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Claus Staringer and Lars Glãser, Freshfields Bruckhaus Deringer, Vienna
By reference to local legal or regulatory provisions, administrative practices, results of tax audits or case law, please comment on the likelihood of, and scope for local challenges, and possible legal defences, in respect of:
• prolonged losses
• low margins
• “wrongly characterised” arrangements
• uncommercial arrangements that should be disregarded.
The awareness of TP issues has always been present within the Austrian tax administration. Nevertheless, in recent years, practitioners are observing that TP has developed into a topic of high priority in Austria. In addition to the applicability of the OECD Transfer Pricing Guidelines (OECD-TPG), the Austrian Ministry of Finance published its opinion on several TP issues in the Austrian Transfer Pricing Guidelines 2010 (Verrechnungspreisrichtlinien 2010; VPR 2010). The recently published OECD report on Base Erosion and Profit Shifting (BEPS) will likely contribute to such development as the OECD discussion draft on special considerations for intangibles did. For taxpayers, these developments increase the likelihood of challenges regarding transfer pricing planning arrangements.
The Austrian tax administration generally follows the principles outlined by the OECD. Further, the Austrian Ministry of Finance published its opinion on several transfer pricing issues in the VPR 2010. Therefore, although these publications do not have legally binding effect in Austria, a taxpayer will be well advised to follow such guidelines in order to reduce the risk of transfer pricing challenges. As to a concrete fact situation, a taxpayer may seek additional certainty by obtaining answers via the Express Answer Service of the Austrian Ministry of Finance, the conclusion of Advance Pricing Arrangements or by participating in the horizontal monitoring project of the Austrian tax administration.
Austrian taxpayers may request an expert opinion from the Austrian Ministry of Finance within the “Express Answer Service” (EAS) reflecting the Ministry's general position in relation to international tax cases, including, inter alia, transfer pricing issues. From a legal perspective, although such expert opinions are not binding, they are subject to the principle of utmost good faith (Treu und Glauben) and in practice obeyed by the tax offices. EAS are published on the website of the Austrian Ministry of Finance.1
Besides the above described EAS, as from January 1, 2011, pursuant to Section 118 Austrian Fiscal Code (Bundesabgabenordnung; BAO), taxpayers are legally entitled to request a binding ruling from the tax office regarding, inter alia, transfer pricing issues. The application for such ruling has to comprise a comprehensive description of the facts which are not realised at the moment of the application, a statement regarding the specific interest of the taxpayer in such ruling, the formulation of a precise legal question and a reasoned opinion regarding the formulated legal question. Further, the request has to include the administrative fee the taxpayer is obliged to pay for the ruling, which depends on the taxpayer's turnover in the twelve months preceding the last balance sheet date and is between €1,500.00 and €20,000.00. The tax ruling (Bescheid) of the tax office has to comprise the facts considered relevant for the tax assessment, the legal assessment, the legal provisions taken as a basis for such assessment, the taxes or assessments and periods the tax ruling applies to and the extent of reporting obligations for the taxpayer, in particular, whether and when the facts where realised or in how far the realised facts deviated from the ruling request.
Horizontal monitoring is a rather new development in Austrian tax compliance that allows for a real time co-operation between the taxpayer and the tax authorities. Legal basis for horizontal monitoring is to be found in Sections 143 and 144 BAO, as well as in Sections 147 et seq BAO. Horizontal monitoring aims at eliminating or reducing cost- and time-intense tax audits by discussing and solving tax issues at the moment when they arise and not years later during the auditing process. In a best-case scenario all tax issues are accorded with the authorities. In Austria, a pilot project in horizontal monitoring commenced in 2011. Every Austrian enterprise is eligible to participate in the pilot project and upon acceptance into the project must disclose its internal tax control system which is the basis for future co-operation. The description of the internal control system should include a description of how critical tax issues are dealt with internally as well as an overview of ongoing tax litigation, APAs, group guidelines and transfer pricing guidelines. Based upon the information disclosed in the internal control system, the horizontal monitoring process identifies critical issues which are then to be monitored and audited in close co-operation.
Austrian tax law does not contain specific provisions regarding transfer pricing issues. In general, Austrian transfer pricing is based on the arm's length principle. The content of this principle is not regulated in detail by Austrian domestic law, but primarily based on the international concept of the arm's length principle as developed by the OECD and in tax treaties. There is practical relevance of the OECD-TPG and the Austrian VPR 2010, which set forth the administrative practice in Austria and explicitly refer to the OECD Transfer Pricing Guidelines as well. Furthermore, it should be noted that Austrian tax authorities generally follow a “dynamic” approach as to OECD work. Therefore, transfer pricing work carried out by the OECD since 1996 is also considered relevant. The interpretation by the Austrian tax administration is, in most cases, in line with the reports of the OECD.
Considering base erosion and profit shifting, transfer pricing issues in connection with intangible property are of particular importance as the association of profits with intangible rights principally allows for a legally accepted shift of risks within multinational groups of companies.
Although the Austrian VPR 2010 do not put specific restrictions on transfer pricing planning involving intangible property in place, they describe in general terms how income from intangible property, such as royalties,2 intangibles and business restructurings3 and the attribution of intangible property to permanent establishments4 is to be dealt with for Austrian transfer pricing purposes. In general terms, although the special character of certain intangibles may complicate the search for comparables and may make it difficult to determine the value at the time of the first transaction, the arm's length principle pertains equally to the determination of transfer pricing involving intangible property and the same valuation methods are utilised.
However, a specific restriction on the transfer of intangible property which was acquired free of charge can be found in Section 6 paragraph 6 of the Austrian Income Tax Act (Einkommensteuergesetz; EStG). According to this provision, the transfer of business assets to the enterprise of the same taxpayer in another state is generally viewed as a taxable alienation with the sales price having to meet the arm's length criterion (“exit tax”). If the transfer is conducted to an EU-Member State, the tax is calculated but not assessed. As far as the transfer of intangible property previously acquired free of charge is concerned, the tax deductible expenses form the assessment basis for the “exit tax”. If the taxpayer fails to disclose the actual expenses, 65 percent of the arm's length price or, at the most, the recorded value of the asset abroad are the tax basis.
Another restriction on the transfer of intangible property may be seen in the concept of economic ownership (Wirtschaftliches Eigentum upon which the allocation of payments (income) and expenses in connection with intangible property (or, for that matter, any asset) is based. Applying this concept, the tax authorities may deem a legally valid transaction in which intangible assets are transferred irrelevant for tax purposes if economic ownership has not been transferred.
The transfer of risk is a sensible issue from the perspective of BEPS as profit potential may be shifted rather easily under intra-group contractual arrangements. Again, Austrian tax law does not contain specific provisions regarding transfer pricing issues in connection with risk transfer. However, arrangements involving cross border redeployment of functions, assets and/or risks are covered by individual tax rulings (EAS) and general guidelines issued by the Austrian Ministry of Finance, as well as the VPR 2010 which deal with business restructurings and the thereby possibly occurring risk transfers. In general, the examination of the allocation of functions and, therefore, risks between related parties starts from the review of the contractual terms. However, according to para 54 of the Austrian VPR 2010, the tax treatment in line with such documentation is subject to the functions and risks being allocated accordingly in economic reality. Therefore, a sole analysis of the contractual situation is not sufficient. It is rather necessary to examine whether the parties conform to the terms of the contracts. This basically corresponds to the principle of aligning the economic substance of a transaction with its contractual terms, as laid down in paras 21 et seq of the OECD study on “Transfer Pricing Aspects of Business Restructurings” (OECD-TPBR) and paras 1.26 and 1.28-1.29 of the OECD-TPG. Therefore, the transfer of functions and risks does not only have to be documented but must also reflect economic reality. According to the Austrian Ministry of Finance, special care has to be taken if the double tax treaty with the country the functions/risks were transferred to provides for the exemption method and, therefore, leads to a saving of Austrian income tax. If functions and risks are transferred to such countries, the function analysis has to demonstrate that the receiving entity is able to fulfil such functions, i.e. the number of employees effectively working in the receiving entity, the duties such employees effectively fulfil and whether they are sufficiently qualified to do so.
Although the arm's length principle does not require compensation for loss of profit/loss potential per se, a company with considerable rights and/or other assets at the time of the restructuring must be appropriately remunerated in order to justify the sacrifice of a loss of profit potential. In this respect an analysis of functions and risks before and after a restructuring is necessary to determine the amount of compensation the transferring company is entitled to receive and which group companies are obliged to pay such remuneration. As the arm's length principle does not apply to a group of companies as such but to the single group unit, it makes no difference in this respect as to whether or not the transfer of risks was necessary from a group perspective. The remuneration rather has to compensate the loss of profit potential of the single group unit. Further, the fact that not only profit potential but also loss potential was transferred to the receiving entity does not discharge this entity from its compensation obligation if the overall expectation would be a decrease of profit of the transferring entity.
The Austrian VPR 2010 do not deal with the transfer of high value functions in particular but refer to the consequences of transfers of functions in general, e.g. in the course of business restructurings. According to para 129 of the Austrian draft VPR 2010, a transfer of functions generally appears in the following forms:
• Change in distribution structure: full-fledged distributors are converted into limited risk distributors or commissionaires;
• Change in production structure: full-fledged manufacturers are converted into contract-manufacturers;
• Rationalisation of operations: Restructuring of business operations within concentration and specialisation of operations;
• IP-companies: Transfers of intangible property rights to a central entity (so called Intellectual Property Companies).
The Austrian VPR 2010 deal with some of these scenarios in more detail. If, for instance, a full-fledged distributor is converted into a limited risk distributor or commissionaire, it is important to examine whether the distributor has developed local marketing intangibles over the years preceding the business restructuring and, if so, what the nature and the value of these intangibles is. If it is found that the activities carried out before the restructuring led the full-fledged distributor to own some intangibles while the long-established limited risk distributor does not, the arm's length principle may require these intangibles either to be remunerated upon the restructuring if they are transferred by the full-fledged distributor to a foreign related party, or to be taken into account in the determination of the arm's length remuneration of the post-restructuring activities if they are not transferred.5 If a full-fledged manufacturer is converted into a contract manufacturer, it has to be examined whether know-how is transferred to another entity the development of which was tax deductible in Austria. Such an intangible would need to be taken into account in the determination of an arm's length compensation payment from the receiving entity to the transferring entity.6 If, due to a business restructuring, the manufacturing process is transferred to a third party acting as a contract-manufacturer resident in a low-wage country, the cost savings have to be attributed to the transferring entity, not the third party manufacturer.7 If an Austrian entity should voluntarily terminate a contract that provided benefits to it in order to allow a foreign related party to enter into a similar contract and benefit from the profit potential attached to it, the foreign entity is obliged to compensate the Austrian entity for the received business opportunities, regardless of a corresponding contractual obligation.8
The Austrian VPR 2010 stipulate that cross-border intra-group financing has to follow the general rules on transfer pricing as set out in the VPR 2010 and the OECD-TPG and restrictions can only be derived from these general rules. Specifically, the comparable uncontrolled price method (CUP) has to be preferred over other methods in establishing an arm's length interest rate if comparable transactions between unrelated parties take place on the financial and equity market. However, a solid comparability between intra-group transactions and transactions involving commercial banks can never be established since the entrepreneurial goals of a commercial bank and therefore its pricing method differ from those of other groups of companies. The debt interest rate of commercial banks forms one restriction insofar as it constitutes the upper limit for the determination of an arm's length interest rate in intra-group financing. On the other hand a credit interest rate may be used where the financing entity disposes of enough liquidity. These rules apply regardless of whether the financing is routed through a financing entity in a “tax haven” or elsewhere, however, in case of suspected profit shifting abroad, documentation and disclosure requirements are stricter.
Further, Austrian national tax law includes in the Corporate Income Tax Act (Körperschaftsteuergesetz; KStG)a rule9 which can be viewed as a restriction on transfer pricing planning involving cross-border financing. In general this rule allows for the deduction of interest incurred in connection with the acquisition of shareholdings qualifying for the participation exemption under Section 10 KStG: However, this provision denies deductibility of interest payments in intra-group transactions where the acquisition of shares by a directly or indirectly related enterprise, or, directly or indirectly controlling shareholder is debt-financed.
Austrian tax law does not provide for explicit rules on thin-capitalisation. An introduction of such provisions was briefly discussed in 2010/2011 but so far not implemented. However, on a case by case-basis Austrian administrative practice and the Supreme Administrative Court (Verwaltungsgerichtshof; VwGH) have developed arm's length debt-equity-ratios up to which the deduction of interest has been accepted. These ratios are not definite and serve only as a guideline. In many cases, a ratio of 3:1 (debt to equity) is applied.
Further, in case of exceptional circumstances Austrian tax authorities may re-characterise shareholder loans into hidden equity contributions. Based on the jurisprudence of the Austrian VwGH such re-characterisation should only be admissible if the corporation is in a financial crisis and the shareholder should - from an economic point of view - provide equity rather than granting a shareholder loan. Such loan has the mere purpose of avoiding any liability of the shareholder if the corporation enters into liquidation. Examples of such exceptional circumstances which might justify such re-characterisation of shareholder loans into equity are for instance:
• an inadequacy between the equity capital and the long term financing requirements,
• an equity rate which is considerably lower than the industrial sector's average,
• the company's inability to raise debt financing with non-shareholders, or
• specific conditions of the loan (e.g. profit participation).
If a shareholder loan is to be re-characterised into equity capital by Austrian tax authorities, interest payments by the lender will not be tax deductible and will be regarded as constructive dividends to the borrower (shareholder).
Austrian tax law does not provide for CFC rules as such (i.e. no taxation of income not effectively distributed or due) nor does it include any anti-base erosion rules.
Anti-hybrid rules are, inter alia, considered as suitable to fight base erosion and profit shifting. In this respect, for instance, Section 10, para 7 KStG denies the tax exemption for inbound dividends which would generally qualify for the international participation exemption of Section 10 KStG if the dividend payments are tax deductible in the state of source. This rule aims at avoiding double non-taxation caused by differing entity/cash-flow classifications.
Tax planning in Austria is limited by the application of general anti-avoidance rules contained in Sections 22 and 23 BAO. Such provisions have to be taken into consideration in any tax planning structure including transfer pricing scenarios.
Section 22 BAO provides for a general anti-abuse provision under which taxation cannot be avoided or reduced or tax benefits be achieved by means of an abuse of structural concepts under civil law. Representatives of the Austrian tax authorities and the majority of rulings of the VwGH consider the provision to apply if the chosen legal structure is unusual and inappropriate to achieve the desired economic effect, if the reason of the structure may only be found in the intention to achieve tax advantages and no good commercial or other bona fide reason underlies the chosen structure. Further, Section 23 BAO stipulates that sham deals are to be disregarded for tax purposes and that general civil or criminal law principles (such as prohibitions, principle of morality, legal personality and capacity to act, contestability of a legal transaction) are generally not applied to facts of a tax case.
We are not aware that the answers given above would be different in a scenario where an internet-based business was involved. Implications for that sector have to be found in the general principles outlined above.
Claus Staringer is a Principal Consultant and Lars Glãser is an Associate at Freshfields Bruckhaus Deringer's Vienna office. They may be contacted at:
2 See VPR 2010, para 102 et seq.
3 See VPR 2010, para 129 et seq.
4 See VPR 2010, para 189 et seq.
5 See VPR 2010, para 139.
6 See VPR 2010, para 140.
7 See VPR 2010, para 143.
8 See VPR 2010, para 141.
9 See Section 11, para 1, subsection 4 KStG.
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