Germany vs “Z Pipeline": Transfer Pricing Disputes in Multinational Operations

Case Information

Court: FG Düsseldorf
Case No: 3 K 1940/17 F
Applicant: Z Pipeline
Defendant: German Tax Authorities
Judgment Date: May 12, 2023

Judgment Summary

The FG Düsseldorf judgment of May 12, 2023, revolves around the transfer pricing dispute of a multinational enterprise operating a pipeline network across Germany, Belgium, and the Netherlands. The court found that the defendant’s method of profit allocation did not align with the arm’s length principle and violated the existing double taxation treaties. The judgment emphasized the necessity for proper profit allocation that reflects the actual economic activities and risks undertaken by different parts of a multinational enterprise.

Key Points of the Judgment:

Background

The applicant, a limited partnership founded in 1968, operates a pipeline network through Germany, Belgium, and the Netherlands. This network facilitates the transport of goods and provides management services for third-party pipelines. The applicant’s pipeline system spans multiple countries, making the allocation of profits between these jurisdictions a significant issue.

Core Dispute

The core dispute focused on how the profits from operating the pipeline network should be divided among Germany, Belgium, and the Netherlands. The tax office in Germany allocated the majority of the profits to Germany using the cost-plus method, arguing that the critical functions and risks were managed from the German headquarters. The applicant contested this allocation, arguing that the allocation did not reflect the actual economic activities and proposed a different method based on the usage of the pipeline network.

Court Findings

The court ruled in favour of the applicant, stating that the tax office’s method did not adhere to the arm’s length principle as required by the double taxation treaties with Belgium and the Netherlands. The court found that the profits should be allocated based on the economic activities performed in each country, including the usage of the pipeline network in those countries. The court emphasized the need for a profit allocation method that accurately reflects each permanent establishment’s functions, risks, and assets.

Outcome

The court amended the tax assessment 2011, significantly reducing the domestic income allocated to Germany and increasing the tax-exempt income allocated to Belgium and the Netherlands. The defendant was also ordered to bear the costs of the proceedings.

TP Method Used

The tax office employed the cost-plus method, which allocates profits based on the costs incurred and a markup. However, the court found this method inappropriate for the case, as it did not adequately reflect the actual economic contributions of the permanent establishments in Belgium and the Netherlands.

Major Issues or Areas of Contention

Allocation of Profits: The main issue was how profits should be allocated across different jurisdictions, particularly given each country’s differing economic activities and risks.
Application of the Arm’s Length Principle: The court critiqued the defendant’s application of the arm’s length principle, emphasizing that it did not consider the revenue generated by the pipeline network in each jurisdiction.
Interpretation of Double Taxation Treaties: Another significant area of contention was the interpretation of the double taxation treaties with Belgium and the Netherlands.

Was This Decision Expected or Controversial?

This decision was somewhat expected, given the emphasis on accurate profit allocation in line with the arm’s length principle. However, it highlighted the complexities and potential for controversy in interpreting double taxation treaties and applying transfer pricing rules, especially in cross-border operations with significant immovable assets.

Significance for Multinationals

The judgment underscores the importance for multinational enterprises (MNEs) to ensure that their transfer pricing practices accurately reflect the economic activities performed in each jurisdiction. Failure to do so can lead to significant tax disputes and reallocation of profits, as seen in this case.

Significance for Revenue Services

For revenue authorities, this judgment reinforces the need to rigorously apply the arm’s length principle and ensure that profit allocations reflect actual economic activity and risk-taking in each jurisdiction. The case also highlights the importance of clear and consistent application of double taxation treaties.

Importance of Engaging with Transfer Pricing Experts

This case illustrates the critical importance of engaging with transfer pricing experts. Such experts can help MNEs navigate complex international tax laws, develop compliant transfer pricing strategies, and avoid costly disputes with tax authorities. Proper documentation and expert advice can be invaluable in defending against challenges from tax authorities and ensuring that transfer pricing arrangements are robust and defendable.

How a Case Like This Could Be Avoided or Better Managed

A case like this could be better managed or even avoided through proactive tax risk management strategies, including:

Implementing a Tax Risk Management Process: Establishing clear processes to identify, assess, and mitigate tax risks across jurisdictions.
Forming a Tax Steering Committee: A tax steering committee can provide oversight and ensure that transfer pricing policies align with the business’s operations and comply with local and international tax laws. Click here to download our exclusive (FREE) eBook: “The Essential Role of a Tax Steering Committee.”
Regular Transfer Pricing Audits: Conduct regular audits to ensure that transfer pricing practices align with the arm’s length principle and that documentation is up-to-date.

By taking these preventative measures, MNEs can significantly reduce the risk of transfer pricing disputes and ensure smoother tax compliance across multiple jurisdictions.