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 ...

In 2012, Flir Commercial Systems AB sold intangible assets from a branch in Belgium and subsequently claimed a tax relief of more than SEK 2 billion in fictitious Belgian tax due to the sale. The Swedish Tax Agency decided not to allow relief for the Belgian “tax”, and issued a tax assessment where the relief of approximately SEK 2 billion was denied and a surcharge of approximately SEK 800 million was added. An appeal was filed with the Administrative Court, In March 2020 the Administrative Court concluded that the Swedish Tax Agency was correct in not allowing relief for the fictitious Belgian tax. In the opinion of the Administrative Court, the Double tax agreement prevents Belgium from taxing increases in the value of the assets from the time where the assets were owned in Sweden. Consequently, any fictitious tax cannot be credited in the Swedish taxation of the transfer. The Court also considers that the Swedish Tax Agency was correct in imposing a tax surcharge and that there is no reason to reduce the surcharge. The company’s appeal is therefore rejected. An appeal was then filed with the Administrative Court of Appeal Decision of the Administrative Court of Appeal The Court upheld the decision of the Administrative Court and the assessment issued and the penalty added by the tax authorities. The Administrative Court of Appeal found that when assessing the amount of credit to be given for notional tax on a transfer of business, the tax treaty with the other country must also be taken into account. In the case at hand, assets were transferred to the company’s Belgian branch shortly before the assets were disposed of through the transfer of business. The tax treaty limited Belgium’s taxing rights to the increase in value accrued in Belgium after the allocation and a credit could be given up to an amount equal to that tax. In the case at hand, the company had claimed a notional credit for tax on the increase in value that had taken place in Sweden before the assets were transferred to Belgium, while the transferee company in Belgium was not taxed on the corresponding increase in value when the assets were subsequently disposed of, as the Belgian tax authority considered that the tax treaty prevented such taxation. The Court of Appeal held that there were grounds for back-taxation and the imposition of a tax surcharge on the basis of incorrect information. The information provided by the company was not considered sufficient to trigger the Tax Agency’s special investigation obligation and the tax fine was not considered unreasonable even though it amounted to a very large sum. Click here for English Translation Click here for translation ...

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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The Swedish Branch of Yazaki Europe Ltd had been heavily lossmaking for more than five years. The Branch only had a limited number of customers in Sweden and where it acted as a simple information exchange provider. The branch had limited risks, as all risk related to R&D functions were located outside Sweden. Excerpt from the Judgement of the Court “…the District Court finds that the branch has had limited opportunities to influence the costs of the products, the choice of suppliers and service providers regarding the development of the products in the projects run in collaboration with the Swedish customers, and price to the customer. Furthermore, the branch has been referred to make purchases in the currencies that result from the group structure. The branch states that…the work done by the branch has been of such scope and importance that significant people functions are to be considered in the branch for virtually all risks that can be associated with production and development. – the sale of the goods and services sold from the branch. The branch also states that the branch’s Branch Manager was the CEO and certified part of the Electronics & Instrumentation Business Unit (EIBU), a collaboration between various business units within YEL. The branch relies on a statement from expert Roberto Bernales Soriano. …The job descriptions, agreements and protocols, as well as the investigation in general, do not, in the opinion of the Administrative Court, support any decisive decision in the branch or that the head office’s role should have been limited to such passive decision-making as is discussed in the expert opinion cited by the branch. The investigation does not therefore support that it is in the branch that most of the risks and assets associated with the production for the sale in the branch have been handled. Deloitte’s functional analysis and benchmarking study as well as other studies were conducted in 2015, ie. in retrospect. …The Court of Appeal considers that the value of the functional analysis and the new benchmarking study as well as other studies is limited. … the District Court considers that the branch was primarily responsible for sales to Swedish customers, have been collectors and intermediaries of information to and from customers and other units. The TP documentation and other investigations show that the branch has not borne the risks posed by the branch. In view of the activities carried out in the branch, the limited functions that existed in the branch and the limited risks borne by the branch, there is clear support for the notion that the branch has been a service provider, which should have reported a stable profit during the years that is now in question and not such a risk-bearing entity as the branch thinks. It is clear from the investigation that the losses were incurred as a result of the day-to-day sales operations in the branch and not because the branch has taken such risks as an entrepreneur takes. Thus, it is clear that the reported profit does not reflect the financial result the branch would have had if it had been an independent company. … In order to be able to estimate the result in this case, a discretionary assessment must be made. …The Swedish Tax Agency has taken into account the existing investigation and made relevant comparisons. In the light of what is stated in the TP documentation on the Group’s remuneration levels for the production units , for management and for design and development services, the profit assessed by the Swedish Tax Agency – the margin of 2 per cent for the branch in the current year, is considered prudently estimated.“ Click here for translation ...

The Swedish branch of Technology Partners International Europe Ltd. was loss-making. The branch had no significant people functions but only two employees performing low value-added services. From the Judgement of the Court of Appeal “The distribution of revenue and costs between a British company and its Swedish branch is regulated for the current tax years in Article 7 of the 1983 double taxation agreement with the United Kingdom. Further guidance on the application of this issue can be obtained in the 2008 OECD report on profit allocation. A two-step test according to the so-called functional separate entity approach, as described in the administrative law, must be done. The Court of Appeal agrees, in light of the information provided by the branch during the Swedish Tax Agency’s investigation and because the Nordic manager cannot be linked to the branch, in the administrative court’s assessment that the branch has in the current years lacked so-called significant people functions. Nor has the branch had any function which has meant financially significant activities or areas of responsibility. It is therefore a so-called low risk service provider vis-à-vis the head office. The Swedish Tax Agency has used the net margin method to determine the arm’s length level in the distribution of income. The work has been based on the costs to be attributed to the branch and used a profit margin of 5% on the basis that the branch may in any case be considered to provide so-called low value adding services. The branch has referred to ongoing restructuring work in the Nordic organization in the Group, market and business strategic aspects as well as the assessment made in the Group’s internal pricing policy. However, the Tax Agency may be deemed to have shown that the branch’s income and expenses must be determined in accordance with the appealed decisions. What the branch has presented does not change this assessment. The appeal must therefore be rejected in this part.” Click here for translation ...