Introduction to International Taxation PDF 2024

Introduction to International Taxation. Dr. Achim Roeder Ruhr-Universität Bochum Summer Term 2024  Organisational matters – content & language Content: Lecture: § Tax aspects of cross-border activities with a focus on double taxation issues § Unilateral as...

Introduction to International Taxation. Dr. Achim Roeder Ruhr-Universität Bochum Summer Term 2024  Organisational matters – content & language Content: Lecture: § Tax aspects of cross-border activities with a focus on double taxation issues § Unilateral as well as bi- or multilateral regulations to prevent double taxation as well as double non-taxation § Focus on transfer pricing § General international tax law and new developments, e.g. OECD Pillar I & II Tutorial: § Repetition of selected contents of the lecture § Focus on German international tax law and transfer pricing Language: Lecture in English Tutorial in German RUB Introduction to International Taxation, Summer Term 2024 2  Organisational matters – schedule & written exam Indicative Schedule, 08:00-12:00: Lecture Tutorial April 09, 23, 30 May 07, 14 June 04, 11, 18 July 02, 09, 16 Written exam: Questions in English Answers can be provided in English or German Date of written exam: probably 23 July 2024, 14:00 to 16:00 RUB Introduction to International Taxation, Summer Term 2024 3  Organisational matters – literature Literature: Arnold, International Tax Primer (5th edition), Den Haag 2023 Malherbe, Elements of International Taxation Bruxelles 2015 Oats Principles of International Taxation (8th edition), London 2021 Rohatgi, Roy Rohatgi on International Taxation, Volume 1: Principles (3rd edition) , Amsterdam 2018 RUB Introduction to International Taxation, Summer Term 2024 4  Structure 1. Economic aspects of cross border taxation 2. Double tax treaties 3. Tax law of the European Union 4. Aspects of transfer pricing 5. Controlled foreign companies 6. Current developments RUB Introduction to International Taxation, Summer Term 2024 5  Structure 1. Economic aspects of cross border taxation 1.1 Fundamentals 1.2 Double taxation and double tax exemption 1.3 Reasons for double taxation and double tax exemption 1.4 Avoidance of double taxation 1.5 Neutrality of taxation for economic decisions 2. Double tax treaties 3. Tax law of the European Union 4. Aspects of transfer pricing 5. Controlled foreign companies 6. Current developments RUB Introduction to International Taxation, Summer Term 2024 6  1. Economic aspects of cross border taxation 1.1 Fundamentals (1) Definition of taxation Taxation required to finance public spending for the provision of public goods, (re-)distribution of resources and economic stabilisation Compulsory levies Objectives: Imposed to raise revenue for the provision of public goods, for the redistribution of income and wealth, to promote social and economic welfare, to support economic stability, to harmonize domestic trade Elements of taxation Tax base (income or revenue, capital, expenditure, consumption, wealth …) Tax rate Taxpayer (legal vs. economic) Criteria to evaluate tax systems: equity (horizontal vs. vertical) and efficiency/neutrality Administrative and compliance costs of taxation RUB Introduction to International Taxation, Summer Term 2024 7  1. Economic aspects of cross border taxation 1.1 Fundamentals (2) Major trends in international taxation over time 1900 to 1950: limited cross border trade 1960s and 1970s: removal of trade barriers, growing integration of capital markets, growing tax evasion 1980s and 2000s: increased co-operation between nations, declining tax rates (OECD average 50% early 1980s to less than 30% today) 2010s: Financial crisis, BEPS, taxation of digital economy 2020s: COVID, climate crisis, war in Ukraine RUB Introduction to International Taxation, Summer Term 2024 8  1. Economic aspects of cross border taxation 1.2 Double taxation and double tax exemption (1) Definitions Legal double taxation § Same tax object § Same tax subject § Identical periods § Comparable tax Economic double taxation § Same tax object § Different tax subject Double tax exemption § No uniform definition § Tax loopholes caused by tax system § Tax loopholes caused by tax planning RUB Introduction to International Taxation, Summer Term 2024 9  1. Basic principles 1.2 Double taxation and double tax exemption (2) Distortion of competition and impact on economic choices of taxpayers regarding international transactions tax base economic target Juridical double taxation or Economic double taxation or double tax exemption double tax exemption RUB Introduction to International Taxation, Summer Term 2024 10  1. Basic principles 1.3 Reasons for double taxation and double tax exemption (1) Sovereign taxation right: No restriction on the state’s right to tax Taxation without regard to other states Connecting factors for taxation Personal attachment (residence rule) Economic attachment (source rule) - digitalization Differing connecting factors Citizenship (e.g. USA) Residence (typically in industrialized countries) Source (typically in developing countries, but trend in industrialized countries) Varying basis for computing the tax Universal tax system: taxation on the basis of worldwide income Territorial tax system: taxation of income arising in fiscal jurisdiction RUB Introduction to International Taxation, Summer Term 2024 11  1. Basic principles 1.3 Reasons for double taxation and double tax exemption (2) Two states with identical Connecting factor connecting factor and tax base for taxation Residence Source Citizenship Universal Taxation basis Territorial Red: double taxation Green: no double taxation Yellow: tax exemption possible RUB Introduction to International Taxation, Summer Term 2024 12  1. Basic principles 1.3 Reasons for double taxation and double tax exemption (3) Tax is levied by residence state Yes No Yes Double taxation Taxation at source Tax is levied by source state No Taxation at place of residence Double tax exemption RUB Introduction to International Taxation, Summer Term 2024 13  1. Basic principles 1.3 Reasons for double taxation and double tax exemption (4) Different connecting factors used simultaneously For example: the same income is taxed twice, first by the country where it is derived under its “source rules” and then in the country where the taxpayer resides under its “residence rule” Qualification conflicts Income characterization conflicts: two states characterize or classify the same income or capital differently and, therefore, apply differing tax provisions Mismatching tax systems: § States have different accounting methods § States require different transfer prices (Example) Avoidance of double taxation Tax is levied by residence state, i.e. the source state waives taxation right Tax is levied by source state, i.e. residence state waives taxation right RUB Introduction to International Taxation, Summer Term 2024 14  1. Basic principles 1.3 Reasons for double taxation and double tax exemption (5) Country A (sA=40%) Country B (sB=30%) TP? Parent Subsidiary manufacturing costs: € 95 revenue from customers: € 125 Transfer price for tax purposes in country A 125 95 Tax in country A: 12 Tax in country A: 0 Transfer price for 95 Tax in country B: 9 Tax in country B: 9 tax purposes in country Tax in country A: 12 Tax in country A: 0 B 125 Tax in country B: 0 Tax in country B: 0 RUB Introduction to International Taxation, Summer Term 2024 15  1. Basic principles 1.4 Avoidance of double taxation (1) No international consensus on the appropriate method for granting relief from international double taxation. The following three methods are commonly used: Exemption method: The residence country provides its taxpayers with an exemption for foreign-source income. Credit method: The residence country provides its taxpayers with a credit against taxes otherwise payable for income taxes paid to a foreign country. § Unlimited tax credit: Combined domestic and foreign tax rate on the foreign- source income is equal to domestic tax rate § Limited tax credit: The credit for foreign taxes paid is limited to the amount of the domestic tax payable on the foreign-source income → effective tax rate is determined by the highest of the applicable domestic and foreign tax rates Deduction method: The residence country allows its taxpayers to claim a deduction for taxes, including income taxes, paid to a foreign government in respect of foreign source income. RUB Introduction to International Taxation, Summer Term 2024 16  1. Basic principles 1.4 Avoidance of double taxation (2) Example Domestic income: 150,000; Domestic tax rate (sI): 40% Foreign income: 50,000; Foreign tax rate (sA): 25%, 50%, 40% sA=25% Tax exemption Tax credit Tax deduction SA 12,500 12,500 12,500 SI 60,000 67,500 75,000 SA+SI 72,500 80,000 87,500 SI (200,000) 80,000 80,000 80,000 RUB Introduction to International Taxation, Summer Term 2024 17  1. Basic principles 1.4 Avoidance of double taxation (3) sA=50% Tax exemption Tax credit Tax deduction SA 25,000 25,000 25,000 SI 60,000 55,000 70,000 SA+SI 85,000 80,000 95,000 SI (200,000) 80,000 80,000 80,000 sA=40% Tax exemption Tax credit Tax deduction SA 20,000 20,000 20,000 SI 60,000 60,000 72,000 SA+SI 80,000 80,000 92,000 SI (200,000) 80,000 80,000 80,000 RUB Introduction to International Taxation, Summer Term 2024 18  1. Basic principles 1.5 Neutrality of taxation for economic decisions (1) National – Neutrality of taxation for investment decisions Taxation that distorts decisions imposes a welfare cost World without taxation as baseline Taxation has no influence on the ranking of investment alternatives Taxation has no influence on the invested amount Cross border – Neutrality of taxation for choice of investment location Taxation at location of investment has no effect on choice of investment location = capital export neutrality (or CEN); taxation should not influence whether investors resident in one jurisdiction invest their capital at home or abroad Residence of investor has no effect on choice of investment location = capital import neutrality (or CIN); taxation should not influence whether an investment is made by a domestic or a foreign investor (legal/policy interpretation, i.e. level playing field between foreign and domestic investors) RUB Introduction to International Taxation, Summer Term 2024 19  1. Basic principles 1.5 Neutrality of taxation for economic decisions (2) Taxation on the basis of worldwide income Establish taxation at the tax rate of the residence state Achieve capital export neutrality by unlimited tax credit Domestic tax rate considered most important Taxation on the basis of source income Establish taxation at the tax rate of source state Achieve capital import neutrality by tax exemption Foreign tax rate considered most important Example Investor, resident in country A, decides between investment in country B or C Tax rates in the specific countries: sA=50%, sB=40%, sC=60% RUB Introduction to International Taxation, Summer Term 2024 20  1. Basic principles 1.5 Neutrality of taxation for economic decisions (3) Capital export neutrality Location of investment domestic foreign resident r = rI · (1 – sI) r = rA · (1 – sI) Investor foreign r = rI · (1 – sA) r = rA · (1 – sA) Assumptions Perfect competition on capital market No arbitrage through change of investment location Consequences Harmonization of gross interest yields (production efficiency) Net interest yields depending on state of residence RUB Introduction to International Taxation, Summer Term 2024 21  1. Basic principles 1.5 Neutrality of taxation for economic decisions (4) Capital export neutrality Country B Country C rv=14% rv sA = 50% rv=8% rs,B=7% rs rs,C=4% rs=(1-sA)·rv RUB Introduction to International Taxation, Summer Term 2024 22  1. Basic principles 1.5 Neutrality of taxation for economic decisions (5) Capital import neutrality Location of investment domestic foreign resident r = rI · (1 – sI) r = rA · (1 – sA) Investor foreign r = rI · (1 – sI) r = rA · (1 – sA) Assumptions: Perfect competition on capital market Consequences Harmonization of net interest yields Investors realize different gross interest yields Production efficiency is only achieved in case of similar tax rates RUB Introduction to International Taxation, Summer Term 2024 23  1. Basic principles 1.5 Neutrality of taxation for economic decisions (6) Capital import neutrality sB = 40% sc = 60% Country B Country C rv,C=15% rv,B=14% rv,B=10% rv,C=8% rs=8,4% rs=6% rs=3,2% rs=(1-sB)·rv rs=(1-sC)·rv RUB Introduction to International Taxation, Summer Term 2024 24  1. Basic principles 1.5 Neutrality of taxation for economic decisions (7) Comparison capital import neutrality vs. capital export neutrality Capital import neutrality Capital export neutrality Advantages Advantages No distortion of competition in local markets Neutral with regard to cross-border movement of persons , goods, services and capital Simplified administration: only national accounting necessary, not global Equability in terms of absolute equal treatment of residents Disadvantages Globally efficient capital allocation No global production efficiency Neutralization of local tax advantages Easing international tax competition and tax planning by way of shifting income or capital Disadvantages Limitation of tax competition between states Extensive administrative effort due to broad accounting in the residence state RUB Introduction to International Taxation, Summer Term 2024 25  Structure 1. Economic aspects of cross border taxation 2. Double tax treaties 2.1 Introduction 2.2 OECD Model Tax Convention 2.3 Permanent establishments 3. Tax law of the European Union 4. Aspects of transfer pricing 5. Controlled foreign companies 6. Current developments RUB Introduction to International Taxation, Summer Term 2024 26  2. Double tax treaties 2.1 Introduction (1) Double tax convention Treaties are agreements between sovereign states Elimination of double taxation → Facilitate cross-border trade and investment by eliminating the tax impediments to these cross-border flows Elimination of double tax exemption; prevention of fiscal evasion or avoidance → Secure public revenue By assignment of the taxation right to one or both of the Contracting States Treaty provisions usually override those of domestic tax law Two influential model conventions § OECD Model Convention on Income and Capital (OECD MC) § United Nations Double Taxation Convention between Developed and Developing Countries (UN MC) Most German tax treaties are based on the OECD MC; but there are differences in the details RUB Introduction to International Taxation, Summer Term 2024 27  2. Double tax treaties 2.1 Introduction (2) Interpretation of tax treaties Vienna Convention on the Law of Treaties § Interpretation rules of the Vienna Convention apply to all treaties § Most countries have signed the Vienna Convention (notable exception: USA) § Basis rule of interpretation: “A treaty shall be interpreted in good faith in accordance with the ordinary meaning and given to the terms of the treaty in their context and in light of object and purpose.” Three-stages process of interpretation 1. Does the treaty provide a definition of the term (special or general)? 2. If the treaty does not provide a definition, what is the domestic meaning of it? 3. Does the context of the treaty require a meaning different from the domestic meaning? Commentary to the OECD Model Convention § Highly necessary for interpreting treaties between Contracting States § Contains observations by particular countries on specific aspects of the Commentary RUB Introduction to International Taxation, Summer Term 2024 28  2. Double tax treaties 2.2 OECD Model Convention (1) Structure of the OECD Model Convention I. Scope of the Convention (Art. 1, 2) Definitions: including e.g. who may benefit from the treaty, residents, taxable II. Definitions (Art. 3-5) presence of business enterprises III. Taxation of income (Art. 6-21) Classification and allocation of income IV. Taxation of capital (Art. 22) Rights to tax capital V. Methods for elimination of double taxation (Art. 23) Methods of double tax relief VI. Special provisions (Art. 24-29) Administrative and anti- avoidance provisions VII. Final provisions (Art. 30-31) Current version of Model Convention dates back to 1963, with most recent updates in July 2008, July 2010, July 2014 and November 2017 RUB Introduction to International Taxation, Summer Term 2024 29  2. Double tax treaties 2.2 OECD Model Convention (2) I. Scope of the Convention Article 1: Persons covered Requirements in order to claim benefits under the treaty § persons who are § residents of one or both of the contracting states Article 2: Taxes covered Taxes on income and on capital List of the taxes covered when it was signed Extension to new taxes introduced after the treaty has been signed II. Definitions Article 3: General definitions General definitions of treaty terms Not defined elsewhere in the model convention Definition apply, unless the context otherwise requires RUB Introduction to International Taxation, Summer Term 2024 30  2. Double tax treaties 2.2 OECD Model Convention (3) Article 4: Residence Definition of residence under the tax treaty Special rule if an individual is tax resident in both contracting states (tie-breaker rules; from 2017 mutual agreement required for companies) Article 5: Permanent establishment Definition of permanent establishment under the treaty; broadly includes place of management, branch, office, factory, workshop, mine, long-term construction sites III. Taxation of income Article 6: Income from immovable property Income from immovable property, e.g. rent from office building or from land used for agriculture, may be taxed in the state in which that property is located, i.e. in the source state Article 7: Business profits The article provides for the taxation of cross-border business profits of an enterprise Permanent establishment required (Article 5) RUB Introduction to International Taxation, Summer Term 2024 31  2. Double tax treaties 2.2 OECD Model Convention (4) Article 8: International transport (general rule: taxed in country of residence) Article 9: Associated enterprises → Section 4. “Transfer Pricing” Article 10: Dividends (taxed in both states; with WHT capped at 15%) Article 11: Interest (taxed in both state; with WHT capped at 10%) Article 12: Royalties (taxed in country of residence of beneficial owner) Article 13: Capital gains (taxed in country of residence of taxpayer; but land) Article 14: Independent Personal Services [Deleted] Article 15: Income from employment (basic rule: source country if stay >183 days) Article 16: Director’s fees (basic rule residence of company) Article 17: Artists and sportspersons (basic rule: source country) Article 18: Pensions (basic rule: country of residence, but many exceptions) Article 19: Government Service (basic rule: source country) Article 20: Students (basic rule: source country) Article 21: Other income (e.g. gambling winnings; country of residence) RUB Introduction to International Taxation, Summer Term 2024 32  2. Double tax treaties 2.2 OECD Model Convention (5) IV. Taxation of capital Article 22: Capital The article applies to taxes on capital from the possession or ownership of capital, and not to the income from gains from capital Under this article, the state of residence has generally the exclusive taxation rights on all items of capital V. Methods for elimination of double taxation Article 23 A: Exemption method Tax exemption with progression Article 23 B: Credit method Credit for the foreign taxes paid in the other Contracting State RUB Introduction to International Taxation, Summer Term 2024 33  2. Double tax treaties 2.2 OECD Model Convention (6) VI. Special provisions Article 24: Non-discrimination Article 25: Mutual agreement procedure Disputes affecting a taxpayer resident in a contracting state due to taxation which is or is likely to be inconsistent with the treaty provisions (Art. 25 (1), (2)) Difficulties relating to the interpretation or application (Art. 25 (3)) Elimination of double taxation in cases not provided for in the treaty (Art. 25 (3)) → The contracting states are required to make efforts Article 26: Exchange of information Article 27: Assistance in the collection of taxes Article 28: Members of diplomatic missions and consular posts Article 29: Entitlement to benefits VI. Final provisions Article 30: Entry into force Article 31: Termination RUB Introduction to International Taxation, Summer Term 2024 34  2. Double tax treaties 2.3 Permanent establishments (1) Legal entity HO Country A Country B PE RUB Introduction to International Taxation, Summer Term 2024 35  2. Double tax treaties 2.3 Permanent establishments (2) 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. … [This definition broadly includes: places of management, branches, offices, factories, workshops, mines, oil wells etc. and buildings and construction sites lasting more than 12 months] 4. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: a. the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; RUB Introduction to International Taxation, Summer Term 2024 36  2. Double tax treaties 2.3 Permanent establishments (3) 4. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: d. the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; e. the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; f. the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that such activity or in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character. RUB Introduction to International Taxation, Summer Term 2024 37  2. Double tax treaties 2.3 Permanent establishments (4) Legal entity A HO Country A Country B Legal entity C RUB Introduction to International Taxation, Summer Term 2024 38  2. Double tax treaties 2.3 Permanent establishments (5) 5. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 6, where a person is acting in a Contracting State on behalf of an enterprise and in doing so, habitually concludes contracts, or habitually plays a principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are a) in the name of the enterprise, or b) for the transfer of ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or c) for the provision of services by that enterprise that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business (other than a fixed place of business to which paragraph 4.1 would apply), would not make this fixed place of business a permanent establishment under the provisions of that paragraph. RUB Introduction to International Taxation, Summer Term 2024 39  2. Double tax treaties 2.3 Permanent establishments (6) Legal entity A HO Country A Country B Legal entity B Legal entity C „PE“ RUB Introduction to International Taxation, Summer Term 2024 40  2. Double tax treaties 2.3 Permanent establishments (7) 6. Paragraph 5 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independent agent and acts for the enterprise in the ordinary course of that business. Where, however, a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise. 7. … 8. … RUB Introduction to International Taxation, Summer Term 2024 41  Structure 1. Economic aspects of cross border taxation 2. Double tax treaties 3. Tax law of the European Union 3.1 Introduction 3.2 Value Added Tax 3.3 Direct Taxes 4. Aspects of transfer pricing 5. Controlled foreign companies 6. Case studies on tax planning 7. Taxation and digitalization RUB Introduction to International Taxation, Summer Term 2024 42  3. Tax Law in the European Union 3.1 Introduction EU Institutions European Council (Art. 15 Treaty on European Union – TEU) Council of the European Union (Art. 16 TEU) European Commission (Art. 17 TEU) European Parliament (Art. 14 TEU) European Court of Justice (Art. 19 TEU) European Court of Auditors (Art. 13 TEU) RUB Introduction to International Taxation, Summer Term 2024 43  3. Tax Law in the European Union 3.1 Introduction EU principles affecting tax issues – fundamental freedoms Freedom of movement for workers Freedom of establishment of nationals of a Member State in the territory of another Member State Freedom for a national of a Member State to provide services to a person in another Member State Freedom of movement of capital between Member States, and between Member States and third countries Primary vs. Secondary Law RUB Introduction to International Taxation, Summer Term 2024 44  3. Tax Law in the European Union 3.2 Value Added Tax EU responsible for harmonization of indirect taxation Union Customs Code provides a comprehensive framework for customs rules and procedures in the EU customs territory RUB Introduction to International Taxation, Summer Term 2024 45  3. Tax Law in the European Union 3.2 Value Added Tax VAT basics Value added tax (VAT) is an indirect consumption tax, i.e. paid on purchases of goods and services not on (net) income/profits Taxable business will charge VAT to its customers; it will pay this VAT to its tax authority after deducting VAT it has been charged by its suppliers (input VAT) In the EU (and in most other countries imputing VAT) the so-called „credit-invoice“ method is applied, i.e. VAT is charged on each individual sales invoice of a business and the business can obtain a VAT credit for each valid purchase invoice Different VAT rates (e.g. 0% rate) as well as exemptions (e.g. financial services, real estate) may apply RUB Introduction to International Taxation, Summer Term 2024 46  3. Tax Law in the European Union 3.2 Value Added Tax VAT example Business A sells to Business B Net selling price of 400 plus VAT at 20% gives a gross selling price of 480 Business A will declare VAT of 80 Business B sells to Consumer C Net selling price of 500 plus VAT at 20% gives a gross selling price of 600 Business B will declare VAT of 100 – 80 (input VAT) = 20 Consumer C will pay a gross selling price of 600 that includes VAT payments of 100 Can changes in VAT affect the profits of a business? RUB Introduction to International Taxation, Summer Term 2024 48  3. Tax Law in the European Union 3.2 Value Added Tax Monopoly model equilibrium Price Demand Equilibrium Marginal Cost Marginal Revenue Quantity RUB Introduction to International Taxation, Summer Term 2024 49  3. Tax Law in the European Union 3.2 Value Added Tax Increase of VAT rate as increase of cost in monopoly model Price Demand E new E old Marginal Cost new Marginal Cost old Marginal Revenue Quantity RUB Introduction to International Taxation, Summer Term 2024 50  3. Tax Law in the European Union 3.2 Value Added Tax VAT on cross-border trade Which country is permitted to tax a transaction? Where is the place of taxation? Usually VAT should be taxed at the place of consumption Different transactions exist: B2B vs. B2C Two alternative systems exist: Destination system: no VAT charged to exporting supplier but to customer on import to country of destination Origin system: VAT charged by the exporting supplier in its home country No international consensus Destination system requires so-called “place of supply” rules determining when a sale is a domestic sale and when it is an export (e.g. resident in country A is selling to resident in country B but goods are located in country C) Reverse charge: imports of goods under a destination system – VAT is not paid to a foreign supplier but importing firm will charge VAT itself RUB Introduction to International Taxation, Summer Term 2024 51  3. Tax Law in the European Union 3.2 Value Added Tax VAT in the EU EU single market with free trade of goods and services requires harmonized VAT systems and avoidance of border controls to facilitate these goals European countries adopted VAT as a common system for indirect taxation in 1967 In 1993 a system based on a mixture of origin and destination principles has been implemented generally applying the principles as laid out below but with numerous exceptions and special rules B2B transactions: Where goods are transported to the customer the destination principle applies under the reverse charge procedure B2C transactions: The supplier is to charge VAT at the rate of its home country, i.e. the origin principle is used Specific administrative issue: Multiple registration for VAT in different countries VAT fraud taking advantage of the reverse charge system RUB Introduction to International Taxation, Summer Term 2024 52  3. Tax Law in the European Union 3.3 Direct Taxes Member States are responsible for direct taxation Only general harmonization within framework of regulations governing the common market as well as the economic and monetary union RUB Introduction to International Taxation, Summer Term 2024 53  3. Tax Law in the European Union 3.3 Direct Taxes Major rulings EU Court of Justice Schumacker, C-279/93 – cross-border commuting Belgium to Germany Lankhorst-Hohorst, C-324/00 – cross-border shareholder financing Lasteyrie du Saillant, C-9/02 – taxation of exit from France to Belgium Marks & Spencer, C-446/03 – deduction of cross-border losses Cadbury Schweppes, C-196/04 – CFC rules Rewe Zentralfinanz, C-347/04 – deduction of loss in fair value of shares Société de Gestion Industrielle SA, C-311/08 – potential justification of discriminating treatment Commission/Germany, C-284/09 – dividend taxation of portfolio investments RUB Introduction to International Taxation, Summer Term 2024 54  3. Tax Law in the European Union 3.3 Direct Taxes Parent-Subsidiary Directive (1990) Avoiding double taxation on dividends and other distributions paid by subsidiaries to parent companies that are located in two different member states Resident state of subsidiary has only taxation right for profits realized by the subsidiary Resident state of the parent company avoids double taxation of dividends and distributions by way of tax exemption or tax credit Minimum holding quota: 10% (since 2009) This rule applies for companies and other legal entities (listed in the appendix) RUB Introduction to International Taxation, Summer Term 2024 55  3. Tax Law in the European Union 3.3 Direct Taxes Merger Directive (1990) The creation of a Single European Market requires (cross-border) reorganization of historically developed legal and organizational corporate structures Cross border reorganizations regularly lead to realization of hidden reserves and corresponding tax payments => restructuring obstacle Merger directive shall secure tax neutral reorganizations Four cases of application § Merger: Transfer of all assets and abandonment of juristic autonomy § Demerger: Transfer of businesses or separable parts of business operations to one or more recipients § Contribution: Transfer of a business or separable part of a business operation against shares § Share-exchange: Acquisition of majority voting interest against own shares This rule applies to companies and other legal person (listed in the appendix) Specific rules for European Companies and European Cooperative Society RUB Introduction to International Taxation, Summer Term 2024 56  3. Tax Law in the European Union 3.3 Direct Taxes Interest and Royalty Directive (2003) The directive eliminates the taxes levied by source states, through either withholding or assessment, on qualifying intra-group payments of interest and royalties between associated companies and permanent establishments of Member States. Specific legal form of an entity in Europe, e.g. Societas Europaea (SE) Corporation with seat (place of head office) in the European Union Current taxation: Rules of company’s seat state apply No taxation of hidden reserves in case of a relocation if assets still belong to a domestic permanent establishment Fundamental freedom and derived non-discrimination rule and ban on restrictions Freedom of establishment and services Free movement of goods and capital RUB Introduction to International Taxation, Summer Term 2024 57  3. Tax Law in the European Union 3.3 Direct Taxes Arbitration Convention (1990) Permits the optional use of arbitration procedures to resolve transfer pricing conflicts within the Member States of the European Union Background: In case of an upward adjustment of profits of an enterprise of one member state, most bilateral double taxation treaties include a provision for a corresponding downward adjustment of profits of the associated enterprise concern, but they do not impose a binding obligation on the Contracting States to eliminate double taxation. Contracting States are allowed to secure a solution by mutual agreement during a period of two years. In case of no result within two years the competent authorities must set up an advisory commission to deliver an opinion on the elimination of double taxation. The commission must deliver its opinion within six months. If, within a further six months, an agreement cannot be reached on alternative steps to eliminate double taxation, the competent authorities must accept the commission’s decision. Scope: Transfer Pricing and Permanent Establishment issues RUB Introduction to International Taxation, Summer Term 2024 58  3. Tax Law in the European Union 3.3 Direct Taxes Arbitration Convention (Timeframe) 2 years 6 months 6 months Arbitration Application Mutual Agreement Procedure Agreement Procedure Required Duration: maximum of 2 years In case no Six further content of the agreement has A mutual agreement procedure is conducted in the months for application is been reached interest of the taxpayer contracting quite ð Appointment states to extensive The tax authorities are dependent on cooperation of of an advisory reach an – important for the taxpayer committee (two agreement the beginning participants for of the time The taxpayer does not participate in the negotiations each country period involved + Term can be extended by the responsible authorities chairperson + within three with consent from the involved companies two independent years after participants) receipt of tax assessment Decision within notice six months RUB Introduction to International Taxation, Summer Term 2024 59  3. Tax Law in the European Union 3.3 Direct Taxes Council directive on tax dispute resolution mechanisms (2017) Council Directive (EU) 2017/1852 dated 10 October 2017 on procedures for the settlement of double taxation disputes Additional procedure for taxpayers to resolve double taxation disputes with an arbitration phase for all double taxation cases within the EU Alternative to mutual agreement procedure according to DTA and EU Arbitration Convention Scope of application: disputes about the interpretation and application of double tax treaties in individual cases i.e. not only transfer pricing issues, not only company taxation, but also cases without actual double taxation Procedure is initiated at the request of the taxpayer Length and structure of procedure similar to EU Arbitration Convention RUB Introduction to International Taxation, Summer Term 2024 60  Structure 1. Economic aspects of cross border taxation 2. Double tax treaties 3. Tax law of the European Union 4. Aspects of transfer pricing 4.1 Introductory example and tax legal basis 4.2 Economic analysis and transfer pricing methods 4.3 Transfer pricing documentation 4.4 Applied economic analysis – Services 5. Controlled foreign companies 6. Current developments RUB Introduction to International Taxation, Summer Term 2024 61  4. Aspects of Transfer Pricing 4.1 Introductory Example and Tax Legal Basis Introductory Example (1) M D I Domestic Foreign Independent Transfer price Market price manufacturer distributor company Affiliated/related companies RUB Introduction to International Taxation, Summer Term 2024 62  4. Aspects of Transfer Pricing 4.1 Introductory Example and Tax Legal Basis Introductory Example (2) Domestic manufacturer M produces bags Production costs amount to € 10 per bag Transfer price per unit for foreign distributor D: a) € 5 b) € 30 c) € 50 d) € 70 e) € 95 Purchase price for final customer: € 90 per unit; no further costs for D Production = Sales = 1 million bags RUB Introduction to International Taxation, Summer Term 2024 63  4. Aspects of Transfer Pricing 4.1 Introductory Example and Tax Legal Basis Introductory Example (3) Transfer Profit/Loss Profit/Loss Group Tax burden Tax burden Overall tax price M D profit M (40 %) D (25 %) burden a) €5 - € 5m € 85m € 80m - € 21.25m € 21.25m b) € 30 € 20m € 60m € 80m € 8m € 15m € 23m c) € 50 € 40m € 40m € 80m € 16m € 10m € 26m d) € 70 € 60m € 20m € 80m € 24m € 5m € 29m e) € 95 € 85m - € 5m € 80m € 34m - € 34m RUB Introduction to International Taxation, Summer Term 2024 64  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods 0° Celsius 273, 15° Kelvin 32° Fahrenheit Konvention Naturwissenschaft; Konvention USA Kontinentaleuropa nur positiv RUB Introduction to International Taxation, Summer Term 2024 65  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Functions Intangibles Risks RUB Introduction to International Taxation, Summer Term 2024 66  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Before After Share I Share II RUB Introduction to International Taxation, Summer Term 2024 67  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods The purpose is assessing the arm’s length nature of prices used for tax purposes taking into account a given functional and risk profile No exact science, i.e. price determination is based on explicit and implicit assumptions and is affected by information uncertainty. Consequence: There is usually a range of arm’s length prices Important prerequisite for the choice of a transfer pricing method: Availability of sufficient third-party data (e.g. prices, mark-ups) and other information (e.g. sufficiently segmented cost/sales data) RUB Introduction to International Taxation, Summer Term 2024 68  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods RUB Introduction to International Taxation, Summer Term 2024 69  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Comparable Uncontrolled Price Method (1) The CUP method compares the price charged for products, services or property rights in a controlled transaction to the price charged for goods or services transferred in a comparable uncontrolled transaction in comparable circumstances (e.g. at the same time, at the same stage in the value chain and under similar conditions). External vs. internal price test Direct vs. indirect price test Offer prices (e.g. price lists, credit offers) vs. controllable transactions actually completed The application of the CUP method is subject to maximum requirements in terms of comparability; regularly complied with in the case of replaceable assets in organized markets → CUP method not applicable in most cases Typical areas of application of the CUP method: § License fees § Interest rates RUB Introduction to International Taxation, Summer Term 2024 70  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Comparable Uncontrolled Price Method (2) A A sells machine to affiliated internal external party B A Independent D D A sells similar company D machine to sells similar unrelated machine to B B buys similar company C unrelated machine from company C unrelated company D C B C RUB Introduction to International Taxation, Summer Term 2024 71  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Comparable Uncontrolled Price Method (3) Pros Cons Preferred method by OECD and Maximum requirements in terms of some fiscal authorities comparability (properties of asset/services/rights, functions and risks) Often not possible to identify comparable or very similar transaction RUB Introduction to International Taxation, Summer Term 2024 72  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Resale Price Method (1) Approach § Basis: Price at which a product, service or property right that has been purchased by a related party is resold to an unrelated party § This price is reduced by an appropriate gross margin on the respective price representing the amount from which the reseller would seek to - cover its selling and other operating expenses and - make an appropriate profit (functions/risks) No material treatment or processing by the seller, i.e. commonly applicable to distribution activities Rarely applicable as external arm‘s length comparison, since relevant external data (gross margins) hardly available RUB Introduction to International Taxation, Summer Term 2024 73  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Resale Price Method (2) P&L Statement Revenue - Cost of sales Gross profit Gross margin = Sales revenue = Gross profit - Administrative and distribution expenses = Net profit Parent Unrelated company manufacturer Unrelated Comparable Subsidiary gross distributor margins? Unrelated A Unrelated B RUB Introduction to International Taxation, Summer Term 2024 74  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Resale Price Method (3) Pros Cons Preferred method by OECD and Extensive requirements in terms of some fiscal authorities comparability of transactions Relatively easy to apply Data regarding the gross margin of transactions between independent parties are not publicly available Gross margins are often not comparable due to e.g. differences between accounting standards (e.g. HGB; IFRS; US-GAAP) RUB Introduction to International Taxation, Summer Term 2024 75  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Cost-Plus Method (1) Transfer price for product, service or property right is based on production costs plus an arm‘s length cost mark-up First thoughts § Use of the same calculation methods as used for transactions with unrelated third parties (internal arm‘s length test) or § Calculation method according to business principles General option for definition of costs, but determined on the basis of available external data § Plan, normal or actual costs § Full costs or portion of overall costs § Cash-relevant vs. imputed term of costs § Accounting standards (HGB, IFRS, US-GAAP) → Often plan or actual full costs Typically applicable to production or service transactions RUB Introduction to International Taxation, Summer Term 2024 76  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Cost-Plus Method (2) A Direct and indirect Costs production costs + Reflects an adequate profit with respect to Mark-up the functions and the accepted risks = Transfer price B Subsidiary Parent company (toll manufacturer) mark-up third party third party mark-up mark-up Unrelated toll Unrelated manufacturer principal RUB Introduction to International Taxation, Summer Term 2024 77  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Cost-Plus Method (3) Pros Cons Preferred method by OECD and Extensive requirements in terms of some fiscal authorities comparability of transaction Relatively easy to apply Hardly applicable particularly as external arm‘s length comparison due to the lack of available external data Comparability issues due to differences between accounting standards (e.g. HGB; IFRS; US- GAAP) RUB Introduction to International Taxation, Summer Term 2024 78  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Transactional Net Margin Method (1) Transfer prices are indirectly derived from a transactional arm‘s length (net) profit level indicator Typical profit level indicators are determined e.g. on the basis of net margins based on sales, costs, fixed assets or capital Limited functional profile of comparable companies (homogeneous) Typically publicly available financial data from databases applied Aggregation of single transactions regularly possible and required, respectively (e.g. sales of different products) → Only applicable to „routine companies“ RUB Introduction to International Taxation, Summer Term 2024 79  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Transactional Net Margin Method (2) Parent P&L statement Sales revenue - Cost of sales = Gross profit - Administrative and distribution expenses Profit on = Net profit (operating income) Profit on sales sales Comparable, Subsidiary independent (distribution) distributor RUB Introduction to International Taxation, Summer Term 2024 80  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Transactional Net Margin Method (3) Sales + 200 ® from budget/plan TP matrix TP1 TP2 TPn CoGS (Vol x TP) - 150 ® TP x Volume V1 V1·TP1 V1·TP2 V1·TPn V2 V2·TP1 V2·TP2 V2·TPn Gross Margin = 50 Vn Vn·TP1 Vn·TP2 Vn·TPn å 150 SGA - 44 ® from budget/plan EBIT = Target = 6 ® from benchmarking EBIT = [2% to 4%] Þ with sales = 200 absolute EBIT should range from 4 – 8 Sales RUB Introduction to International Taxation, Summer Term 2024 81  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Transactional Net Margin Method (4) Pros Cons Net profit indicators are less affected No preferred method by transactional differences It is necessary to examine the Net profit indicator can be influenced functions and risks for only one of the by some factors that would either not associated enterprises (the “tested have an effect on price or gross party”) margins between independent parties No significant influence of differences Identifying comparable entities with between accounting standards on net identical functions profit Data availability Information about functional profits of the tested party are necessary Relatively high compliance costs required (e.g. database search) RUB Introduction to International Taxation, Summer Term 2024 82  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Residual profit split (1) Two-stage approach: Routine functions/IP receive common market routine remuneration Residual profit is allocated according to proportion of non-routine IP Residual profit = overall profit – routine profits Identification of routine functions, such as Contract and routine research Production Distribution and marketing Administration / management Warranty services → Receive common market remuneration (e.g. on cost-plus basis; preferably on the basis of existing transfer pricing systems) RUB Introduction to International Taxation, Summer Term 2024 83  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Residual profit split (2) Non-routine IP: Process development IP Product development IP Allocation of the residual profit to related companies A and B relative to the relevant share in the non-routine IP E.g. based on accumulated R&D costs Probable weighting of relevant influence on the value (analysis of value drivers is required) RUB Introduction to International Taxation, Summer Term 2024 84  4. Aspects of Transfer Pricing 4.2 Economic Analysis and Transfer Pricing Methods Residual profit split (3) Sales revenue Routine Returns Residual Profit Allocation according to added Residual Profit A value contribution Residual Profit B Administration Distribution H y p A lt e r n a o th e t ic t iv e A p Production al A p rm ’ ro ach s Le : ngt Routine R&D h Te s t RUB Introduction to International Taxation, Summer Term 2024 85  4. Aspects of Transfer Pricing 4.3 Transfer Pricing Documentation — Comprehensive overview about — Aggregated (financial) group‘s business operations information per country (“blueprint”) — Report separate to Master und — Access for all relevant tax Local File authorities worldwide Country- — Access for all relevant tax — Annual review and update in by-Country authorities worldwide Master preparation for tax return Reporting File — Preparation within 12 month OECD after the fiscal year APPROACH Local File — Detailed information on significant — Access for local tax authorities transactions of legal entity — Finalization until filing of tax return — Addendum to Master File RUB Introduction to International Taxation, Summer Term 2024 87  4. Aspects of Transfer Pricing 4.3 Transfer Pricing Documentation CbyC R Name of the MNE group and fiscal year concerned: Revenues Profit Income Tax Tangible Assets Income Tax Tax Unrelated Related (Loss) Accrued – Stated Accumulated Number of other than Cash Total Paid (on Jurisdiction Party Party Before Current Capital Earnings Employees and Cash cash basis) Income Tax Year Equivalents Country A Country B Name of the MNE group and fiscal year concerned: Main business activity(ies) Provision of Services Holding or Managing Regulated Financial intellectual property Sales, Marketing or to unrelated parties Tax Holding shares or Support Services Manufacturing or Management or Administrative, Internal Group Jurisdiction of Purchasing or Development Procurement Research & other equity instruments Distribution Production Insurance Constituent Organisation or Services Dormant Finance Other Tax Entities resident Incorporation if Jurisdiction in the Tax different from Jurisdiction Tax Jurisdiction of Residence Country A Entity A Country B ü ü Entity B ü ü PE 1 ü Name of the MNE group and fiscal year concerned: Please include any further brief information or explanation you consider necessary or that would facilitate the understanding of the compulsory information provided in the Country-by-Country report. RUB Introduction to International Taxation, Summer Term 2024 88  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services OECD “Good Practice” Process 1) Determination of years to be covered 2) Broad-based analysis of taxpayer’s circumstances 3) Understanding the controlled transaction(s) under examination 4) Review of existing internal comparables, if any 5) Determination of available sources of information on external comparables 6) Selection of most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator 7) Identification of potential comparables 8) Determination of and making comparability adjustments where appropriate 9) Interpretation and use of data collected, determination of the arm’s length remuneration RUB Introduction to International Taxation, Summer Term 2024 89  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 90  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Services – Chapter VII OECD Guidelines MNE groups typically arrange for wide scope of services between its members Services in particular include administrative, technical, financial and commercial services (including management, coordination, control) Arrangements for charging intra-group services Direct-charge methods applicable especically if services are also rendered to independent parties (internal comparables), e.g. based on recorded work done Indirect-charge methods including cost allocations and cost apportionments based on estimations and approximations (e.g. turnover or staff employed as keys); should also give regard to value of the service to service recipient Arm’s length compensation should consider perspective of service provider as well as perspective of service recipient Often CUP or cost-based methods like cost plus or cost based TNMM to be employed RUB Introduction to International Taxation, Summer Term 2024 91  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 92  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Research (7.41 OECD Guidelines) Form of actual service arrangements may vary significantly: Detailed programs/work schedules prescribed by principal Researcher required to work in broadly defined categories only Relevance of DEMPE functions Detailed functional analysis required prior to deciding on the appropriate transfer pricing method Consider options realistically available to principal (e.g. costs of insourcing the research) RUB Introduction to International Taxation, Summer Term 2024 93  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 94  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Low Value-adding Services (7.47 OECD Guidelines) Elective, simplified cost-based approach provided by OECD Definition/features of low value-adding services: Supportive nature Not part of core business No unique and valuable intangibles involved or created Neither substantial or significant risks assumed or controlled by service provider nor created for service provider No low value-adding services: core business, R&D, manufacturing, purchasing, sales/marketing/distribution, financial transactions, natural resources, insurance, senior management Positive examples: accounting, processing accounts, HR, IT, PR, legal, tax, administration Actual costs of services to be pooled and allocated based on keys reflecting expected benefits; profit mark-up set at 5% of costs RUB Introduction to International Taxation, Summer Term 2024 95  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Commercial Databases Compilation of financial information filed/disclosed by companies and available in electronic format Not all information available for all countries as filing/disclosing requirements differ Databases should be used in an objective manner Use of databases should “not encourage quantity over quality” Improve database results with data from other publicly available sources Careful not to compare results of companies instead of transactions Use of non-domestic, e.g. regional comparables RUB Introduction to International Taxation, Summer Term 2024 96  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 97  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Transactional Net Margin Method Strengths Less affected by transactional differences and more tolerant to differences in functional profile General availability of external comparable data One-sided method, i.e. tests one party only Weaknesses Information may not be available at time of transaction (external comparables) Necessary segmentation of financial data may be complex One-sided nature of method may affect reliability Potential issues in triangular situations Net profit should directly or indirectly relate to controlled transaction and be of operating nature (e.g. no interest, no taxes); no distortion by other controlled transactions Typically fully loaded costs, including all direct and indirect costs RUB Introduction to International Taxation, Summer Term 2024 98  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Profit Level Indicator Net Cost Plus Net Cost Plus Mark-up is a financial ratio defined as operating profit over cost of goods sold (COGS) plus operating expenses (OPEX). Net cost plus mark−up = Operating P/L / (COGS+OPEX) Because of limited availability of financial data regarding costs and expenses, sum of OPEX and COGS is approximated by the difference between operating turnover and operating P/L: OPEX+COGS = Turnover−Operating P/L Profitability of comparable companies generally not constant over period of several years; can be affected e.g. by economic or product life cycles To prevent bias and to provide constant and robust results, the arm’s length ranges are calculated for a multiple year period using a weighted average RUB Introduction to International Taxation, Summer Term 2024 99  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Use of Interquartile Range Five OECD comparability factors include: Characteristics of the property or services transferred Functions performed by the parties (taking into account assets used and risks assumed) Contractual terms Economic circumstances Business strategies pursued by the parties As database benchmark analysis relies on available public information, not all comparability factors as specified by the OECD can be reviewed To acknowledge the limited comparability, an interquartile range is calculated, which reduces the likelihood of over- or underestimation RUB Introduction to International Taxation, Summer Term 2024 100  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Identification of Comparables OECD describes two approaches in principle: “Additive” approach, i.e. start from zero and add potential comparables to compile list “Deductive” approach, i.e. start from wide set of companies and reduce it to final list by rejection Typical criteria for selection/rejection of comparables include e.g.: Size in terms of e.g. sales, assets, number of employees Intangible-related criteria to indicate existence of valuable intangibles Size of inventory, if relevant Particular situations like start-up or bankrupcy Objective process should be transparent, systematic and reproducible/verifiable RUB Introduction to International Taxation, Summer Term 2024 101  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 102  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services RUB Introduction to International Taxation, Summer Term 2024 103  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Industry NACE Codes Transport 4910 to 5310 IT 6100 to 6312; 6399 Marketing and PR 1800 to 1820; 5800 to 6020; 7300 to 7320 Finance 6400 to 6630; 7700 to 7740; 8291 Legal 6910 Accounting 6920 Management 7000 to 7022 R&D 7100 to 7220; 7400 to 7490 HR 7810 to 7830; Backoffice 7900 to 7990; 8200 to 8230; 8299 RUB Introduction to International Taxation, Summer Term 2024 104  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Price Setting - not including companies with losses Quartile 2008 2009 2010 2011 2012 2013 2014 … 2020 2021 2022 Avg. 1st Quartile 2,0% 1,8% 1,7% 1,7% 1,6% 1,7% 1,9% 1,6% 1,3% 1,3% 1,7% Median 4,6% 4,2% 3,9% 3,9% 3,7% 3,8% 4,1% 5,0% 4,8% 4,9% 4,3% 3. Quartile 9,6% 8,9% 8,5% 8,3% 7,9% 8,0% 8,4% 12,7% 12,8% 12,6% 9,8% Counts 9.439 9.337 9.770 9.764 9.371 9.584 9.299 20.084 23.101 21.614 13.136 Price Testing - including companies with losses Quartile 2008 2009 2010 2011 2012 2013 2014 … 2020 2021 2022 Avg. 1st Quartile 1,3% 0,9% 1,0% 1,1% 0,7% 0,9% 1,2% 0,8% 1,3% 1,3% 1,1% Median 3,8% 3,3% 3,2% 3,2% 2,8% 3,0% 3,5% 4,1% 4,8% 4,9% 3,7% 3. Quartile 8,6% 7,7% 7,6% 7,4% 6,8% 7,1% 7,7% 11,2% 12,8% 12,6% 9,0% Counts 10.566 10.927 11.050 11.068 11.087 11.089 10.403 22.605 23101 21.614 14.351 RUB Introduction to International Taxation, Summer Term 2024 105  4. Aspects of Transfer Pricing 4.4 Applied Economic Analysis – Services Industry 1st Quartile Median Average 3rd Quartile Legal 3,2% 11,6% 18,6% 30,6% Accounting 3,1% 6,3% 9,7% 13,3% Finance 1,8% 5,7% 11,4% 13,9% R&D 2,6% 5,3% 7,7% 10,7% IT 2,7% 5,3% 7,6% 10,2% Management 1,2% 4,0% 7,3% 9,2% Marketing & PR 1,4% 3,8% 4,9% 6,9% HR 1,3% 2,5% 3,2% 4,6% Transport 1,0% 2,4% 3,6% 4,9% Backoffice 0,5% 1,8% 3,2% 4,3% Data f0r 2008 to 2014 RUB Introduction to International Taxation, Summer Term 2024 106  Structure 1. Economic aspects of cross border taxation 2. Double tax treaties 3. Tax law of the European Union 4. Aspects of transfer pricing 5. Controlled foreign companies 6. Current developments RUB Introduction to International Taxation, Summer Term 2024 107  5. Controlled Foreign Company Principles Foreign corporations are generally considered to be a separate taxable entity The shareholders of a foreign corporation are generally not taxable until they receive a distribution from their corporation → Domestic tax on foreign-source income can be deferred or postponed by establishing a foreign corporation; the deferral benefit is greatest if the foreign tax rate is low The advantage of this kind of tax planning is addressed by CFC rules loan Parent Subsidiary