements show that there was a transfer of more than just separate assets and liabilities. The factual and legal position of [company 2] and [company 1] has changed significantly as a result of the reorganization. In this respect, the Court considered the following. 27. Whereas prior to the reorganization [company 1] operated independently under its own name on the purchasing and sales markets, independently hedged price risks and ran the full risk of good and bad luck in all its activities, after the reorganization it only provides (production) services to [company 3] for a fixed fee for a certain period of time. The claimant’s contention that already with the establishment of the [company 6] in 2000 there was far-reaching coordination as a result of which [company 1] no longer operated completely independently but only as a processing facility is only supported by written statements from employees in 2019. These statements are difficult to reconcile with the 2009 Functional Analysis, in which the [company 6] is not even mentioned. Therefore, the Court does not attach the value that the claimant wishes to see attached to these statements. That [company 3] and [company 4] were involved in the (strategic) planning of [company 1] prior to the reorganization is not surprising in view of the global activities of the group. However, no more can be deduced from the Functional Analysis than that [company 3] and [company 4] were operating in cooperation with [company 1]. That the form in which this cooperation is cast detracts from the independence of [company 1] described elsewhere in the Functional Analysis has not become plausible on the basis of the documents. 28. A similar analysis can be made of [company 2’s] activities before and after the reorganisation. Whereas prior to the reorganisation [company 2] operated independently under its own name on the purchasing and sales markets, independently hedged price risks (not only for its own benefit, but for the benefit of the activities of all group companies that it coordinated worldwide), and ran the full risk of good and bad opportunities in all its activities, after the reorganisation it only provides (production) services to [company 3] for a fixed fee for a limited period of time. 29. The claimant has stated without contradiction that the profitability of [company 4] depends to a large extent on daily global and regional price fluctuations over which [company 4] has no influence, and that the market developments are therefore analysed on a daily basis. From the description of the market expertise of [company 3] after the reorganization in the Functional Analysis (see recital 8), the Court deduces that the market expertise present in the group of [company 4], gained from hedging, taking positions on markets and contract negotiations, forms the basis for the activities of [company 3] after the reorganization. This description explicitly states that this knowledge plays a key role in improving the profitability of the Dutch oilseed business. In that connection, reference is made to the fact that [company 3] will set the price and volume guidelines for purchases and sales, conclude the contracts and take care of the hedging. It is established that all these activities were carried out by [company 1] and [company 2] prior to the reorganisation. It has not become plausible that, prior to the reorganization, [company 3] was already engaged in such similar activities that those of [company 1] and [company 2] can only be regarded as additional. During the reorganization, not only stocks, current purchase and sales contracts, currency contracts and futures, etc. were transferred to [company 3], but also dozens of employees, including traders from [company 1] and [company 2], were transferred to [company 3]. The Court therefore deems it plausible that the aforementioned market expertise was not actually invested in [company 3] itself until the transfer of these employees. 30. The prices agreed as part of the reorganisation only concern the transfer of assets and liabilities. However, in view of the foregoing, this transfer cannot be viewed separately from the concentration of market expertise at [company 3] that was previously held by [company 1] and [company 2]. The fact that the market expertise at the latter company was also supported by employees who were not employed by it does not mean that this knowledge should not be attributed to the company of [company 2]. In addition to market expertise, the power of decision regarding purchases, sales and hedging was also transferred from [company 1] and [company 2] to [company 3]. Since having market expertise, seen against the background of the aforementioned power of decision, plays a key role in the activities of [company 3] after the reorganization aimed at increasing profitability, the Court deems it plausible that a value must be attributed to it separately that has not already been reflected in the agreed prices for the assets and liabilities. The Court also sees support for this conclusion in the circumstance that the turnover and cash flow of [company 1] and [company 2] – as has not been contradicted by the claimant – decreased considerably after the reorganization, while those of [company 3] increased considerably.” Click here for English translation Click here for other translation ...

There will also be cases where before-and-after comparisons can be made because the transactions prior to the restructuring were not controlled, for instance where the restructuring follows an acquisition, and where adjustments can reliably be made to account for the differences between the pre-restructuring uncontrolled transactions and the post-restructuring controlled transactions. See example at paragraph 9.110. Whether such uncontrolled transactions provide reliable comparables would have to be evaluated in light of the guidance at paragraph 3.2 ...

The analysis of the business before and after the restructuring may reveal that while some functions, assets and risks were transferred, other functions may still be carried out by the “stripped” entity. Typically, as part of the restructuring the entity may have been purportedly stripped of intangibles or risk, but after the restructuring it continues to carry out some or all of the functions it previously performed. Following the restructuring, however, the “stripped” entity performs those functions under contract to a foreign associated enterprise. The accurate delineation of the actual transaction between the foreign associated enterprise and the “stripped” entity will determine the actual commercial or financial relations between them, including whether the contractual terms are consistent with the conduct of the parties and other facts of the case. Arm’s length compensation for each party should be consistent with its actual functions performed, assets used and risks assumed after the restructuring ...

That being said, in business restructurings, before-and-after comparisons could play a role in understanding the restructuring itself and could be part of a before-and-after comparability (including functional) analysis to understand the changes that accounted for the changes in the allocation of profit/loss amongst the parties. In effect, information on the arrangements that existed prior to the restructuring and on the conditions of the restructuring itself could be essential to understand the context in which the post-restructuring arrangements were put in place and to assess whether such arrangements are arm’s length. It can also shed light on the options realistically available to the restructured entity. (See paragraphs 9.27-9.31 for a discussion of options realistically available; see also paragraphs 9.102-9.106 for a discussion of possible factual differences between situations that result from a restructuring and situations that were structured as such from the beginning and of how such differences may affect the options realistically available to the parties in negotiating the terms of the new arrangement and therefore the conditions of the restructuring and/or of the post-restructuring arrangements.) ...

One important issue with such before-and-after comparisons is that a comparison of the profits from the post-restructuring controlled transactions with the profits made in controlled transactions prior to the restructuring would not suffice given Article 9 of the OECD Model Tax Convention provides for a comparison to be made with uncontrolled transactions. Comparisons of a taxpayer’s controlled transactions with other controlled transactions are irrelevant to the application of the arm’s length principle and therefore should not be used by a tax administration as the basis for a transfer pricing adjustment or by a taxpayer to support its transfer pricing policy ...

The accurate delineation of the transactions comprising the business restructuring requires performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved. Accordingly, the analysis focuses on what the parties actually do and the capabilities, as well as the type and nature of assets used or contributed by the parties in a pre-restructuring and post-restructuring scenarios. See Section D. 1.2 of Chapter I. Given the importance of risk in the analysis of business restructurings, the following section provides specific guidance on the analysis of risk in transactions comprising the business restructuring ...

Aspects of identifying the commercial or financial relations between the parties which are particularly relevant to determining the arm’s length conditions of business restructurings, are analysed in the following sections: The accurate delineation of the transactions comprising the business restructuring and the functions, assets and risks before and after the restructuring (see Section B.1); The business reasons for and the expected benefits from the restructuring, including the role of synergies (see Section B.2); The other options realistically available to the parties (see Section B.3) ...

According to Colgate Palmolive, following a restructuring, the local group company in Spain was changed from being a “fully fledged distributor” responsible for all areas of the distribution process to being a “limited risk distributor” (it only performs certain functions). A newly established Swiss company, Colgate Palmolive Europe, instead became the principal entrepreneur in Europe. The changed TP setup had a significant impact on the earnings in the Spanish group company. Net margins was reduced from around 16% before the restructuring, to 3.5% after the restructuring. Following a thorough examination of the functions, assets and risks before and after application of the new setup, the Tax administration held that Colgate Palmolive Europe could not be qualified as the “principal entrepreneur” in Europe. The swiss company was in substance a service provider for which the remuneration should be determined based on the cost plus method. Judgement of the Court The High Court held in favour of the tax administration and dismissed the appeal of Colgate Palmolive. Excerpt “.…the conclusion, in our opinion, can only be that the Administration is right, since in reality – remember that certain functions were already being carried out by the French Headquarter – there is no significant change in the situation existing prior to the restructuring in the years in question. This being so, it is not surprising that the Agreement reasons that “the existence of transactions between related entities, the Spanish and Swiss entities, determines the application of the regime provided for in Article 16 of the Consolidated Text of the Corporate Income Tax Law (TRLIS) and in its implementing regulations, mainly Chapter V of Title I of the Corporate Income Tax Regulations (RIS), taking into account the change of regulation introduced by Law 36/2006 applicable, in the case of Colgate Palmolive, as from the financial year 2007”. Adding that “in relation to the existence of transactions between related companies, it is also necessary to take into account Article 9 of the Spanish-Swiss Double Taxation Agreement, inspired by the OECD Model Agreement, which provides that the profits of associated companies may be adjusted when the conditions present in their commercial or financial relations differ from those that would be agreed between independent entities. This article recognises the so-called arm’s length principle, the interpretation of which must take into account the OECD Doctrine, contained in the Commentary to Article 9 itself and its 1995 Transfer Pricing Guidelines, which have been significantly updated in 2010”. As reasoned in the Agreement, the Board shares the reasoning, “according to the exhaustive description contained in the verification file, the characterisation of CP Europe as a “principal trader” is inappropriate, it being more correct to consider that such an entity is in reality a service provider. It is therefore considered that the method chosen by the group to value the transactions is inappropriate and that the appropriate valuation method is the cost plus method. This method, in addition to being a traditional method (and therefore preferable under our internal regulations and the Guidelines), is, in accordance with the OECD Guidelines (paragraph 2.32 and 2.39 in the 2010 version), particularly appropriate for valuing the provision of services”. The fact is that ‘the valuation method applied by Colgate Palmolive is not appropriate, as it results in the residual profit of the group’s operations in Spain being concentrated in the CP Europe entity, which makes no sense if the economic activity of each entity (CP USA, CP Spain and CP Europe) in the overall business in our country is taken into account. The Guidelines themselves highlight in their chapter 7 dedicated to intra-group services (paragraph 7.31, before and after 2010) the cost plus method, together with the comparable free price, as the method to be used to value this type of services between related entities. The work of the Joint Transfer Pricing Forum of the European Union, which also assumes that this is the method most frequently used to value this type of transaction”. The Inspectorate adds, quite reasonably, that “until 2005, the group itself valued transactions between the French Headquarter, with the role of service provider, and the other entities of the group – including CP Spain – using the cost plus method”. The consequence of all the above is that, as stated on p. 73 of the report -reasoning endorsed by the Agreement- “in order to value the transactions between CP Europe and CP Spain, the transactional net margin method, taking CP Spain as the analysed party (Tesdet party), is inappropriate. Instead, it is considered that the most appropriate method for valuing the transactions is the cost plus method, which is based on attributing to the provider of those services – CP Europe – a gross margin on the costs it incurs which are attributable to the Spanish market [it should be recalled that following the analysis carried out it has been concluded that CP Europe cannot be considered as a principal trader, but rather as an entity which performs the functions of a service provider]’. This means that, in the years in question, it is not correct to attribute to CP EUROPE the residual profit derived from the group’s operations in Spain, but rather that this residual profit, deducting the remuneration of the owner of the intangible asset -CP USA- and of the service provider -CEP EUROPE-, should fall on CP SPAIN. The calculations are set out in pp. 74 to 81 of the report, as well as in pp. 59 to 62 of the Agreement. The Board, particularly in the absence of any arguments to the contrary, considers them to be correct. For all the foregoing reasons, the plea is dismissed.” Click here for English Translation Click here for other translation ...

There will also be cases where before-and-after comparisons can be made because the transactions prior to the restructuring were not controlled, for instance where the restructuring follows an acquisition, and where adjustments can reliably be made to account for the differences between the pre-restructuring uncontrolled transactions and the post-restructuring controlled transactions. See example at paragraph 9.110. Whether such uncontrolled transactions provide reliable comparables would have to be evaluated in light of the guidance at paragraph 3.2 ...

The analysis of the business before and after the restructuring may reveal that while some functions, assets and risks were transferred, other functions may still be carried out by the “stripped” entity. Typically, as part of the restructuring the entity may have been purportedly stripped of intangibles or risk, but after the restructuring it continues to carry out some or all of the functions it previously performed. Following the restructuring, however, the “stripped” entity performs those functions under contract to a foreign associated enterprise. The accurate delineation of the actual transaction between the foreign associated enterprise and the “stripped” entity will determine the actual commercial or financial relations between them, including whether the contractual terms are consistent with the conduct of the parties and other facts of the case. Arm’s length compensation for each party should be consistent with its actual functions performed, assets used and risks assumed after the restructuring ...

That being said, in business restructurings, before-and-after comparisons could play a role in understanding the restructuring itself and could be part of a before-and-after comparability (including functional) analysis to understand the changes that accounted for the changes in the allocation of profit/loss amongst the parties. In effect, information on the arrangements that existed prior to the restructuring and on the conditions of the restructuring itself could be essential to understand the context in which the post-restructuring arrangements were put in place and to assess whether such arrangements are arm’s length. It can also shed light on the options realistically available to the restructured entity. (See paragraphs 9.27-9.31 for a discussion of options realistically available; see also paragraphs 9.102-9.106 for a discussion of possible factual differences between situations that result from a restructuring and situations that were structured as such from the beginning and of how such differences may affect the options realistically available to the parties in negotiating the terms of the new arrangement and therefore the conditions of the restructuring and/or of the post-restructuring arrangements.) ...

One important issue with such before-and-after comparisons is that a comparison of the profits from the post-restructuring controlled transactions with the profits made in controlled transactions prior to the restructuring would not suffice given Article 9 of the OECD Model Tax Convention provides for a comparison to be made with uncontrolled transactions. Comparisons of a taxpayer’s controlled transactions with other controlled transactions are irrelevant to the application of the arm’s length principle and therefore should not be used by a tax administration as the basis for a transfer pricing adjustment or by a taxpayer to support its transfer pricing policy ...

The accurate delineation of the transactions comprising the business restructuring requires performing a functional analysis that seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed before and after the restructuring by the parties involved. Accordingly, the analysis focuses on what the parties actually do and the capabilities, as well as the type and nature of assets used or contributed by the parties in a pre-restructuring and post-restructuring scenarios. See Section D. 1.2 of Chapter I. Given the importance of risk in the analysis of business restructurings, the following section provides specific guidance on the analysis of risk in transactions comprising the business restructuring ...

Aspects of identifying the commercial or financial relations between the parties which are particularly relevant to determining the arm’s length conditions of business restructurings, are analysed in the following sections: The accurate delineation of the transactions comprising the business restructuring and the functions, assets and risks before and after the restructuring (see Section B.1); The business reasons for and the expected benefits from the restructuring, including the role of synergies (see Section B.2); The other options realistically available to the parties (see Section B.3) ...