Part 1 - AL-Tax

Chapter 7function features (cf. Paragraph 3.4.10.3b – second dash). The argument there isthat the functional and risk profiles differ significantly between the tested-partyand third-party companies, which might be considered as comparable quantities.Hence, at best, database-driven margin analysis can support plausibility argumentsof arm’s length analysis. The Administrative Principles assume (in Paragraph3.4.10.2c) that the ordinary and prudent businessman of a hybrid company calculatesarm’s length prices by means of budget planning calculations (Paragraph3.4.12.6a) and, if the plan is not met during any given financial year on the basisof continuous budget-actual assessments, the prudent businessman is expectedto react with internal measures such as sales price adaptation, purchase pricerenegotiation, cost cutting, etc. The Administrative Principles 2005 do not ruleon any standardized approach of arm’s length analysis which will be audited bythe tax auditor. They rather guide the tax auditor in such a way that classicaldatabase-driven margin analysis alone is not sufficient to document arm’s lengthtransfer pricing behavior in the case of hybrid company types.Rather, budget planning combined with budget-actual assessments and profitforecasts (including investment calculations) are the appropriate arm’s lengthanalysis for hybrid units (Paragraph 3.4.12.6). In particular, long-term loss situationsand restructuring activities require this approach. For example, the taxpayerhas to indicate by means of such analysis that a loss in the start-up years or anyloss-making period is offset by a total period profit. Transfers of market penetrationcosts from the sales unit to the manufacturing unit would be arm’s length, ifthe manufacturing unit also benefits at, or after, the break-even point. Hence, whatdeems a certain transfer pricing situation at arm’s length is the demonstration thatthe businessman seeks to generate profit (‘intention to realize profit’).7.5.3 ‘Entrepreneur’ and allocation of residualsAs indicated above, a test on arm’s length behavior in transfer pricing is economicallyweak – not sound – if the tested party represents an ‘entrepreneur’ unit,especially if such a test is based on comparison with a third party. Rather, theentrepreneurial unit’s profit is a residual: The entrepreneur receives the remainingpart after meeting the contractual obligations on remuneration. It is this logicwhich needs to be reflected in the documentation of arm’s length profit of entrepreneurialrelated-party taxpayers.For arm’s length assessment, it is decisive that the residual can be positive ornegative. In line with the Administrative Principles 2005, we propose that thedocumentation of the arm’s length nature of a residual profit or loss situation for165