On September 7, 2015, the local tax court of Cologne (the “Court”) issued an injunction against the German Federal Central Tax Office (“FCTO”) to prevent the FCTO from conducting a coordinated exchange of information with the E6 countries Canada, Great Britain, France, Australia and Japan, which aimed at gathering intelligence on companies of the digital economy to develop more efficient counter measures against BEPS strategies. The petition was filed by the German subsidiary (“Subsidiary”) of a Multinational Enterprise (“MNE”) in the digital economy (referred to by the Court as the “W-Group” or “W”). The Court held that the intended information exchange would violate the tax secrecy rule set forth in Section 30 of the General Tax Code. The decision emphasizes that the exchange of information is only permissible under the applicable Double Tax Treaty and/or the European Mutual Assistance Directive, if the information requested by the requesting state is “necessary” or “foreseeably relevant” to enforce existing taxation rights. The fact that the information to be exchanged could have been useful to develop counter measures against BEPS was deemed to be irrelevant.
In the context of the Base Erosion and Profit Shifting (“BEPS”) initiative of the OECD, the E6 countries Australia, Canada, France, Germany, Great Britain and Japan agreed in January 2014 to conduct a coordinated exchange of information on certain companies in the digital economy, their business models and their taxation.
Following the agreement reached in January 2014, the German tax administration began gathering information on certain digital economy companies with German operations – including the W-Group.
The ultimate parent of the W-Group (referred to as “W-Inc”) is based in the US and owns a direct/indirect subsidiary in Switzerland (referred to as “W-AG”). In addition, the W-Group operates with local subsidiaries in several European countries including Germany, the UK and Italy. The local subsidiaries are described as rendering sales support and marketing services to W-AG in return for a cost-plus service fee compensation. No specific information is revealed on the W-Group’s business model.
The Court decision quotes an internal report captioned “German Comments on the Case Profile of the W Group” (the “Case Profile”) according to which the transfer prices applied by the W-Group were found to be in the range of comparable companies. Moreover, the Case Profile confirmed that German tax field auditors had been unable to gather sufficient evidence to establish a “watertight” dependent agent permanent establishment finding under current double tax treaty law.
The Subsidiary of the W-Group was informed about the intended information exchange by way of an information letter (the “Information Letter”) in August 2014. The Information Letter explained that the German tax administration intended to conduct an information exchange with Australia, Canada, France, Great Britain and Japan in relation to the W-Group, and to this effect intended to share certain information on the W-Group including information on the corporate structure of the W-Group, the economic activities performed by the W-Group in Germany and the German taxation rights resulting from such activities. The Subsidiary’s request for copies of the requests of information of the requesting states was denied. Moreover, neither the FCTO nor the local tax office of the Subsidiary agreed to provide specific details on the information to be exchanged.
In a subsequent letter dated May 2015 the Subsidiary was provided with further background information on the purpose of the coordinated information exchange. The letter stated that MNEs in the digital economy had come under the general suspicion of shifting profits and eroding local market jurisdiction tax bases. The letter did, however, not set out any facts or circumstances specific to W or the W-Group suggesting that any country (including Germany) would be able to re-assess W or any affiliate of W (including the Subsidiary) on the basis of the current law in effect.
Upon the petition for an injunction filed by the Subsidiary in May 2015, the Court decided that the contemplated information exchange would violate the German tax secrecy. In short, the German tax secrecy rule prevents German tax officials from sharing tax relevant information on taxpayers with other authorities (and/or the public), unless statute explicitly permits such information exchange. The FCTO argued that the intended information exchange was permissible on the basis of the information exchange clauses in the applicable Double Tax Treaties (“DTT”) and/or the European Mutual Assistance Directive (“EMAD”). Both the DTT and the EMAD information exchange clauses require, however, that there is “cause” for the information exchange. While the various conventions use different wording to describe when there is “cause” for an information exchange, the bottom line is that the exchange of information is only permitted if the information is “necessary” or “foreseeably relevant” for carrying out the provisions of the convention or to the administration or enforcement of the domestic laws concerning taxes.
The Court held that there was no “cause” for the information exchange in the case at issue, since the FCTO had failed to demonstrate that the information requested by the requesting states was “necessary” or “foreseeably relevant” to enforce any existing taxation rights. The fact that the information to be exchanged could have been useful to develop counter measures against BEPS and to create new taxation rights was not deemed to be sufficient.
It is noteworthy that the Court did not admit an appeal against its injunction on the basis that its decision rested on generally accepted legal principles. That said, the decision of the Court on the injunction should be viewed as being final and non-appealable. However, it is to be noted that an injunction is a provisional measure to preserve the status quo. The final decision on the permissibility of the intended information exchange will only be made in the main action.
The decision of the local tax court of Cologne strengthens the rights of German taxpayers in mutual assistance procedures on the exchange of information. The decision emphasizes that the exchange of information is only permissible if the information requested by the requesting state is “necessary” or “foreseeably relevant” to enforce existing taxation rights. The decision also underlines that the burden of proof on whether the requirements for information exchange are met is on the tax authorities of the assisting state. General allegations or speculations do not suffice. The instrument of information exchange is not to be viewed by tax authorities as a handy tool to gather general information on taxpayers, their corporate structures, their business models and their (effective) taxation in local market jurisdictions.