A Regional Tax Court in Germany had requested a preliminary ruling from the European Court of Justice on two questions related to German transfer pricing documentation requirements. whether the freedom of establishment (Article 49 TFEU) or the freedom to provide services (Article 56 TFEU) is to be interpreted in such a way that it precludes the obligation to provide transfer pricing documentation for transactions with a foreign related parties (Section 90 (3) AO) and whether the sanctions regulated in section 162(4) AO could be contrary to EU law The Regional Tax Court considered that these provisions establish special documentation requirements for taxpayers with transactions with foreign related parties. In the event of non-compliance with these documentation requirements, section 162(4) AO leads to a sanction in the form of a fine/surcharge. Neither was provided for taxpayers with transactions with domestic related parties. However, such discrimination can be justified by compelling reasons in the public interest. In this context, the Regional Tax Court considered the legitimate objective of preventing tax avoidance and the preservation of the balanced distribution of taxation powers between the Member States as possible grounds for justification. However, the Tax Court was not confident in regards to the level of sanctions – i.e. whether the fine/surcharges went beyond what was necessary to achieve the intended purpose. Judgement of the European Court of Justice The Court ruled that German transfer pricing documentation requirement and related sanctions was not in conflict with EU law. “Article 49 TFEU must be interpreted as meaning that it does not preclude national legislation under which, in the first place, the taxpayer is subject to an obligation to provide documentation on the nature and content of, as well as on the economic and legal bases for, prices and other terms and conditions of his, her or its cross-border business transactions, with parties with which he, she or it has a relationship of interdependence, in capital or other aspects, enabling that taxpayer or those parties to exercise a definite influence over the other, and which provides, in the second place, in the event of infringement of that obligation, not only that his, her or its taxable income in the Member State concerned is rebuttably presumed to be higher than that which has been declared, and the tax authorities may carry out an estimate to the detriment of the taxpayer, but also that a surcharge of an amount equivalent to at least 5% and at most 10% of the excess income determined is imposed, with a minimum amount of EUR 5 000, unless non-compliance with that obligation is excusable or if the fault involved is minor.” ...

Like examination practices, the burden of proof rules for tax cases also differ among OECD member countries. In most jurisdictions, the tax administration bears the burden of proof both in its own internal dealings with the taxpayer (e.g. assessment and appeals) and in litigation. In some of these countries, the burden of proof can be reversed, allowing the tax administration to estimate taxable income, if the taxpayer is found not to have acted in good faith, for example, by not cooperating or complying with reasonable documentation requests or by filing false or misleading returns. In other countries, the burden of proof is on the taxpayer. In this respect, however, the conclusions of paragraphs 4.16 and 4.17 should be noted ...

A Permanent Establishment (PE) in Kenya of MAN Diesel and Turbo SE Germany (MAN) entered into a consortium with a firm called MPG Services to engineer, procure and construct an 87 MW generating capacity thermal power plant on behalf of Thika Power Ltd. The role of MAN’s Kenyan PE in the project was mobilization, engineering and design, reservation of the diesel sets, and steam turbine and other start-up costs associated with its part of the works which included supervision of the assembly and installation of engines and commissioning the engines. MAN Germany was to provide for the materials up to the port of export and the PE was to assist in the onshore part which included supervision of the assembly and installation work as well as commissioning the work but did not include supply of equipment. In 2015, the tax authorities initiated an audit which resulted in a final tax assessment issued in 2017. According to the assessment MAN’s Kenyan PE owed additional taxes on undeclared income (income resulting from the imports of Equipment), penalty and interest in an amount of Kshs 347,518,798.00. MAN filed an appeal with the Tax Appeals Tribunal (TAT) premised on the grounds that the tax authorities erred in fact and in law in its demand for additional tax for FY 2012 and 2013. According to MAN, income from offshore supply of equipment by MAN DT Germany is not attributable to MAN’s Kenyan PE under Article 7 of the DTA by virtue of the Force of Attraction Rule. The Tribunal allowed the appeal and set aside the assessment. The tax authorities then filed an appeal with the High Court. Judgement of the High Court The High Court dismissed the appeal of the tax authorities and decided in favor of MAN’s Kenyan PE. According to the High Court, income from the supply of equipment by MAN DT Germany is not attributable to MAN’s Kenyan PE under Article 7 of the DTA by virtue of the Force of Attraction Rule. Excerpts “44. Identifying the Commissioner’s true case is important because of the nature of his statutory mandate which involves the exercise of an extraordinary administrative power enabling the Commissioner to apply the laws. The exercise of that power involves his ‘determining’ a tax liability. An appeal in this context is against the Commissioner’s ‘decision’ namely his determination of a tax liability and its amount. The basic jurisdictional requirement for the exercise of the power is that the Commissioner is ‘satisfied’ of the various requirements. Once the Commissioner reaches the requisite level of satisfaction, an appeal must, of necessity go to whether he justified in being so satisfied. He must stand or fall by his reasons for exercising the power.” 45. The reason offered by the Commissioner is that the Respondent failed to avail documents to support the income from the imports. This argument sounds attractive. But, the challenge is, the Respondent was not the importer and his role was clearly defined in the documents provided. That being the case, the Commissioner’s decision that stands on shaky ground and the TAT correctly declined to uphold it. 46. Closely tied to the above ground is the appellant’s argument that the Respondent did not produce some documents as required by section 23 of the TPA. Whereas the said section obliges a tax payer to avail records, the flip side of this position is that a party can only produce documents in his possession. It could not have been the intention of the law to compel tax payers to produce documents in the hands of a third party and more so, if the transactions were undertaken by third parties. The Respondent persuaded the TAT that it was not the importer and it could not produce documents in the hands of a third party. To expect the Respondent to produce import documents in the hands of a third-party amounts to overly overstretching the ambit of sections 23, 56(1) and 30 of the TPA. On this ground, the appellant argument collapses. 47. The evidence on record on this particular issue leaves no doubt that the Respondent discharged the burden of proof. As Lord Denning held in Miller v Minister of Pensions,[20] ‘The…{standard of proof}…is well settled. It must carry a reasonable degree of probability…if the evidence is such that the tribunal can say: ‘We think it more probable than not’ the burden is discharged, but, if the probabilities are equal, it is not.’ 48. The burden placed upon the Respondent by the law was to establish by evidence that it was not the importer and to confirm its role under the contract. Simply put, it was required to demonstrate that the tax was not due. The test is whether the Respondent established a prima facie case and having done so, the evidential burden shifted to the appellant to persuade the TAT on the contrary. It never did so. … 56. In conclusion, I find no basis at all upon which I can interfere with the TAT’s decision. The upshot is that the appellant’s appeal fails. The appeal is hereby dismissed with costs to the Respondent.” Click here for other translation ...

Enoplastic SpA is engaged in production of closures for vine, spirits, oil and vinegars. Following an audit an assessment was issued by the tax authorities regarding transfer pricing. An appeal was filed by Enoplastic and the Regional Court later set aside the assessment stating that the tax authorities had not proved the existence of a tax advantage nor that the pricing determined by Enoplastic had not been at arm’s length. An appeal was then filed by the tax authorities claiming that the burden of proof was on Enoplastic due to the principle of proximity of evidence and that transfer pricing adjustments was not premised on proof of an intention to obtain tax savings. Judgement of the Supreme Court The Supreme Court upheld the decision to set aside the tax assessment. However, the basis on which the decision of Regional Court had been issued was incorrect. According to the Supreme Court transfer pricing adjustments should not be confused with tax fraud or avoidance, even if transfer pricing may be used for such purposes. Thus, transfer pricing adjustments is not premised on the tax authorities proving that a tax advantage has been archived by the incorrect pricing. The tax authorities must prove the existence of economic transactions between controlled parties at a price that appears to deviate from the normal price. Only where such evidence has been provided by the tax authorities will the burden of proof shift to the taxpayer who will then have to prove that the transaction has been priced in accordance with the arm’s length principle. Judgement of the Court The Supreme Administrative Court Click here for English translation Click here for other translation ...

Like examination practices, the burden of proof rules for tax cases also differ among OECD member countries. In most jurisdictions, the tax administration bears the burden of proof both in its own internal dealings with the taxpayer (e.g. assessment and appeals) and in litigation. In some of these countries, the burden of proof can be reversed, allowing the tax administration to estimate taxable income, if the taxpayer is found not to have acted in good faith, for example, by not cooperating or complying with reasonable documentation requests or by filing false or misleading returns. In other countries, the burden of proof is on the taxpayer. In this respect, however, the conclusions of paragraphs 4.16 and 4.17 should be noted ...