Germany The courts ruled that there is a hidden capital contribution because of the corporation-shareholder relationship of a third party(nonshareholder). Here, the court applied the prudent business manager standard. The nonshareholder would not have agreed to the conditions of the transaction if the nonshareholder had dealt with the com In the case of a hidden capital contribution, the income of the parties to the trans action must be adjusted accordingly. This adjustment takes place on the recipient side, reducing the income. The adjustment takes place on the side of the parent company, increasing the asset for the investment in the subsidiary and the income It is important to note that only tangible or intangible property can be subject to a contribution. The use of property or the rendering of services to the company is not within the scope of the provision (d) Section 1 of the Foreign Tax Code According to section 1 of the German Foreign Tax Code, the income of a tax payer is increased if such income was diminished in the course of a business rela- tion with a related party abroad. The income of the taxpayer is increased if the terms and conditions of the transaction deviate from those that an unrelated party would have agreed to under the same or similar circumstances. In such a case, the income should be increased to a level that is commensurate with third-party con ditions. This section of the Foreign Tax Code is the only provision in German tax law that explicitly mentions the arms length standard The intention of section 1 of the German Foreign Tax Code was to expand do mestic law to enable the tax administration to increase the income of a domestic taxpayer for all non-arms length transactions. In this context it should be noted that section 1 of the Foreign Tax Code can be used only to increase domestic in come(e.g, German parent gives royalty-free license to a subsidiary). This prov sion cannot be applied to reduce a taxpayer's German income(e. g. foreign parent gives royalty-free license to German subsidiary) In practice, this reduction provision plays a minor role since section l of the ge man Foreign Tax Code states that the rules for hidden profit distribution and rules for hidden capital contribution take precedent. Most cases covered by the provi sion deal with problems that do not apply to the rules for a hidden capital contri bution. Examples of such situations include where the benefit received by a foreign subsidiary does not constitute tangible or intangible property or where the defini- tion of a related party is broader than under the provisions dealing with hidden profit distribution or hidden capital contribution See Corporation Tax Regulations, 8 36a, Federal Tax Court, February 28, 1956, BStB1 III 1956, p. 154: Fed eral Tax Court, October 26, 1987, BStB1. II 1988, p. 348 1See Wassermeyer, in: Flick/Wassermeyer/Baumhoff(eds), Aussensteuevrecht, 6th ed, Cologne:Schmidt 1999,31 AStG, n. 76; Kroppen/Ltibker, ITPJ 1999, P 33
24.3 Relevant Principles to Derive the Arm's Length Price 24-7 (e) Article 9 of the Tax Treaties Germany has an extensive treaty network with more than 70 countries. Germany has agreed to the use of the arm,s length principle in virtually all its tax treaties. The tax treaties are not directly applicable to the taxpayers as such, but the treaty provisions have to be converted into federal law. Therefore, once the statutes have been enacted, the tax treaties principally have the same legal equality as domestic gislation Since treaty law is lex specialis to domestic law, it is argued that article 9 of a tax treaty limits the application of domestic tax law. The tax administration seem ingly expressed a different view in the administrative principles. According to sec- tion 1. 2. 1. of the administrative principles, the allocation provisions of german tax law also remain applicable in those cases of related interest that are not covered by he allocation provisions of the tax treaties The administrative principles argue that it would be inconsistent with the sense and purpose of the tax treaties if the treaty prevented income adjustments required by the particular case. However, if this view was correct, article 9 would have no legal effect, since domestic law would govern the rules on how to allo- cate the income. Obviously, this approach would circumvent the intention of the tax treaties 24.3 RELEVANT PRINCIPLES TO DERIVE THE ARMS LENGTH PRICE (a) Comparability Analysis The comparison of transactions between related and unrelated parties is the cor- nerstone for applying the arms length standard. It is critical for the comparison that the transactions between related and unrelated parties be generated under the same or similar conditions. All factors affecting the transfer price should therefore be taken into consideration(e. g, functions, risks, contractual terms, markets). Dif- ferences may influence the prices between related and unrelated transactions. In OECD Guidelines and the U.S. Regulations ag that event, it is necessary to adjust the prices accordingly. The administrative prin ciples basically give a wide variety of possible factors that might require an ad- justment. The German view is very similar to the comparability standards under the However, in practice, it is often decisive to what extent the tax authorities be- lieve that adjustments are necessary and how such adjustments can be made This analytical process often results in the application of different methods across te Schaumburg, Internationales Steuerrecht, Pp, 25 ff Sicker, in: Debatin/Wassermeyer, Doppelbesteuerung, article 9 MA, n, 185 ff. Kroppen, in: Becker/Kroppen, le verrechnungspreise, n. w13 ff. 20 See OECD Guidelines 55 1.15-1.35; U.S. Regulations, 5 1.482-1(d)