Germany: Fed Tax Court rules on Article 9 of the OECD Model Tax Agreement

Tax Controversy & Dispute Resolution ()

In its judgment of October, 11 2012 (I R 75/12) the German Federal Tax Court had to address the issue of the German Tax Authority arguing the disallowance of intercompany charges, under German domestic tax law, in cases where no formal agreement is in place between the parties prior to the transaction taking place. The German Tax Authority has historically disallowed intercompany costs in this situation, even when the value of the goods or services meets the arm’s length principle.

The Court held in favour of the taxpayer, that in the case of associated enterprises, the arm’s length principle as set out in a double taxation convention (according to Article 9 Section 2 OECD Model Tax Agreement, reflected in Article 6 Section 1 Double Tax Convention between The Netherlands and Germany – the Double Tax Convention under review in this case) provides a block against the German tax Authority using the conditions of Section 8 Paragraph 3 Sentence 2 of the German Corporation Tax Act (“GCTA”) to argue for a disallowance of intercompany charges.

As a consequence, German tax authorities may not challenge the deductibility of business expenses (i.e., adjust income correspondingly) purely because these expenses are based on a contractual agreement that does not fulfil certain formal requirements (for example, is non-ambiguous and agreed upon in advance).