The EU Joint Transfer Pricing Forum (EUJTP) issued a report on compensating adjustments (EUJTP Report) in January 2014 that provides practical solutions for year end-adjustments in the EU. The issue of whether a taxpayer is required to comply with the arm’s length principle at the time an intragroup transaction was undertaken based on information available at that time (arm’s length price setting approach) or whether it is sufficient that the actual outcome of the controlled transactions complies with the arm’s length principle (arm’s length outcome testing approach) is controversial both within the OECD and the EU.
On the issue of year-end adjustments, the EU member states agreed in the EUJTP Report that (i) the profits of related enterprises with respect to the commercial or financial relations between them should be calculated symmetrically, i.e. enterprises participating in a transaction should use the same price for the transaction, and (ii) a compensating adjustment initiated by a taxpayer should be accepted if the requirements listed below are met. Thus, if the EU member states involved have less prescriptive rules on compensating adjustments, those rules apply. However, the report does not encourage EU member states to introduce more requirements for compensating adjustments than currently apply. The requirements are as follows:
- Before the relevant transaction or series of transactions, the taxpayer made reasonable efforts to achieve an arm’s length outcome.
- The taxpayer makes the adjustment symmetrically in the accounts in both EU member states involved.
- The taxpayer applies the same approach consistently over time.
- The taxpayer makes the adjustment before closing the books or at the time the tax return is filed.
- The taxpayer can explain why its forecast did not match the result achieved if so required under the domestic legislation in at least one of the EU member states involved.
German tax law and transfer pricing rules follow a formal approach to year-end adjustments and do not allow the application of the arm’s length outcome testing approach. The German tax authorities traditionally have been critical of year-end transfer pricing adjustments and generally allow them only in limited cases and provided special conditions are satisfied (e.g. the year-end adjustments must be made based on clear and unambiguous rules agreed on in advance).
The EUJTP Report appears to ease the strict German requirements on year-end adjustments because the report seems to accept such adjustments provided they are made before the books are closed or the tax return filed. However, considering German GAAP rules, such a broad interpretation of the EUJTP Report appears doubtful. Under German GAAP, year-end adjustments can be considered and reflected in the relevant financial year only if the parties agreed before the end of the relevant financial year on the circumstances for which a year-end adjustment could be made, i.e. the final calculation of the year-end adjustment may be made only until the books are closed. Therefore, year-end adjustments based on agreements made after the end of the year but before the books are closed still may be challenged by the German tax authorities.
Source: Deloitte Tax News.
